Farm Credit Watch: How FCS Gets Away with Accepting Deposits

Bankers in many areas of the country have discovered that the FCS associations they compete against effectively are accepting deposits. The associations accept these funds as one element of the cash-management services they offer to their member/borrowers. Technically, the funds deposited with the FCS represent an advance payment against an outstanding loan or line of credit from the association. Check the Compeer Financial website for a good example of the range of cash management services some associations offer. Note how frequently the word “deposit” is used.

FCS institutions are not authorized to accept deposits in the manner that banks do, but years ago the Farm Credit Administration and the Treasury Department constructed a legal justification for the manner in which deposits can now be accepted by FCS associations. First, the Farm Credit Act permits each of the four FCS banks to issue bonds both individually as well as collectively through the Federal Farm Credit Banks Funding Corporation. Second, in 1990 the Treasury Department issued a letter to the Farm Credit Administration (FCA) exempting FCS banks from key provisions of the Securities Exchange Act of 1934. This exemption permitted each FCS bank to sell bonds directly to FCS member/borrowers as well as to FCS employees and retirees, without providing the disclosures usually associated with the sale of securities.

An FCS association acts as agent in selling the bonds of the bank that funds it. Funds deposited with an association are immediately forwarded to the bank to purchase the bank’s bonds with a face value equal to the amount deposited with the association. Consequently, the association has no liability for the deposits it accepts. The Treasury letter required that purchasers of these bonds (effectively FCS depositors) be given “printed materials [that] clearly state that the [farm credit bank] and not the association is the issuer” of the bonds, that the bonds “are not direct obligations of the United States,” and that the bonds “are in no way insured or guaranteed as to principal or interest by the United States or any governmental entity.” It is highly unlikely that FCS depositors understand that they effectively are buying an uninsured bond. At the end of 2016, AgriBank had $939 million of member investment bonds outstanding and CoBank had $1.5 billion of “cash investment services payable” outstanding. It noted that these payables mature within a year; if a bond can be redeemed overnight it effectively functions as a demand deposit. The other two FCS banks — Farm Credit Bank of Texas and AgFirst — appear not to offer these bonds. Presumably, then, the associations they fund cannot accept deposits in connection with cash management services they offer to their member/borrowers.

Presumably the exemption the Treasury Department approved in 1990 enhanced the ability of the FCS banks to fund their balance sheets directly to complement the funds raised through the Funding Corporation. However, today more and more associations, in cooperation with the FCS banks, are using that exemption for an entirely different purpose — to compete against commercial banks in offering cash-management services. Offering cash-management is not why Congress created the FCS.

Credit-quality issues emerging in some larger FCS associations

The quarterly and annual FCS information statements published by the Federal Farm Credit Banks Funding Corporation include a table listing key data and ratios for all FCS associations with total assets exceeding $1 billion . The spreadsheet lists the 37 associations that had more than $1 billion of assets on both March 31, 2017, and March 31, 2016. They hold almost 90% of the total assets of all FCS associations. What is evident in these numbers is the variability across these associations in key measures of performance and financial soundness.

For example, non-performing assets as a percent of total loans plus other property owned at March 31, 2017, varied from 2.46% down to .02%. The adequacy of loss provisioning, as measured by the allowance for loan losses as a percent of non-performing assets also varied significantly on that date, from 20.5% to 2800%. Especially troubling numbers for both measures are noted in red. The wide range of these numbers raises this question: Are some of the larger associations not being as diligent as they should be in identifying troubled loans and reserving for eventual losses on those loans? Time will tell. This question is especially relevant for the second-largest association, Louisville-based Farm Credit Mid-America (FCMA). Moving down the spreadsheet, rankings by return on average assets (ROA) and net interest margin (NIM) also show great variability, with ROA ranging from 2.51% to 1.20% and NIM ranging from 3.59% to 2.14%. Notably, FCMA is at or near the bottom of both of these rankings. FCW readers are encouraged to massage the data in this spreadsheet to see what conclusions they reach about the financial condition of the larger FCS associations.

On July 1, five associations became two

On June 27 the FCA gave final approval to two sets of mergers of FCS associations that became effective on July 1. The merger of Badgerland Financial and 1st Farm Credit Services into AgStar has created the third-largest FCS association, with total assets of approximately $19 billion. Now called Compeer Financial — hardly suggestive of agricultural finance — it serves eastern and south Minnesota, western and southern Wisconsin, and northern and western Illinois. Separately, United FCS merged into AgCountry FCS to create the ninth-largest FCS association with total assets of approximately $7 billion. It serves western Minnesota, eastern North Dakota, and a portion of eastern Wisconsin almost 200 miles to the east. With these mergers, the ten largest of the FCS’s 70 associations hold 67% of total association assets. The FCS is increasingly dominated by very large, multi-state associations.

AgStar — an out-of-market ‘investor’

Prior to gobbling up two smaller associations to form Compeer, on January 10 the FCA authorized AgStar to invest up to $2 million in bonds issued by a long-term care facility in Wisconsin. Although the facility may have been located within the territory served by AgStar, financing a long-term care facility, however worthy the project may be, hardly fits within the scope of the FCS’s financing authority. Further, these bonds are really a loan recast to look like an investment. More troubling, though, was the FCA’s April 7 authorization for AgStar to “invest up to $2.5 million in taxable bonds to be issued by a rural continuous care facility in Texas,” which of course is hundreds of miles south of AgStar’s territory. Leaving aside the propriety of such an investment, what could AgStar possibly know about the continuous care market in Texas? Most interestingly, on June 5, the FCA authorized CoBank “to invest up to $1 million in taxable bonds to be issued by a continuous care facility in Texas.” Quite likely, this is the same facility whose bonds AgStar is purchasing. One can reasonably ask why Texas-based FCS associations or the Farm Credit Bank of Texas are not buying those bonds.