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Testimony of the 107th Congress
Senate Agriculture Committee
February 26th, 2001
Thank you. Senator Lugar and Senator Harkin, we appreciate the Senate Agriculture committee's interest in conducting this timely hearing today. My name is Dale Leighty, and I currently serve as the Vice Chairman of ICBA's Agriculture-Rural America Committee and I am also the President of the First National Bank of Las Animas in Las Animas, Colorado. Ours is an $80 million asset bank and with approximately $60 million in loans, most of which are agricultural credits. Our town has 2,500 people and our county has 5,500 residents.
Mr. Chairman, the ICBA, with two-thirds of our member banks located in small communities of under 10,000 population, has a long standing interest in ensuring credit availability to our nation's farmers, small businessmen and women and other credit consumers in our nation's rural communities.
ICBA is the only national trade organization that exclusively represents the interests of our nation's community banks, representing 5,300 institutions at more than 17,000 locations nationwide. Community banks are independently owned and operated and are characterized by attention to customer service, lower fees and small business, agricultural and consumer lending. ICBA members hold nearly $486 billion in insured deposits, $592 billion in assets and more than $355 billion in loans for consumers, small businesses and farms in the communities they serve. Our member banks employ 239,000 citizens in the communities they serve.
We Agree With Many in the FCS - National Charters Are Bad Public Policy
Mr. Chairman, the old perception that bankers and the Farm Credit System can't agree on anything is not true. We agree with the many Farm Credit Associations who are opposed to this proposal. Since none of these institutions are at today's hearing, I ask that the sample letters I have brought along be placed into the hearing record. My testimony today will emphasize some of these many points of agreement that we share with these FCS associations in opposition to removing geographical boundaries and allowing intra-system competition within this GSE - the only GSE that would have such an arrangement.
The opposing FCS associations expressed concerns that this new direction is a dramatic change in the FCS that would benefit only the large FCS lenders. They argue it would hurt the cooperative nature of the FCS and undermine service to family farmers. They further argue it is simply a way for large FCS associations, that had not adequately serviced their existing geographical territories, to cherry-pick the best loans away from other lenders.
In fact, one Farm Credit System association wrote that in their Farm Credit District a survey showed "that more than a majority of the associations are opposed to the 'National Charter' approach.” Also, based on contacts their management had with association representatives across the country, quote, "we find support is 'luke warm' and only exists at all primarily due to the belief that this is the only approach which FCA will support."
FCA withdrew the proposal without explanation when it was labeled "customer choice". FCA subsequently developed a national charter booklet, then attempted to adopt national charters without a public comment period and even now wants to allow only a 30 day public comment period. Clearly the evidence is this proposal has not been embraced enthusiastically except by a few and it has generated many concerns and questions.
What are some of the points of our agreement with FCS institutions on why National Charters are bad public policy? The bottom line for both banks and many FCS institutions, based on their written comments, is that there are much simpler, much easier, less disruptive and less painful ways to achieve the same objectives. That FCA doesn't embrace these simpler, less disruptive solutions, suggests the stated objectives are not the primary objectives for this proposal, which greatly concerns us.
One initial point to consider is that there is little, if any, need for this proposal. In fact, I would like to submit for the record the arguments proponents of national charters have stated - all of them you will see refuted by FCS associations themselves!
Let me summarize a partial list of concerns:
Not a Customer Choice Issue
When this proposal was originally presented by FCA a couple years ago it was labeled "customer choice". The argument then for removing geographical boundaries was supposedly that large farm customers, with operations in more than one state, were prevented for shopping for their choice of FCS lenders. This was not true then nor is it true now. As pointed out by FCS associations, FCS associations typically grant concurrence for such loans routinely and many have reciprocal territory concurrence agreements in place which ensures the customer has lender choices.
