Farm Credit Watch: Congress Modifies Tax Bill Provision Benefiting Ag Co-ops

By Bert Ely

As last month’s Farm Credit Watch reported, the major tax bill Congress enacted at the end of last year added a new section 199A to the Internal Revenue Code, one portion of which would greatly benefit agricultural cooperatives at the expense of investor-owned grain companies of all sizes — not only Cargill and Archer Daniels Midland but also much small companies purchasing grain from farmers. That would be the case because 199A would allow farmers “to deduct up to 20 percent of their totals sales to cooperatives,” which would have let some farmers reduce their taxable income to zero. Quite understandably, investor-owned grain companies of all sizes protested the obvious unfairness, to them, of 199A, calling it the “grain glitch.” Congress responded to their complaints, in the just-passed omnibus spending bill, with a provision that caps a farmer’s deduction on grain sales to coops at 20 percent of net income, excluding capital gains. Farmers still retain other benefits from doing business at coops where they are members. The FCS, and CoBank in particular, may still benefit from the revised provision, to the extent that it results in increased loan demand from coops that borrow from CoBank.

Tax bill drives the FCS’s effective tax rate even lower
One effect of last year’s tax bill was to drive the FCS’s effective tax rate in 2017 to a new low — to just 0.73 percent, compared to 3.48 percent for 2016 and 4.03 percent for 2015. This sharp decline was due largely to the tax bill’s effect on CoBank. Like other corporations, CoBank had to recalculated its deferred tax assets and tax liabilities, as of the end of 2017, at the new lower tax rate; doing so generated a $142.3 million tax benefit for CoBank, reducing its tax bill from $171 million in 2015 and $158 million in 2016 to just $15 million for 2017. The tax bill for the rest of the FCS actually increased, from a miniscule $17 million in 2016, for an effective tax rate of just 0.43 percent, to a still miniscule $23 million, on $4.087 billion of pre-tax income in 2017, for an effective tax rate of 0.56 percent. These absurdly low effective tax rates highlight why Congress needs to undertake a fundamental examination of how the FCS is taxed relative to commercial banks and other taxpaying firms financing farmers and rural America.

FCSIC rebates $162.7 million to FCS institutions
The Farm Credit System Insurance Corporation, the arm of the FCS which insures the timely payment of principal and interest on debt issued by the Federal Farm Credit Banks Funding Corporation (the FCS’s link to the capital markets), will “return” to the four FCS banks $162.7 million of “excess funds.” This return of these funds essentially is a rebate of premiums previously paid by the banks to the FCSIC. Each bank, in turn, almost certainly will rebate a substantial portion of the excess funds it receives to the FCS associations it funds, reflecting the fact that each bank allocates to those associations a portion of the premiums the bank pays to the FCSIC. This rebate has occurred because the fund balance in the FCSIC currently exceeds the amount of assets the FCSIC must hold to meet a minimum balance requirement, called the “secure base amount,” equal to 2 percent of the outstanding debt issued by the Funding Corporation.

The timing of this rebate is questionable given the likelihood of growing credit-quality problems within the FCS due to declining net farm income and the unwise practice of some associations to encourage their borrowers to defer loan principal repayments, a practice I questioned in last month’s FCW. As the FCSIC news release announcing this rebate noted, “the FCSIC board has the authority to hold the excess funds if conditions warrant doing so.” Current conditions certainly do warrant holding back those excess funds. It would have been far more appropriate, though, for the FCSIC to send those funds to the U.S. Treasury as compensation for the $10 billion taxpayer-backed line-of-credit Treasury began providing to the FCSIC in Sept. 2013. In the Dec. 2017 FCW, I discussed the most recent extension of this line-of-credit, to Sept. 2018. To date, the FCSIC has paid absolutely zero to the Treasury for this line of credit. Sending this FCSIC payment to the Treasury also would compensate taxpayers for the insufficient amount of income tax paid by the FCS, as discussed above.

Lone Star Ag Credit not subject to an FCA enforcement order
As prior issues of the FCW have reported, Loan Star Ag Credit, which is headquartered in Fort Worth, Texas, has not issued any financial reports since the first quarter of 2017. On Aug. 9, 2017, Lone Star issued a letter stating that its financial statements for 2016 and the first quarter of 2017 “should no longer be relied upon” due to it having discovered “appraisal and accounting irregularities affecting a segment of [Lone Star’s] lending portfolio.” Additionally, the Farm Credit Administration withdrew from its database all Lone Star call reports filed with the FCA after 2015. In effect, Lone Star’s finances have been a black hole for over two years. Worse, Lone Star “is not in compliance with some requirements of its general financing agreement with the Farm Credit Bank of Texas, its funding bank.” That bank has dealt with Lone Star’s accounting problems by issuing a “waiver of default” so that Lone Star can continue borrowing from the bank.

What is especially troubling about the Lone Star accounting mess is that the FCA apparently has not issued any enforcement order, or written agreement, as the FCA calls such orders, against Lone Star. The absence of any FCA written agreement against Lone Star can be deduced from the fact that in the discussion of FCS regulatory matters in the 2017 Annual Information Statement of the Farm Credit System, published by the Funding Corporation, there is no discussion of written agreements the FCA has entered into with FCS institutions. Prior years’ Information Statements have indicated how many written agreements were outstanding and the total assets of the institutions subject to written agreements. The apparent absence of an enforcement order against Lone Star evidences a serious problem at the FCA — its continued unwillingness to publish its enforcement orders, something the banking regulators routinely do. Any bank with accounting problems of the magnitude of Lone Star’s would have long ago been subject to a tough enforcement order issued by its primary federal regulator, and that order would have been published for all to read.

What FCS associations are you competing against?
I often find that bankers do not know which FCS association or associations they are competing against or where local FCS offices are located. The Farm Credit Council, the FCS trade association, has helpfully made that information available, on farmcredit.com/locations. Simply select a state and office type (branch or headquarters) and then click on Apply to find those office locations. You also can search by ZIP code, county, or city. Learn more about your local FCS competition — who they are and where they are located — by using this easy-to-use search tool.

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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