The Farm Credit System, America’s least known government-sponsored enterprise, has an excessively complex and increasingly obsolete organizational structure. I wrote a white paper for ABA in August that explains why this structure needs to be simplified and how that can be accomplished.
The FCS dates to 1916, when Congress established the Federal Land Bank System, which consisted of 12 regional Federal Land Banks (FLBs) to provide real estate financing to farmers and ranchers. FLB loans were originated by local Federal Land Banks Associations (FLBAs), which were lending cooperatives owned by their borrowers.
The Farm Credit Act of 1933 authorized the creation of Production Credit Associations, or PCAs, to make short-term loans to farmers and ranchers, as well as twelve regional cooperative banks and a Central Bank for Cooperatives to lend to agricultural and rural utility cooperatives. The assigned territories for the PCAs often coincided with FLBA territories.
The FLBA/PCA overlap led to the creation of local Agricultural Credit Associations (ACAs) that provided both real estate and non-real estate credit to farmers and ranchers. ACAs then began to structure themselves as “parent ACAs,” each with a PCA subsidiary as well as a Federal Land Credit Association (FLCA) that not only had the lending powers of an FLBA, but could then keep the real estate loans it originated, thereby retaining for each ACA the real-estate tax exemption the FCS has long enjoyed.
The 1987 bailout of the FCS, triggered by the 1980s’ ag crisis, led to significant consolidation within the FCS—the number of FCS entities shrank from 845 at the end of 1984 to 196 on July 1, 1999. The cooperative banks eventually consolidated into CoBank, which has the exclusive authority within the FCS to lend to cooperatively-owned agricultural businesses and rural utilities.
Today, the FCS has just four regional banks, including CoBank, and 69 associations. This map features the territories served by the four banks, while this map shows the association territories.
The FCS banks, other than CoBank, act solely as funding intermediaries between the FCS associations and the Federal Farm Credit Banks Funding Corporation, which raises funds by selling in the capital markets notes and bonds known as the Systemwide Debt Securities.
As the dominant creditor of the associations it has lent to, each FCS bank provides some financial oversight of those associations. That oversight supposedly complements the regulatory oversight and periodic safety-and-soundness examinations carried out by the FCS’s regulator, the Farm Credit Administration.
The tremendous variation in the size of the areas served by the FCS associations parallels the enormous asset-size differential among them. As of March 31, 2019, the associations ranged from total assets of $29.88 billion (Farm Credit Services of America, serving four states) and $23.71 billion (Farm Credit Mid-America, serving all or portions of four states) to Delta ACA, which serves just five counties in southeast Arkansas, with $49 million of assets.
Further consolidation among the remaining four FCS banks is unlikely because of a little-known feature of FCS debt issued by the Funding Corporation—each additional bank merger would further weaken the joint-and-several liability the remaining banks would have for the Systemwide Debt Securities issued by the Funding Corporation. That is, if an FCS bank cannot pay the interest due on the funds it has borrowed from the Funding Corporation or repay the borrowed funds when due, then the other three banks are jointly liable for that debt.
The next FCS bank merger would further weaken the joint-and-severally-liable feature now backing FCS debt by reducing to two the number of other banks liable for a troubled bank’s obligations if that bank could not meet its debt obligations in a timely manner. Each of the remaining banks would have to shoulder a larger portion of the defaulting bank’s debt, thereby increasing the likelihood that the other banks would default. Most interestingly, the joint-and-several liability feature backstopping debt issued by the Funding Corporation does not extend to the FCS associations.
As the FCS associations continue to consolidate while the number of banks has shrunk to an irreducible number, the time has come to authorize each association to borrow directly from the Funding Corporation, which in turn would assume the association oversight functions now performed by the four banks. That is, the functions of three of the banks—all but CoBank—would simply be assumed by the Funding Corporation and the banks liquidated. The equity capital in each bank would then be transferred to the associations that belonged to that bank, thereby strengthening the capital of those associations.
Most importantly, the joint-and-several obligation now residing with the four banks would shift to the much larger number of FCS associations as they began borrowing directly from the Funding Corporation. That shift would greatly strengthen the joint-and-several liability feature of FCS debt, which in turn would reduce the taxpayer risk posed by the FCS, a risk that became a reality in 1987. Interestingly, on at least three occasions, former FCA board chairman, the late Dallas Tonsager implored the FCS to study its present structure and to suggest how the FCS should be restructured.
Simplifying the structure of the FCS would improve its operating efficiency, which presumably would benefit its member/borrowers, while strengthening the FCA’s safety-and-soundness regulation of the FCS.
An important element of FCS restructuring is to extend CoBank’s currently exclusive lending authorities to all FCS associations. Today, other FCS entities cannot lend to rural cooperatives, except with CoBank’s consent or by purchasing a participation in a loan to a cooperative originated by CoBank.
In conclusion, empowering FCS associations to borrow directly from the Funding Corporation while shifting other FCS bank functions to the Funding Corporation and the FCA would improve the operating efficiency of the FCS while reducing the substantial insolvency risk the FCS now poses to taxpayers.