Not a Diversification Issue
As of late, the most often cited argument made by proponents is that the proposal will allow the System to reduce risks by being able to diversify across territories and across commodities. But the System can already do this through loan participations. Participations are loan sharing arrangements where the association originating the loan can share in the profits (or losses) of the shared loans with another association. These participations can be done anywhere in the U.S. and have the added advantage of relying on the local association's knowledge of the customer base and various risk factors inherent in that particular geographic region.
Relying on loan participations would be far less risky and far less disruptive than causing the loss of many local lenders from serving agriculture.
In addition, the USDA has loan guarantee programs and Farmer Mac has a secondary market program to purchase loans. Both of these are in place to help lenders reduce risks. Yet, USDA economists report that FCS has not utilized the USDA loan guarantee programs to serve beginning, socially disadvantaged or higher risk farmers anywhere near the level that commercial banks have. I ask that this attachment also be entered into the hearing record.
The bottom line is that there are already several mechanisms in place to reduce risks for System lenders. It appears, however, that they are not utilizing these programs. This raises the question Mr. Chairman, why adopt this proposal when FCS institutions are currently underutilizing existing risk reduction mechanisms?
Will Increase - Not Decrease - Safety and Soundness Risks
FCA and other proponents argue the proposal will, due to greater diversity of loan portfolios and territories, reduce safety and soundness risks. At the same time, proponents completely ignore other risks that result from venturing into unfamiliar geographic areas and lending on commodities and in climates where they have little, if any, previous lending experience.
An important question is why it makes sense for associations to compete when competing associations are jointly and severally liable for each other's failures?
The board of one FCA association wrote they had "concerns about how the FCA would maintain safety and soundness control of the lending and operational risks the System entities might pursue. These risks could develop to such a scope and scale as to trigger losses that would impact the remainder of the System institutions."
Another association wrote, "Agriculture can be very volatile and one needs to understand the borrower's operation in order to understand the risks. We have seen too often where the efforts to build an agriculture loan portfolio by offering low market rates or easy credit terms and conditions have led to problem loans, risky portfolios and failed farming operations."
Another FCS association representative wrote, "I firmly believe we should not put our capital at risk by venturing into areas or industries where we do not have the resources or expertise to properly service the business." Yet another FCS association wrote, "Internal competition cannot be policed by FCA or the System itself and may well lead to the System's failure, rather than guaranteeing its success. (Emphasis added)"
Another FCS association representative wrote, "Better rates and better terms, etc., will only occur if one of the competing System entities is willing to earn less than the market would dictate. Therefore, we are extremely uneasy with the proposal to engage in a free-for-all among System institutions in this extremely competitive environment. In our opinion, this is a classic safety and soundness issue, which puts member investment in System institutions at risk."
Further, FCA has stated that risks will be controlled through FCA examinations and their authority to correct deficiencies. But the FCA only conducts examinations of institutions once every 18 months and no longer requires prior approval of new product offerings. It does little good to shut the gate once the cows have gotten out.
In fact, one FCS association wrote, "We are convinced of the following: the safety and soundness risks of the proposed intra-System competition are being totally ignored." Another wrote, "We do not believe that the Farm Credit Administration has the ability to regulate Associations with nation-wide charters; and, will lead to Safety and Soundness concerns when Associations start lending in areas in which they have little expertise."
Will HURT - Not Help - Family Farmers
FCA has stated that this proposal will help family farmers. In fact, they have said it will help all family farmers. Really? Not according to the many FCS associations who feel forced to apply for national charters to remain on the same competitive playing field as their FCS brethern. These associations believe, and we concur, that more profitable farmers in more profitable geographic areas will be targeted because the smaller loans will not be viewed as cost efficient. In fact, they have pointed out that in those territories where there is already limited overchartering of FCS territories this is precisely what is NOW occurring.
Some of their comments are:
"Open competition may cause FCS to only serve more profitable geographic areas or commodities and avoid areas that are not as profitable or desirable."
