Is the FCS Understating Its Emerging Credit-Quality Issues?

As bankers know all too well, farmers and ranchers are suffering from a sustained period of low commodity prices, rising input costs, heavy rains and flooding, and more recently, trade issues that are harming agricultural exports. Not surprising, those factors have hurt farm income, which peaked in 2013. As in past cycles, sustained declines in farm income lead to increased cash-flow problems for farmers and ranchers, which in turn lead to rising credit-quality problems for ag lenders. As the late FCA Chairman Tonsager stated in his last speech, “the farm economy continues to deteriorate.” One indicator of the financial stress farmers are experiencing—a recent report stated that the delinquency rate on direct loans made by the USDA’s Farm Service Agency was 19.4%  in January of this year compared with 16.5%  a year earlier.

Even though the FCS focuses on lending to financially stronger farmers, a key question is how well the FCS is acknowledging growing credit-quality problems in its loan portfolio and/or shedding weaker credits by calling loans and not renewing lines of credit. A review of annual information statements issued by the Federal Farm Credit Banks Funding Corporation, which raises the funds the FCS lends, as well as the first-quarter 2019 Information Statement suggests that at least some FCS banks and associations are dragging their feet in recognizing credit problems.

The FCS classifies its loans with terms 1) acceptable, 2) other assets especially mentioned (OAEM), or 3) substandard/doubtful. In the latter category, the percentage of the total amount of FCS loans outstanding rose from 1.9% at the end of 2015 to 3.5% at the end of last year while loans classified as OAEM rose over the same period from 2.1% to 3.1%. Consequently, loans classified as acceptable declined from 96% at the end of 2015 to 93.4% at the end of 2018, a deterioration that is not as severe as other data would suggest. While no one wishes that the FCS would have loan-quality problems at the level it experienced in the 1980s, which triggered its 1987 taxpayer bailout, one has to wonder if the FCS’s loan quality is as good as reported or, alternatively, if the FCS is aggressively shedding itself of weaker borrowers, which would go against the initial rationale for creating the FCS, to provide credit to farmers and ranchers who cannot obtain credit from other sources. The Senate and House agriculture committees should be concerned about this possibility, and question the FCA on why it may be happening.

The question of whether the FCS is adequately acknowledging the magnitude of its current and prospective credit risks will become more pressing if the financial stress on farmers and ranchers increases for the reasons noted above. The FCS’s most recent quarterly and annual Information Statements include a discussion of the FCS’s credit-risk management practices. The description of these practices probably can be found in any book on bank credit analysis—the crucial question, of course, is how well are these policies being executed on a day-to-day basis? At two associations in recent years—Farm Credit Services Southwest in Arizona and Lone Star Ag Credit in Texas—serious credit and lending problems suggest that not all FCS institutions are adhering to sound credit-risk management practices. A related question—how good a job are the FCA and the four FCS banks which fund the associations doing in monitoring the retail lending activities of the associations? The agriculture committees should ask that question of the FCA.

There is a more fundamental question about the FCS’s credit risks that the information statements do not address—how well do the FCS and the FCA monitor, and respond to, the macroeconomic risks facing agriculture and rural America, and therefore the FCS, whose credit risks lie almost entirely in rural America? The near-failure of the FCS in the 1980s, which triggered the FCS’s 1987 taxpayer bailout, essentially was driven by macroeconomic factors, notably rising interest rates which contributed to the popping of a farmland bubble largely inflated the FCS’s excessively loose and underpriced real estate lending in the 1970s. This is another question the agriculture committees should ask the FCA.

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About Author

Bert Ely

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