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Testimony of the 108th Congress

FCS Role in Agriculture Lending

Prepared Remarks of John Evans Jr.
House Agriculture Subcommittee
Conservation, Credit, Rural Development & Research
September 29, 2004

Thank you, Chairman Lucas and Congressman Holden for conducting this hearing today to examine the Farm Credit System's role in agriculture lending and whether and how FCS Associations should be allowed to leave the System. These are two very important issues and we appreciate the opportunity to testify before this subcommittee.

ICBA Members - Serving Agriculture & Rural Communities

I am the President of the Chief Executive Officer of the D.L. Evans Bank in Burley, Idaho. I'm also Chairman of ICBA's Agriculture-Rural America Committee. Our bank is very involved in agricultural lending.

75 percent of ICBA member banks are located in small communities of under 10,000 population and our members have a long-standing interest in providing credit to American agriculture and our rural communities. ICBA is the only national trade organization that exclusively represents the interests of our nation's community banks.

Scope of Today's Hearing & Banker Survey Views

The subcommittee is asking two very important questions in regards to today's hearing. As you know, the recent announcement of an agreement by a large foreign co-operative bank to purchase FCSAmerica (FCSA) has generated a lot of discussion both inside and outside of the System. This development has also raised a number of complex questions not only in terms of exiting the System, but also in terms of the role of the FCS in lending to agriculture.

Community bankers have had numerous ongoing concerns with what they rightly recognize as unfair competitive advantages and questionable lending activities of the System. These unfair competitive advantages have long ago outlived their initially intended purpose and we believe a restructuring of the System is long overdue. The FCS is the only GSE that competes against the private sector at the retail level using tax and funding advantages not available to commercial lenders. This is far different from the housing related GSEs, which provide a secondary market and liquidity function to the private sector.

When this proposed acquisition was announced on July 30th, ICBA issued a press release raising several issues discussed below. We also surveyed bankers in the four states that would be directly impacted by the acquisition as well as bankers in surrounding states since the proposed acquisition would also be the basis of expanding the new entity's lending into other states.

We received several hundred responses to our survey for a response rate of approximately 20 percent. Due to the large number of responses, the final tabulation of results is still underway, but we will highlight some of their comments in our testimony. Our survey focused on three key issues including the proposed purchase of FCSA; whether banks have adequate access to funding sources; and recommendations to Congress regarding the System's role in serving agriculture.

Issues Regarding Exiting the Farm Credit System

FCS Inconsistency - National Policies or Local Board Decision Making?

Since one issue the subcommittee is looking at is the role of the System in serving agriculture, we want to first point out several inconsistencies by System representatives on the proposed acquisition of FCSA because these inconsistencies by FCS officials relate to important policy changes now under consideration. When the proposed purchase was announced, several FCS spokesmen quickly denounced the purchase agreement and questioned whether this development would be in the best interests of farmers.

We'd like to point out that the decision to exit the FCS was made by the Board of Directors of the FCSA. However, just last June, System representatives had the audacity to lobby the FCA requesting expanded scope and eligibility authorities so FCS entities could make loans to individuals who have little relation to agriculture and for loan purposes completely unrelated to agriculture. In fact, FCS representatives suggested to their regulator that the FCA should remove itself from oversight of the System's scope and eligibility (who they can lend to and for what purposes) activities. They stated that national regulations are not appropriate to address local and regional needs across the country. Instead, System representatives suggested that the boards of directors of FCS associations should be allowed to make these decisions.

FCS representatives made statements such as these:

"Agriculture, the structure of farming, and the other financing needs of operators are too diverse for one policy to be set in McLean that will make sense nationwide."

"We suggest that it be left to the boards of directors of System institutions to establish their lending policies."

"FCS boards should have the flexibility to determine how best to serve agriculture and rural areas . . . Being made up of farmers from the area served, an Association's board of directors is elected because they understand the local agricultural environment."