"Intra-system competition is for only large loans - Associations are only interested in soliciting large out-of-territory loans that have adequate volume to cover the extra expense of handling and will contribute towards association efficiency (cost per dollar loaned). There will not be any competition for the smaller loans, as they are not cost efficient."
"We conclude that the principal reason for the new philosophy is to create the necessity for associations to merge. We do not believe such mergers will improve service to our customers."
"Competition for the large loans will result in reduced interest rate spreads for these loans, and an offsetting increase on small and marginal loans."
"Even with the LSA requirements (Emphasis added), a likely result over time will be for associations to place less emphasis and focus on smaller, less profitable loans in marginal agricultural areas, and increase efforts in areas with stronger agriculture and larger, more profitable loans."
"There is no valid argument that supports the claim that a competing association is going to seek to expand their young, beginning, small and minority program outside their local service territory (LSA). No, the loans being sought will be only the large, high quality accounts ("cherry picking")."
"Please re-consider this philosophy statement and see it's negative impact to agricultural borrowers. Who will finance the young farmers of tomorrow? Someone down the street might, but no one across the nation is going to give the first consideration. All of us will go after the same operators and when the holes in financing agriculture develop, we will be too fragmented to fix. Let's please look at alternatives for the customer's sake, not for the sake of District banks or associations."
"Unfortunately, the removal of boundaries could result in fewer Associations due to intra-System competition and therefore, lead to higher interest rates over time (emphasis added). Obviously, this would not be beneficial for our customers."
"The basis for opposition centers primarily on the possibility that the small and/or marginal customers the system is to serve will be adversely affected by the proposal."
"Young, beginning, small and minority customers will be underserved in the rush to compete for larger, more profitable loans. This would be in direct conflict with congressional intent and FCA's own regulations."
Mr. Chairman, it is inconceivable that Congress wants to provide less help and poorer service to family farmers. But both sets of perspectives - that of the FCA and other supporters and that of FCS associations opposed to this proposal - can't be correct. They are mutually exclusive viewpoints. We are not simply speculating here - it is a matter of basic economics. Family farmers will not be targeted by out of territory lenders under this proposal because it will cost more to underwrite, service and monitor loans that could be many states away from the originating lender.
They certainly won't be going after the less viable credits. The ultimate consequence of this isn't better service, it's the potential for fewer credit choices and poorer service. To be viable, local lenders must be able to lend to a broad cross section of constituents in their market. They can't be profitable lending only to the marginal or less profitable customers. But this is a prospect that many local lenders, including both local banks and local FCS associations, would face since the large, aggressive FCS lenders would engage in predatory pricing to snatch away the better farm loans.
FCA has shown little interest in policing predatory pricing tactics, another concern raised by both bankers and FCS associations and FCA is not implementing any new safeguards or oversight mechanisms in this area.
Local Service Area (LSA) Plans Are Insufficient To Guarantee Service to Family Farmers
The FCA has suggested that they would be able to guarantee, through LSA plans, that FCS lenders would continue to service their local territories before venturing into new territories and that this will ensure the new policy targets family farmers. But the LSAs are totally inadequate for several reasons. Let me mention a few of these reasons.
First, FCA does not require any targeting of young, beginning, socially disadvantaged or family farmers by the lenders venturing into new lending areas. So the focus on out of territory lending is totally geared to large credits. There are no requirements, no portfolio goals for example, that struggling family farmers be the primary objective for venturing into new territories.
Second, the policy does nothing to increase service to these market segments - young, beginning, socially disadvantaged or family farmers - within existing territories by the "local" FCS lender. It only requires a plan be in place but provides no criteria for the plan, meaning “business as usual”. The new policy allows the associations to "self-assess" themselves as part of their application and report on how good of a job they feel they are doing in their local service areas. This amounts to self-assessment and self policing of their ongoing activities. Commercial lenders have to comply with much more stringent Community Reinvestment Act (CRA) requirements upon which they are examined, graded on and held accountable to transparent and public scrutiny. There are also no requirements for increased use of the USDA guaranteed farm loan programs, for example. So we will see no improvement in the current situation in which bankers often complain that FCS associations ignore the higher risk credits and use their GSE tax and funding advantages to go after larger credits in their existing markets. Only self-assessments and self-evaluation.
