Farm Credit Watch: Tax Bill Reduced FCS’s Competitive Edge in Real Estate Lending

One unintended effect of the wide-ranging tax legislation Congress enacted last month was a slight reduction in the competitive edge the FCS has long had for loans secured by real estate. The profits FCS institutions earn on real estate loans have always been exempt from federal and state income taxes while FCS profits on loans not secured by real estate, such as equipment and production loans, are subject to federal income tax, but not state and local income taxes. The reduction in the basic federal corporate income tax rate from 35 percent to 21 percent effectively has reduced, but certainly did not eliminate, the tax disadvantage bankers have long suffered in competing against the FCS for loans secured by real estate. For banks taxed as corporations, that rate reduction translates into 14 basis points of higher after-tax income for every 100 basis points of pre-tax income on a bank loan secured by farm real estate. The owners of banks taxed as Subchapter S corporations also will enjoy a comparable tax benefit. The FCS, of course, still has a funding cost advantage by virtue of its GSE status, especially for longer term, fixed rate loans, but every basis point of a reduced tax burden helps to lessen the FCS’s unfair and unjustifiable tax and funding cost advantages. Unfortunately, the tax bill did not address the FCS’s ongoing tax advantages that cost taxpayers $1.61 billion in 2016.

FCS of America letter signals future credit-quality problems?
Last month, FCS of America (FCSA), the largest FCS association, with $27 billion in assets, and serving South Dakota, Iowa, Nebraska, and Wyoming, sent a letter to an undisclosed number of its member/borrowers offering to “defer the principal portion of all payments due in 2018 on your fixed or variable rate real estate loan(s).” FCSA has not posted on its website any announcement about this principal-deferral offer or given any indication as to how widely this deferral option is being offered. While the letter suggests that this offer is being made selectively (“Based on your current status . . .”), it has a very simplistic, shotgun-quality to it, as evidenced by the fact that it offers “to defer the principal portion of all payments due in …” [underlining supplied].

There may be some situations where a 12-month deferral of all principal repayment on all of a farmer’s real estate loans makes sense, but there probably are far more situations when it does not make sense from either borrower’s or FCSA’s perspective. In some cases, only a partial deferral on some loans is needed to help the farmer weather the current outlook for commodity prices and operating expenses while in other cases the farmer’s situation is such that his loans need to be restructured or more dramatic action should be taken, such as encouraging the farmer to boost the farm’s equity or downsize his operation. It may be, too, that this letter was sent to some borrowers whose projected cash flow will be sufficient to meet their currently scheduled principal repayments. Simplistic, one-size-fits-all solutions seldom are the best. Worse, FCSA may be kicking the can down the road, by not dealing in a timely manner with those situations where a 12-month deferral of all principal payments is not the most appropriate action to take at this time with a potentially troubled loan. The Farm Credit Administration (FCA), FCSA’s regulator, should carefully examine the wisdom of this letter. The FCA also should check whether this payment-deferral offer has been extended to the member/borrowers of Frontier Farm Credit, the association serving eastern Kansas that is managed by FCSA.

The FCS Insurance Corporation cuts its premium rate
The FCS Insurance Corporation (FCSIC), an arm of the FCA, announced this month that it had reduced its insurance premium rate for 2018 from 15 basis points to 9 basis points per dollar of Systemwide Debt Securities issued by the Federal Farm Credit Banks Funding Corporation, the primary source of funding for FCS loans and investments. The FCSIC, which is the FCS’s counterpart of the FDIC’s Deposit Insurance Fund, or DIF, insures the timely payment of the principal and interest on the Systemwide Debt Securities. FCSIC premiums do not reflect the riskiness of the FCS as a whole or of individual FCS institutions, with one exception — the FCSIC assesses a 10-basis point risk surcharge on nonaccrual loans and other-than-temporarily impaired investments. FCSIC premiums instead are assessed in an amount sufficient to hold the FCSIC fund balance at two percent of the amount of Systemwide Debt Securities outstanding. Hence, the FCSIC premium rate varies with the rate of growth in outstanding FCS debt, which in turn is largely driven by the rate of FCS loan growth.

What is going on at Lone Star Ag Credit?
As the August 2017 FCW first reported, Lone Star Ag Credit, headquartered in Fort Worth, Texas, in August of last year withdrew its financial reports and call reports back to the beginning of 2016 after Lone Star’s management “discovered appraisal and accounting irregularities affecting a segment of [Lone Star’s] lending portfolio.” These problems appear to be similar to what afflicted FCS Southwest, which served most of Arizona; prior to its acquisition by Farm Credit West in November 2015. In a Nov. 9, 2017, letter posted on its website, Lone Star stated that its investigation of accounting irregularities was “ongoing, with its conclusion anticipated during the fourth quarter of 2017.” That means it should soon be issuing audited financial statements for 2017 as well as corrected financial statements back to 2016 as well as filing corrected call reports with the FCA. It will be interesting to see if that occurs as well as whether Lone Star survives or is forced to merge with another FCS association. Perhaps that merger would have to be assisted financially by the FCSIC.

CoBank makes another investment in a private equity fund
In a Jan. 25 press release, CoBank announced that it had made a $7.5 million commitment to a new rural private equity fund, joining five other FCS institutions “to participate in the first round of financing for Open Prairie Rural Opportunities Fund.” The fund will invest in “target areas such as crop protection, ingredients, processing, storage, data management and logistics.” With the fund’s initial commitments of $55 million, CoBank probably is one of its larger investors. The fund will be managed by Open Prairie, which has been licensed by the USDA as a Rural Business Investment Company (RBIC) under USDA’s Rural Business Investment Program. As the news release noted, “this is the third time CoBank has invested in a rural-focused equity fund under the [RBIC] since 2014.” CoBank has invested a total of $52.5 million in these funds. Leaving aside whether a GSE should be making risky, equity-capital investment, this very reasonable and logical question arises: How well have these RBIC investments performed, both in terms of meeting pre-established objectives as well as profitability? I posed this question to a CoBank representative. His emailed answer: We don’t put out a report on the performance of the funds. So much for CoBank transparency.

About Bert Ely

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