"Speaking as a System owner, remember that each System institution remains governed by an elected board of directors. These boards set the policies that guide the activities of these institutions. Our focus is on making sure agriculture is served. We are perfectly capable of keeping the System focused on serving farmers, ranchers and all of modern agriculture."

"A second fact that needs to be remembered is that all FCS entities are directed and controlled by farmer customers. Service to any market segment is carried out under board policy direction with regular reporting on results. These farmer board members are uniquely positioned to know just what their marketplace needs to meet the System's mission."

In fact, in past years when the System has lobbied for expanded powers, they have often said that their local boards of directors would not allow the associations to adopt decisions and pursue strategies that are not in the best interests of their farmer owners.

And yet, when an FCS board of directors made a decision to exit the System, the FCS's lobbying arm in Washington D.C. quickly announced that this decision was not in the best interest of farmers and would "fundamentally hurt" farmers.

We suggest you can't have it both ways. You can't say on one hand, "Leave everything up to our local boards of directors because decisions handed down from Washington aren't suitable for the diversity of needs that exist across rural America." And then on the other hand say, "Our Washington-based lobbying group has determined that this decision made by the Association's local board of directors is inappropriate and must be forever stopped."

Outside Investors Taking Over Farmer-Owned Cooperatives?

A second example of the System's self-serving inconsistency is the contradiction raised by the CoBank proposal requesting new authorities to lend to entities that form as Limited Liability Corporations (LLCs) that have both a producer and investor class where the producer class would have as little as 50 percent voting control. Under this arrangement, the outside investor could easily take control over this new style of LLC "cooperative".

But in the case of FCSA, their cooperative has 100% farmer voting control! And yet, the System's representatives strongly oppose the proposed sale and allowing it to go to a vote of the farmer owners. Why is the System supporting legislation to potentially allow every other cooperative in the U.S. to be on the chopping block except for its own? If a cooperative with 100 percent farmer voting control should not be allowed to vote on its termination, as FCS officials opposed to the FCSA sale are arguing, then what does that say about a structure where farmers have only 50 percent farmer voting control? It says that Congress should be very careful and concerned about how any LLC-farm cooperative legislative proposal is drafted and also about outside investors taking control of farmer cooperatives.

Exiting the FCS - Some General Banker Views

The first survey question we asked bankers was whether they favored or opposed the proposed purchase of FCSA. While there is a mix of opinions, a majority of bankers favored the proposed purchase. Bankers recognized that the new entity would pay taxes on all of its lending income, unlike the FCS, which is exempt from paying taxes on real estate income, exempt from paying sales taxes and exempt from various state and local taxes.

Following are some sample survey comments of bankers:

"FCS just cherry picks the best customers with their tax-favored pricing!"

"It's all about funding. Right now I cannot compete against FCS due to their ability to fund loans with interest rates lower than I can obtain. Rabobank on the other hand is a tax paying entity which would level the playing field for us."

"We feel that we can compete with any bank on a level playing field."

"Taxpayer subsidized lenders are always more difficult to compete with than a private company in a free market."

Some bankers felt the proposed sale indicates that the marketplace is suggesting it doesn't need the System in its current form. They pointed out that in today's lending environment there are a multitude of lenders providing credit and services to farmers. There are several thousand community banks heavily involved in serving agriculture, approximately 2,500 banks are "ag banks" as defined by the Federal Reserve. Other types of lenders serving agriculture include the finance arms of seed, feed, equipment and chemical companies as well as mortgage companies and life insurance companies, the latter of which also make real estate loans. Without question, there are many more credit providers for agriculture than when the System was formed in 1916.

Some bankers did express some concerns regarding the whether the new FCSA entity would be regulated as strictly as state or national banks are regulated.

In terms of those bankers who had concerns about the proposed purchase, a basic issue is the prospect of having another competitor that would be buying a large book of business that was built up over many years using GSE tax and funding advantages. Thus, community banks would have a major new competitor with residual GSE advantages as well as having another GSE being re-established in the same area. The residual GSE advantages also include the lending infrastructure that has been built up over many years - buildings, staff, loan officers and operational expertise and extensive databases.

