Washington Post Article Pulls Back Curtain on the FCS

On April 11, The Washington Post ran a long (1,226 words) and very critical article on the FCS that was neatly summarized in its headline: Critics say Farm Credit System needs to be reined in.

The article clearly reflects the tone of the December 2 hearing the House Agriculture Committee held on the FCS where many committee members asked tough questions and expressed criticisms of the FCS and especially of CoBank. That such an article appeared in the Washington Post is especially important in the FCS debate because the Post is so widely read inside the Washington Beltway, and especially by members of Congress and their staffs. Defenders trotted out their usual defenses of the FCS, such as justifying CoBank loans to Verizon and Frontier Communications because they “provide landline voice service, Internet and wireless access and other services to rural areas.”

Other FCS lending abuses cited by the Post article, all of which were highlighted at the House Ag Committee hearing, included the Cracker Barrel loan and loans to finance a carwash, a vacation home on the Gulf Coast, and an exotic hobby farm. The article ended with the story of an FCS loan, first reported in the FCW, to finance a television producer’s purchase of a 6,500-square-foot home on 55 acres in the Black Hills of South Dakota. That loan soon went into foreclosure.

One interesting aspect of the Post article was the narrowness of the FCS’s defenders quoted in the article – just Bob Engel, CoBank’s CEO, and Todd Van Hoose, CEO of the Farm Credit Council, the FCS trade association. Until recently, Van Hoose was in charge of government affairs for CoBank. It is almost as if CoBank is the FCS. While many other FCS institutions have abused the FCS lending authorities, it appears that CoBank’s abuses, and especially its loans to investor-owned utilities, have drawn unfavorable attention to the entire FCS. One can reasonably wonder what divisions CoBank is creating within the FCS.

How the FCS (read: CoBank) tried to spin the Post article

A week after the Post article appeared, the Farm Credit Council posted on its blog, called The Aggregator, a post headlined “Washington Post Highlights Farm Credit’s Mission and Strength.”

Selectively quoting from the Post article, the author, Karen Macdonald, completely mis-characterized the article, focusing on Bob Engel’s quote that “it is unfortunate that trade associations for the banking industry often ignore the extremely positive and long-standing working relationship that [FCS] has with commercial banks when they are lobbying Congress or communicating with their members.” It is, of course, the rare community banker who speaks positively about the FCS. Interestingly, the blog post did not indicate Macdonald’s affiliation. Quite possibly, she is the same Karen Macdonald who lives in the Denver area, where CoBank is headquartered, and who, according to her LinkedIn entry, was once a “marketing communications manager” at CoBank. Does CoBank have any allies within the FCS?

CoBank angers investors by redeeming subordinated debt

CoBank can’t seem to help itself in angering its various constituencies, including the investment community, which buys FCS debt. CoBank’s latest misstep stems from revisions in FCS capital requirements the Farm Credit Administration, the FCS regulator, recently announced. The new capital regulations are intended to more closely align by 2017 FCS capital requirements with the capital requirements for commercial banks. Under the new capital rules, CoBank’s subordinated debt will no longer qualify as capital for leverage capital purposes. CoBank asserted in a March 11 news release that because the FCA’s announcement of its new capital requirements made CoBank’s subordinated debt redeemable, CoBank would therefore redeem $405 million of 7.875% subordinated notes. In today’s low-rate environment, those notes had been trading at 112.5 cents on the dollar. Investors in those notes understandably howled, and complained to the FCA.

According to one news report, investors are concerned that if CoBank is successful in redeeming its subordinated notes, AgriBank FCB, another of the four FCS banks, will seek to retire $498 million of subordinated notes due in 2019. Those notes, which yield 9.125%, trade at a 20% premium over book value. Farm Credit Bank of Texas and AgStar Financial Services, the fourth-largest FCS association, have smaller amounts of high-yielding subordinated debt outstanding they will probably try to redeem, too. A news article about these forthcoming redemptions reported that “some creditors who stand to lose money have threatened never to buy another CoBank or [FCS] bond again.” That is unlikely, though, given the high creditworthiness of senior FCS debt due to its implicit federal backing – see the next article. It will be interesting to see if any bondholders sue to block the CoBank redemption.

Fitch affirms FCS and FCS Banks’ high credit ratings

Fitch Ratings, one of the three major credit rating agencies, recently reaffirmed the FCS’s “long-term Issuer Default Rating (IDR) and short-term IDR at AAA/F1+ respectively. The Rating Outlook is Stable.” The other two major rating agencies – Moody’s and S&P – also maintain comparable ratings on FCS debt. Fitch noted that “as a government-sponsored entity (GSE), the FCS benefits from implicit government support. Therefore, the ratings and Rating Outlook of the FCS are directly linked to the U.S. Sovereign rating.” This linkage, of course, is why FCS debt trades so tightly to the Treasury yield curve, which in turn gives the FCS one of its key funding advantages over banks and other private-sector lenders – a very low cost of funds. Fitch also “affirmed the long-term and short-term IDRs of [the four FCS banks] as AA-/F1+. The Rating Outlook is Stable.” Fitch went on to note that “the affirmation of the [FCS banks’] IDRs reflect their prudent, conservative credit culture, their unique funding advantage and their structural second-loss position on the majority of their loan portfolio.” [emphasis supplied]

The FCS banks jointly own the Federal Farm Credit Banks Funding Corporation, which issues and markets the FCS’s Systemwide Debt Securities which Fitch rated AAA. The FCS banks use those borrowings to fund both loans they hold on their own books as well to fund their loans to the 74 FCS associations who in turn relend those funds to farmers, ranchers, and others, in direct competition with banks and other private-sector lenders. Consequently, FCS associations can charge lower lending rates because of the FCS’s AAA rating. Because the FCS banks are jointly-and-severally liable for debt the Funding Corporation sells to investors, the FCS can therefore be properly viewed as one giant, highly interconnected financial institution. As the Washington Post reported, “If [the FCS] were a single bank, it would be the ninth largest financial institution – measured by assets – in the United States.”

About Bert Ely

Bert Ely
Bert Ely is a consultant specializing in banking issues. He writes ABA's monthly Farm Credit Watch email bulletin.
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