Third, there are no portfolio limitations on the amount of lending activities the associations can do outside of their territories. So if an FCS association is currently only marginally effective in serving its existing LSA, it could under this plan suggest it is doing a fine job in its LSA and commit a large portion of its resources to pursuing large credit deals in other areas. How much of their portfolios would FCS institutions be required to commit to the LSA under FCA's proposal? 95%? 90%? 80%? 70%? 60%? 50%? 40%? It's undefined and not even required in this proposal, so no one knows.
Fourth, these liberal LSAs will inevitably weaken even further over time as associations merge, causing confusion. LSAs will inevitably cover larger and larger geographic regions making them anything but "local". They certainly won't provide the local lending presence and local community presence that community banks provide. Plus, if an FCS association closes shop, what happens to its LSA? Will there no longer be any association obligated to serve the failed association’s LSA?
Fifth, there is no requirement that the non-LSA FCS lenders be required to make a financial commitment to the community where they are seeking loans from. This will erode community involvement and community support from the LSA lender who will divert resources to fight the incoming competition from non-LSA lenders. Local communities will suffer. Rural communities will suffer.
Sixth, LSAs are not sufficient to keep FCS focused on its public policy mission. The System continually uses the banner titled "modernization" when it pushes for new powers. There has been quite a bit of "modernizing" within the FCS lately as evidenced by all of the new regulatory policies we've seen over the past few years. I want to emphasize that the System has been quite profitable as it is currently structured - generating over $1 billion in annual net profits for the past decade.
Since other GSEs have social obligations, I suggest its time to "modernize" the System by mandating certain financial and/or portfolio obligations aimed at targeting young, beginning, socially disadvantaged and family farmers. Congress could mandate a certain, significant, percentage of FCS associations' loan portfolios or profits be committed to beginning farmers or socially disadvantaged farmers, for example. This could be a benefit to these market segments that may actually have the greatest need in American agriculture and would truly be a "modernization" that serves a valuable social purpose – a fundamental reason GSEs exist.
Will Allow Predatory Pricing
Supporters in the FCS have suggested that this proposal will increase competition, which they suggest is the basis of banker complaints about the proposal. The latter is completely untrue as the supporters know. What they don't tell you is that the only increased competition will be for the largest credits and the only way to get these larger credits is to underprice the market - to engage in predatory pricing.
Let me emphasize this - The booklet establishes no new monitoring and oversight mechanisms in regards to monitoring for predatory pricing even though considerable concern was expressed over this issue by FCS institutions. Section 12 U.S.C. 2001 Section 1.1 of the Farm Credit Act, which states what the Congressional policies and objectives for FCS activities are concludes with this language:
“Provided, that in no case is any borrower to be charged a rate of interest that is below competitive market rates for similar loans made by private lenders to borrowers of equivalent credit-worthiness and access to alternative credit.”
Yet, FCA does not provide regulatory controls in this area to accompany their regulatory proposals which they always justify using Section 1.1 of the Act. There is nothing in this proposal to guard against large, aggressive FCS lenders engaging in predatory pricing. And this is an area of FCA regulations that has gotten little or no attention. It leads us to conclude this section of the Act may need legislative changes to require enforcement of these provisions. FCA should be conducting periodic surveys of FCS and competitors’ rates and making them available for public scrutiny.
No Legitimate Economic, Cost-Benefit or Needs Analysis Has Been Conducted
FCA has admitted that they have not conducted a formal economic, cost-benefit or needs analysis of the impact of this proposal. With such dramatic changes possible and likely, one would think that would be required of FCA. All the FCA has said is that it has conducted various discussions and briefings. Mr. Chairman, the FCA certainly never contacted any community bankers to discuss needs, trends or how to better serve our rural communities.