Recommendations for Exiting the FCS

The Farm Credit Act (Sections 7.10 & 7.11) does allow its individual institutions to exit the System under very detailed procedures which include: approval by the association's board of directors; approval by the federal regulator, approval by the association's stockholders, procedures for a revote of any approval by stockholders; imposition of a significant exit fee paid to the FCS insurance fund; and re-chartering of other FCS associations to serve the abandoned area. This combination of procedures makes it pretty tough to leave the System.

We offer several thoughts for your consideration of whether and how an institution should be allowed to exit the System, keeping in mind the already cumbersome procedures mentioned above. In general, we would not be overly concerned about an FCS association that seeks to voluntarily leave the System on its own for purposes of converting to a state or nationally chartered commercial bank. A commercial bank entity would pay taxes and have strict regulations to comply with.

In 1991 the California Livestock Production Credit Association exited the FCS and became Stockman's Bank which is in operation today. Exiting the System would allow an existing FCS association to keep itself intact; otherwise the only option may be for that association to be merged into a larger FCS association. Merger removes the localized service and decision-making that the FCS association offered and leads to the further concentration of financial assets.

Where a distinction could be made is between the termination of an FCS entity on its own for the purpose of converting to a commercial bank versus the purchase of an FCS entity by an outside investor. Purchase by an outside investor could allow a large company with access to worldwide funding sources a ready-made regional lending infrastructure. In this instance, community banks that concentrate on agricultural lending in the affected states would compete with both the lending prowess of a former GSE and a newly re-chartered GSE. The benefits afforded would include, as mentioned above, the residual GSE benefits that the entity was allowed to develop through years of GSE subsidies afforded to FCS institutions. And, as mentioned above, this issue raises the overall question of whether farmer co-operatives should be allowed to be taken over by outside investors.

One serious fault in the current termination process is that the exiting association pays a fee to the FCS insurance fund. We believe that the exit fee should be directed to the U.S. treasury. The FCS insurance fund will no longer be insuring against losses of the assets of the exiting FCS entity and the entity's assets were built up over time due to GSE benefits that are ultimately backed up by taxpayers.

Bankers made comments similar to these:

  • "If you sell your house, do you have to pay the insurance company a fee?"
  • "Instead of Rabobank paying the exit fee to the FCA, the fee should be paid to the U.S. Treasury because taxpayers of this nation have subsidized the profits that allowed FCS entities to build the capital they have over the years. We the people, through our government, bailed out the entire Farm Credit System throughout the 1980's while small, rural ag banks were allowed to fail in staggering numbers, ruining many communities."

We also do not believe that the territory being exited needs to be covered through the re-chartering of an existing FCS institution. The FCA could simply designate neighboring FCS entities to be eligible to engage in agricultural lending through loan participations with community banks. This would allow FCS to quickly have an ongoing presence in the territory while working through commercial lenders and would be a "win-win" for all parties.

We want to stress that we'll continue to look at this issue during the upcoming months as part of our policy development process.

The Role of the FCS in Serving Agriculture

Community Banks Are the Ones Serving Agriculture in Good Times and Bad

The System likes to suggest to Congress that the FCS is needed to ensure that American agriculture has a competitive, stable source of credit in good times and bad. This is disingenuous. When tough times occurred in agriculture in the mid-1980's, tens of thousands of borrowers were turned away from the System, which received a federal bailout, while hundreds of community banks were allowed to fail. During those difficult times, it was the community banks that picked up the System's discarded borrowers. It was the community banks that were there for farmers in good times as well as bad, not the FCS. We also point out that community banks must meet the lending needs of their communities to keep their local economies strong and vibrant in order for the bank to survive. Community banks do not fold up the tent and leave town in a bad economy, because they are permanent members of their local communities.

