As the chart at right illustrates, the FCS’s on-farm lending as a portion of total FCS lending steadily declined from year-end 2011 to year-end 2015; the slight uptick during 2016 may represent a seasonality in FCS lending that will wash out by the end of this year. The FCS’s on-farm lending – farm mortgages plus production and intermediate term loans – declined from 72.3% of total FCS lending at the end of 2011 to 66.6% of total FCS lending at the end of 2015. Non-farm lending – to agribusinesses, rural utility cooperatives and investor-owned utilities, and other non-farm borrowers – rose from 27.7% of total FCS lending at the end of 2011 to 33.4% – one-third of all FCS lending – by year-end 2015.
Had the FCS’s share of non-farm lending held constant from 2011 onward, at the end of 2015 its non-farm lending would have been $18.6 billion less than it actually was. That amount, equal to 30.9% of the FCS’s actual non-farm lending at year-end 2015, represents taxpayer-subsidized credit that could have been supplied by banks and other private-sector lenders. Given that a substantial amount of the FCS’s on-farm lending would be provided by banks and other private-sector lenders were it not for the FCS’s tax and funding-cost advantages, the excess amount of the FCS’s non-farm lending is even greater. That observation raises a much more fundamental question: Is there any legitimate rationale for any FCS lending off the farm? The FCS’s non-farm lending certainly was not an initial congressional intent when it chartered the FCS 100 years ago.
One can reasonably ask why this analysis does not predate 2011. Well, there is a very good reason – during 2015, “certain [FCS] institutions identified errors in loan type classifications that are used to report loan portfolio information.” Upon making that discovery, the FCS restated loan data by type of loan, but only back to 2011. These loan-classification errors were not insignificant. For example, the FCS initially understated farm real estate loans at the end of 2014 by $2.13 billion and overstated production and intermediate-term loans by $2.69 billion. Likewise, agribusiness loans to cooperatives at year-end 2014 were overstated by $2.19 billion while processing and marketing loans were understated by $2.37 billion. These are not insignificant errors! The Farm Credit Administration (FCA) has said whether loan data by type of loan will be restated prior to 2011 and whether the loan classification errors resulted in erroneous call-report filings by FCS institutions. Call report errors, of course, should raise questions about the quality of FCA supervision of those institutions.
FCS lending woes are rising
The FCS’s lending woes have increased in the face of weak commodity prices, as reported in the FCS’s Quarterly Information Statement for the third quarter of 2016. The FCS’s provision for loan losses for the first nine months of 2016 – $218 million – was more than double the FCS’s $87 million loss provision for the first nine months of 2015. That higher loss provision reflects the increase in the FCS’s non-accrual and restructured loans from $1.61 billion at year-end 2015 to $1.92 billion at September 30, 2016; those amounts equaled .68% and .79% of the total amount of loans outstanding on those dates. The FCS was still reasonably reserved for loan losses at September 30, 2016, with an allowance for loan losses of $1.46 billion, or 76% of non-accrual plus restructured loans, down from 80% at the end of 2015. However, continued weaknesses in commodity prices, coupled with any rise in input prices, could lead to even higher loss provisions.
Despite its increased loss provision, the FCS’s pre-tax income for the first nine months of 2016 rose by $77 million, or 2.1%, over the same period in 2015. However, the FCS trimmed its tax provision by $31 million, to $136 million for the same period from $167 million for the first nine months of 2015. As has previously been the case, CoBank continued to bear most of the FCS’s tax liability. For the first nine months of 2016, CoBank accounted for all but $17 million of the FCS’s tax liability, giving the rest of the FCS an effective tax rate of .6%. For the third quarter of 2016, the rest of the FCS had a pre-tax income of $1.02 billion on which it recorded a tax provision of just $1 million, for an effective tax rate of .1%. Essentially, the FCS, minus CoBank, now operates as a fully tax-exempt lender.
Is the FCS making some unwise interest-rate bets?
At a time when interest rates are much more likely to rise than decline further, the FCS appears to be gambling that rates will stay low even as its funding costs and loss provision have begun rising. According to a presentation of the FCS’s interest-rate spreads, as set out in its Information Statement for the third quarter of 2016, the annualized rate on farm real estate loans was 4.43%, down five basis points from the same quarter in 2015. For the first nine months of 2016, the annualized rate was down one basis point from the same period in 2015. Annualized rates inched up in some other loan categories. Most interestingly, though, was the relatively sharp increase in the annualized rate on production and intermediate-term loans, where the FCS has a smaller tax and funding cost advantage relative to its real estate lending. For the third quarter of 2016, the annualized rate on those loans rose 26 basis points, to 3.97%, from the third quarter of 2015. For the first nine months of 2016, the annualized rate on these loans was up 18 basis points from the same period in 2015.
The FCS’s funding costs have begun to rise. For the first nine months of 2016, the annualized rate on systemwide bonds and medium-term notes rose 20 basis points over the same period in 2015, to 1.26% while short-term discount notes saw a rise of 30 basis points over the same period, to .48%. On an overall basis, the annualized rate on the FCS’s interest-bearing liabilities increased 14 basis points in the third quarter of 2016 to 1.17%, up from 1.03% during the third quarter of 2015 and 1.00% for the first nine months of 2015. Despite rising rates, the FCS appears to have shortened up maturities on its debt. During the first nine months of 2016, the FCS increased its debt due within one year by $12.66 billion while decreasing its debt due after one year by $4.00 billion. To what extent the FCS has hedged this apparent increase in maturity mismatching will not be known until it publishes its annual information statement next March, but it is a troubling trend.
CoBank earned income from the sale or exercise of warrants
CoBank’s Quarterly Report for the third quarter of 2016 had an interesting disclosure – it earned some non-interest income from “proceeds from the disposition of warrants obtained in lending transactions.” I estimate that these proceeds were as much as $6 million. I strongly suspect that these warrants related to CoBank loans to investor-owned utilities as I am not aware that cooperatively-owned utilities, to whom CoBank is entitled to lend, issue such warrants. The FCA should require CoBank to provide more information about these warrants and how much it earned upon their sale or exercise.
FCA Board member Dallas Tonsager new FCA chairman/CEO
On November 22, President Obama designated FCA board member Dallas Tonsager as the new chairman of the FCA board and CEO of the FCA organization. He succeeds Kenneth Spearman, who has been FCA chairman and CEO since March 2015. Tonsager has been a member of the FCA board since March 2015. He previously served on the FCA board from 2004 to 2009. Although Spearman’s term as an FCA board member expired in May of this year, he will continue to serve on the FCA board until he resigns or a successor is appointed by the President and confirmed by the Senate.