Contrary to suggestions that the Treasury Department has somehow been involved in or endorsed the move towards removal of territorial boundaries within the FCS, I point out that is not the case. In a November 30, 2000 letter Treasury sent a letter to FCA Chairman Reyna making the following comments:
"First, we believe the proposal would reduce the focus of Farm Credit System associations focusing on serving all eligible borrowers in their local areas and diminish the System's local cooperative structure. Second, while not directly expanding the lending powers of the Farm Credit System associations, the proposal would likely allow a government-advantaged competitor to increase market share, which in the long term could effect competitiveness in agricultural credit markets . . . We have not undertaken a formal legal review of the charter proposal or the process by which it was done."
In Treasury's October testimony to the House Banking Committee the Treasury Department noted several concerns including the following:
“Such a policy (national charters) raises serious questions about the proper mission of the System. . . such changes may also over time tend to diminish the local, cooperative nature of that System and have long-term effects on the competitiveness of the agricultural lending markets. In particular, they will allow expansion of a government sponsored enterprise - which are traditionally created to correct a market failure - at a time when markets are functioning competitively and even growing.”
“we believe that the System's current structure is an important part of maintaining local focus. . . we did not recommend national charters or any form of intra-System competition. . . it might well diminish competition and innovation in the medium- to long-term by driving other competitors from the market.”
National Charters Remove Local Control of FCS by Farmer Borrowers
FCA’s booklet states that national charters “provide more geographic diversification for selecting eligible stockholder directors” (pg 2). This will lead to loss of local control of FCS association boards since potential board members will now be eligible from anywhere in the U.S.
Sample concerns expressed by FCS association include the following:
“… we are totally opposed to the removal of geographic boundaries of system entities which would no doubt promote predatory pricing and loss of local control.”
“it (removal of geographic boundaries) would allow a segment of the system to use this statement as a self serving catalyst to create a political power base to control future system activities based on their own agenda, rather than the grass roots ownership and management teams currently existing.”
“FCA’s new philosophy appears to direct changes not necessarily beneficial to the customer or end user, but more to affect internal politics, control, and breaking up what has been a most successful member-owned and controlled organization.”
“Our fear is that the mission mandated by the Congress to provide sound and constructive credit to all eligible borrowers may be sacrificed as we move away from the influence of localized governance through economies of size.”
“Specifically, the (FCS Association) board questioned how farmer-director representation would be maintained in such an environment.”
“Intra-system competition at the association level will distort the “grass roots” representation by producing board representation motivated by salaries and perks rather than borrowers’ needs.”
“we believe the process you have put into motion may cause the loss of local identity for associations and create large organizations that may not be responsive to local needs.”
“…we fear the loss of grass roots control of the Farm Credit System. . .”.
Clearly many FCS association recognize that this policy will lead FCS away from locally controlled boards. In fact, FCA’s proposal requires this dilution of local representation by allowing borrowers to serve as directors “regardless of geographic location”. And each association will be required to “ensure that borrowers from its chartered territory are adequately represented on its board of directors”. When chartered territories cover the entire nation, the governance of associations is anything but local.
Shifts FCS Away from Serving Agriculture
FCA and other supporters suggest this proposal is somehow necessary because FCS is a single sector lender and they suggest that FCS must continue to serve the needs of agriculture when other lenders can “abandon farmers and seek profit opportunities elsewhere”. This is just not an accurate picture of rural credit markets. These arguments, of course, forget to note that FCS was given GSE privileges precisely because they are intended to serve a specific sector – agriculture – at a time early in the 20th century when there were some financing needs in agriculture.
Also, bankers have noted that in recent years the FCA has begun to talk about its mission not only in terms of serving agriculture, but in terms of serving “rural America”. That is quite a leap. In fact, the FCA a couple of years ago proposed a broad “scope and eligibility” proposal which included allowing loans to be made to farmers and agri-businesses for both farm and non-farm purposes.