Regulator Aided Mission Creep

Frustration has been expressed by many bankers because of the clear mission creep of the FCS. The System was originally formed to serve agriculture because the market lacked a mechanism to finance long-term, fixed-rate real estate loans. In recent years bankers have witnessed the expansion of the FCS into agricultural business lending that was already well-served by commercial banks and other areas.

The frustration of bankers over this expansion and the cherry picking activities of the FCS is further exacerbated by the System's regulator, which often proposes regulatory expansions of FCS lending activities. For example, recent or pending proposals or decisions include:

  • Scope and Eligibility proposal that would allow unlimited lending to anyone for non-agricultural purposes even if the borrower has only a tangential involvement in agriculture.
  • Development of broad new lending programs under the guise of "investment" authorities, e.g. farmer notes proposal.
  • Preferred stock proposal which has deposit-like features allowing FCS entities to compete for deposits with community banks.
  • Allowance of illegal activities by institutions if using "excess capacity in good faith".

It is important to point out that such actions by the FCA have a direct bearing, not only on FCS institutions, but also on all lenders involved in the rural credit markets, including thousands of community banks across the country.

Looking at Agriculture's Competitive Landscape

Further expansion of what is supposed to be a limited purpose GSE to one that competes against the private sector by providing retail banking products and services to all rural residents will diminish the ability of community banks to serve agriculture and rural communities, resulting in fewer credit choices for rural residents.

We believe that a fundamental question before this committee is how to best ensure a competitive playing field in the agricultural marketplace. A constant complaints from bankers is that the System engages in cherry picking of their best customers. Generally the customers the FCS is going after are the prime or best customers in community bankers' portfolio.

This allows the System to concentrate their efforts on the top one-third of the most profitable farmers and those with the highest equity positions. The System does this because the top one-third of farmers is a very low credit risk and they generally do not require much of the lender's time. Bankers have noticed that the bottom one-third of farmers will not qualify for FCS loans. They have low equity positions and struggle with cash flows most years. They pose the greatest credit risk, yet they need financing and it's often by community banks. When defaults occur, the liquidation of their assets to cover the indebtedness is often problematic. Losses frequently occur. These situations take much more of the lenders' time and decreases productivity.

This leaves the middle one-third of farmers for FCS to pick over. These farmers generally have more marginal balance sheets and cash flows than the top tier producers. A great deal of time must be committed to the evaluation of the financial reports and management ability of these producers. There is a higher degree of total risk for these farmers compared to the top one-third.

Obviously, the tax benefits of the FCS are a major competitive advantage that enables this cherry picking. Some questions bankers raise are: 1) Since the average size of FCS lenders now approaches $1 billion, do multi-billion dollar FCS lenders really need tax advantages to compete with $50, $100, or $250 million community banks?; 2) If the customer is supposedly the ultimate beneficiary of such policies, then why not make the tax advantages available to all lenders?; and 3) If the FCS is using these tax advantages to cherry pick the best customers from community banks - what are they doing to actually earn their GSE advantages?

When the FCS raids the portfolios of community banks, it can cause some community banks to question whether it is worthwhile to serve only those producers in the bottom to medium equity positions. If community banks aren't able to effectively compete for the top one-third of producers, then the quality of their overall portfolio declines and this can raise questions among bank examiners as to why the bank is so heavily involved in the riskier ag loans.

Over time, this can reduce the number of banks serving specialized agricultural markets, whether it is dairy producers, hog producers, fruit and vegetable producers or others. Ultimately, this suggests fewer choices of credit for producers and less competition if commercial lenders are forced out of the marketplace because they can't compete against the subsidized lending of the FCS. When FCS obtains expanded authorities, these types of problems are only exacerbated.

What Was the Intent? - An Important Question

Was the real goal of Congress when it created the FCS in 1916 was to eventually drive community banks out of the agricultural credit market? Was the goal also to allow for the ongoing expansion of the FCS into virtually all the key functions of commercial banks? We really doubt that these were the intentions, but this appears to be what is occurring.

Bankers expressed very strong opinions on this issue, e.g.:

  • "As a small community bank with an FCS office in town we have lost most of our prime ag credits to them. We can't compete with the terms and interest rates they offer. If they are allowed to offer the same products as us, small town banks will be a thing of the past!"
  • "We feel we can compete with banks (that is those who pay taxes) but we can not compete when others don't pay taxes."
  • "Our ag portfolio used to be above 30% of the bank's loans. FCS and the ag economy have reduced that to about 10% over the last 15 years."

Is it in the best interests of rural America to have commercial banks driven out of their marketplace due to unfair competition, thus ensuring fewer credit choices for farmers and ranchers? You can't have it both ways. Community banks aren't always going to be able to serve agriculture if they can't effectively compete against the subsidized tax and funding advantages of the FCS.

FCS - Tear Down That Wall!

Therefore, we believe that if Congress wants to do what is best for rural America, it should look at opening up the funding window of the FCS to community banks. The current unlevel playing field is one reason why bankers have sought to at least have equal access to the FCS funding window as FCS associations. This would provide community banks engaged in agricultural lending a long-term funding source and would ensure the FCS functions as a wholesale supplier of credit to community banks as Congress has long envisioned.

The wholesale funding function is a key role that GSEs play in the financial markets. This was the intention of the Other Financial Institutions (OFI) provisions that are in the Farm Credit Act. Unfortunately, these statutory provisions were last changed in 1981, almost a quarter of a century ago, and do not allow for access to long-term, fixed-rate funds.

Bankers felt very strongly about the need to access more funding sources:

  • "The FCS competition issue in my area is dramatic. With continued consolidation of farms, below market interest rates make it difficult to retain customers. Also, liquidity in rural areas is very tight with no foreseeable improvement in the future. Access to other reasonable funding sources is critical for community banks to survive."
  • "If community banks enjoyed the same tax & funding advantages as FCS, competition for these loans would increase dramatically & Rabobank would less likely want to compete in this market."
  • "Banks have access to FCS utilizing the OFI funding from FCS. However, OFIs are looked upon as a bastard child of the system and not treated equally. If FCS was forced to treat OFIs the same as its own retail lenders then banks would have a reasonable source of funding for ag purposes."
  • "FHLB funding for small business and ag loans is available but is very limited based on the criteria set by each FHLB. We have some credit advances using this as collateral but it is no where near the source of funding we thought it would be when we joined the FHLB."
  • "Although FHLB has a process for accepting ag loans as collateral, in practice they are not too interested in this area."
  • "Sources of funding will become very important in the future due to the decline of population in rural areas. This decline is further impacted by the passing away of elderly depositors, the primary source of funding for banks. A majority of heirs reside in metropolitan areas and funds migrate to where they live."
  • "Community Banks should be able to access low rate FCS funding."
  • "While the FHLB funding is beneficial, it isn't geared towards agricultural lending. The hope would be that FSC funding would be more 'user friendly' for agriculture."
  • "If my bank has the same funding source as FCS then the playing field is equal as far as funding goes. I still have a tax issue to be dealt with."
  • "Population decline in rural areas is drying up local deposits as a source of funding."
  • "FHLB amortized fixed rate loans are limited to 15 year terms - would like the ability to lock in a longer term at a competitive fixed rate."
  • "We need to take advantage of the capital markets using FCS's GSE status to decrease funding costs. The FHLB long term advances are not competitive with what FCS can fund their loans for."
  • "We need a dependable long term source of funds at favorable rates to do the best job possible in managing our entire portfolios. Too many times, investment brokers are pilfering our deposit base making liquidity a problem. The typical deposit custumer today stays short with their deposits not exceeding 24 months while the ag borrowers are very interesting in longer term fixed rate borrowing. This makes for an extreme interest rate risk that we should be able to better manage."
  • "I believe it to be prudent to have diversified sources of wholesale funding as we are relying on that side more and more. This reliance will increase in the future."
  • "FCS understands agriculture. FHLB understands housing. These two are not the same and should be served by the entity created for that purpose. FCS should adopt a wholesaler's function for money instead of its retailer position."
  • "Our rural areas are growing slowly in money available for deposits. For example, in my county in Wisconsin, deposits grew by only 2% in 2003. If we as a bank are going to make funding available to build a better rural America we can not rely on local CD money only. We need to have access to the same bond funding sources as the FCS."
  • "Community banks need all the funding sources they can find. Seasonality of borrowings and deposits make multiple funding sources a necessity, especially when the alternatives may be high-priced deposits in national markets where our name recognition is minimal."