Although that proposal was eventually scaled back somewhat after numerous complaints, it is clear that FCA has been expanding FCS’s activities into non-farm lending areas. These include providing mutual funds, credit cards, student loans, home equity loans which can be used for any purpose, vacation loans, loans to dentists and anesthesiologists for recreational purposes, and on and on. My point, Mr. Chairman, is that this argument of “being limited to a single sector” has worn quite thin and it is clear that FCA wants to push the expanded powers envelope even further in the future.
Where will this lead with national charters? Will CoBank, working through its direct lender associations, or will FCS banks and lenders, form national alliances with national car companies to provide consumer auto financing for Ford or GM cars in towns of under 50,000 population? What about financing all the consumer loans for Home Depot home remodeling projects in “rural” towns? What about teaming up with national businesses to provide financing for furniture sales, office equipment, computers, etc., if they serve “rural America”. What is in place to prevent this under a future FCA eligibility proposal, or even without one? What major national business wouldn’t want to allign themselves with the benefits of a GSE lender? What credit demand would FCS be providing that is not being well met now by private sector lenders?
In regards to “other lenders abandoning farmers”, let me state that this is simply misleading because it ignores the fact that there are several thousand commercial banks that provide financing to agriculture. In many of our communities our community banks could not exist without the agriculture sector because it is the largest segment of our loan portfolios.
In most communities there are several community banks competing for the same business in addition to other competitors. Since community banks like ours serve their communities my bank is not going to go “seek profit opportunities elsewhere” by leaving our community in tough times. And by the way, my regulator would frown upon me as a Colorado community banker if I started to make loans in California and Florida and New Jersey simply by editing or updating an annual business plan. And of course, even as a community banker serving the needs of my community, I am still required to comply with CRA.
FCA/FCS’s Terrible OFI Record
Mr. Chairman, I want to simply point out that the FCA and the FCS, despite all the talk about wanting more competition, have a terrible record for implementing the Other Financial Institutions (OFI) program intended by Congress to allow banks, credit unions, and other groups to access the funding window of the FCS. This would be one positive way more credit could be made available to rural America. But today there are only two dozen OFIs even in existence even though the statutory authority has existed for many decades. The OFIs that do exist get no board representation, no policy input and FCA has not responded to our request to host a meeting of OFIs to gather input and begin developing a workable program.
Congress expected the OFI program would be a significant, substantive program when it passed the authorities. It is time Congress prod the FCA to revise this program and we can share a number of ideas in this regard. But we shouldn’t let the FCA proceed with national chartering unless they address the concerns we have raised today and until they have taken care of something as fundamental as the OFI program to ensure more credit is available from other providers when their association numbers become drastically reduced.
I believe its easy to see that the FCA National Chartering proposal is fraught with problems. It dramatically changes the structure of the System, will lead to rapid consolidation and loss of local control within the System, will encourage predatory pricing with no controls in place to monitor these practices and will lead to large aggressive FCS lenders cherry picking the best loans with no targeting requirements to serve family farmers outside their LSAs. The proposal has a weak and liberal local service area requirement that will become anything but “local” and could lead to alliances with large commercial businesses for non-farm lending purposes.
None of the borrowers served by the FCA’s plan lack adequate credit choices. The rural credit market is quite competitive with a number of creditors in addition to the FCS and banks vying for business. We don’t need to have larger operators and large ag businesses getting special loan deals that will be offset by raising interest rates on smaller borrowers. I’ve outlined a number of concerns. There are also many questions as I’ve indicated.
Additional questions would be:
It would be easy to expand the lists of both the questions and the concerns, but I believe the point is clear – FCA should withdraw their proposal and promote options that would be much less disruptive to the rural credit markets. These options would include loan participations and reciprocal concurrence agreements. Thank you Mr. Chairman.