These are just a few sample comments from bankers in many farm states. Their emphasis on funding is consistent with congressional intent in the Farm Credit Act - to allow community banks greater access to funding sources to better serve their rural borrowers.

A Common Sense Approach

Non banker organizations also recognize the important of rural community banks accessing FCS funds to enable banks to maintain a competitive presence in rural areas. For example, The Center for Rural Affairs made several of the same points mentioned above in their September newsletter, stating:

"The (FCS) banks were initially created with federal money (since repaid) and to this day enjoy competitive advantages over local rural banks. System banks are tax exempt and the Feds back the bonds issued to raise money to loan to farmers. But Farm Credit Services of Omaha has not always used those advantages in the interest of all of agriculture.

"It (FCSA) has positioned itself as a leading financier of industrial agriculture. It has financed some of the biggest corporate hog operations and has a reputation for cherry picking the biggest and most lucrative farm borrowers. Congress should examine the aggressive focus of Farm Credit Services on industrial agriculture and explore new avenues for ensuring adequate credit availability to the rest of agriculture.

"Congress should (also) enhance competition in agricultural lending by enabling locally-owned community banks to also raise money for farm loans through government-backed Farm Credit System bonds - not just Farm Credit banks. That would enable local banks to be more competitive. It would prevent government backing from being used by Farm Credit System banks to build a dominant position in farm lending only to be turned over to an international conglomerate. (Emphasis added)

Conclusion

Mr. Chairman, thanks for the opportunity to testify today. We appreciate your committee looking at some of the complex issues surrounding these topics. Last year the House Agriculture Committee held a hearing on the issue of whether outside investors should be able to invest in farmer owned cooperatives. A member of Congress expressed his concern that our rural communities are dying and its time to try to work together on ways to help the survival of our rural communities.

There are differing views on the prospects of rural America's future. Its population is aging and will only grow older. Young people are leaving. Deposits are being drained away. Community banks have competition on every side from a variety of lenders and companies providing credit. At the same time, we have a predatory lender called the Farm Credit System, which is using its tax and funding advantages to cherry pick the best customers from the portfolios of community banks, weakening their long-term ability to serve agriculture. That cannot be good policy in the eyes of this committee if you want to lay the foundation to create a better future for rural America.

It is time, as Ronald Reagan said in challenging the outmoded isolationism of the Soviet Union's division between East and West Germany, to "Tear Down That Wall!" The FCS currently has built a wall around the ability of others to access its funding window for the betterment of rural America. At the same time the FCS wants to get all the powers it can to act like community banks while denying funding to community banks.

Expanding FCS direct lending powers diminishes the tax base of our rural communities. This makes it harder to fund schools, roads, and other vital infrastructure and services necessary to keep our rural communities viable. If Congress does not reign in the expansionist agenda of the FCS then the long term survival of many community banks and many communities may be jeopardized. We are certainly willing to try and work together with the System, but currently this is a one-way street in favor of the System.

We look forward to working with your committee to further address these issues. We appreciate the opportunity to share our views today and the views of many community banks who responded to questions we raised in our survey on these key issues. Thank you.

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