Resolving the Farm Credit System’s Growing Credit-Quality Problems

By Bert Ely

American agriculture is experiencing extraordinary financial stress, unlike anything farmers and ranchers have experienced in several decades. Those stresses, and their consequences, are reverberating within the FCS.

The FCA has effectively acknowledged the growing credit quality problems within the FCS, though its Financial Institution Rating System, or FIRS ratings of FCS banks and associations. FIRS ratings are comparable to bank CAMELS ratings, with a 1 rating for the strongest FCS institutions and 3 or lower for the weakest.

As of March 2019, 73 institutions were rated—33 had a 1 rating, 33 had a 2 rating and seven had a 3 rating. As of December 2016, 77 institutions were rated—44 had a 1 rating, 31 had a 2 rating and just two had a 3 rating. The increase of five 3-rated institutions over a 28-month period is very troubling, a trend that almost certainly has worsened since March.

The key public-policy question today: How well has the FCS recognized in its financial statements its likely loan losses? An analysis of the quarterly financial statements FCS institutions file with the FCA indicates the high likelihood that during the first nine months of 2019 many FCS associations were slow to recognize the growing deterioration in their borrowers’ finances.

This appended table—“Comparing Key Ratios for FCS Associations”—which groups the associations by the bank which funds them, lists two key asset-quality ratios as of Sept. 30, 2019, and then in the right columns shows the amount of change in those two ratios between Dec. 31, 2018, and Sept. 30, 2019. The percentages in red in the right columns indicate that the association believed it faced a reduced likelihood of incurring a loss on its loans despite an overall deterioration in agricultural finances this year. Percentages in black acknowledge an increased risk of loss.

For the FCS associations as a whole (last line in table) the Allowance for Loan Losses (ALL) percentage actually dropped slightly, by .004 percent to .527 percent from .531 percent at the end of 2018, when deteriorating credit conditions among FCS borrowers should have produced a higher ALL percentage during 2019. Less than half of the associations (32 of 68) boosted their ALL as a percentage of total loans outstanding while that percentage at another five associations did not change. Thirty-one associations, holding almost one-third of all association loans, actually reduced their ALL percentage during the first nine months of 2019.

Increased credit-quality problems during 2019 also were evidenced by an increase in non-performing assets as a percent of loans outstanding plus other property owned (OPO), which consists of repossessed real estate and non-real-estate assets. The FCA defines non-performing assets as consisting of OPO, nonaccrual loans, accruing restructured loans and accruing loans 90 or more days past due. Of the 68 associations, 38 reported an increase in non-performing assets as a percent of loans plus OPO during the first three quarters of 2019 (red numbers) while 28 showed a lower percentage; two were unchanged. For the associations collectively, the non-performing asset percentage increased .09 percent, from .94 percent at the end of 2018 to 1.03 percent at Sept. 30, 2019.

FCS is experiencing increased regulatory failures

An increasingly evident problem within the FCS is regulatory failure, specifically the inability of the FCA and the four FCS banks to adequately monitor accounting and credit-risk management practices within FCS associations. Previous FCWs reported the essentially forced merger in 2015 of Farm Credit Services Southwest, which served most of Arizona and southern California, into Farm Credit West following “a sudden significant increase in the level of delinquent loans affecting an identifiable portion of the association’s lending portfolio.” Lone Star Ag Credit, serving portions of central and north Texas, issued a Notification of Non-Reliance on Previously Issued Financial Statements for 2016 and the first quarter of 2017 due to just-discovered “appraisal and accounting irregularities.” Lone Star has resolved those problems and preserved its independence.

More recently, on July 1, 2019, American AgCredit (AAC) acquired all of the assets and liabilities of Farm Credit Services of Hawaii (FCSH), with each stockholder of FCSH becoming a stockholder of AAC. FCSH will be formally dissolved in the next few months. It appears that FCSH was a failed institution, yet the FCA has said nothing about its disappearance beyond approving a “proposed plan to combine” the associations.

One of the most troubling and systemically critical conditions that has emerged in recent years are loans from FCS banks to FCS associations that have less than acceptable credit quality. Given the threat deteriorating credit quality among FCS borrowers poses to the solvency of FCS associations, the FCA and the FCS bank funding that association should move quickly to prevent a troubled association from failing.

For at least a year, loans from AgFirst bank to one association have been classified as Other Assets Especially Mentioned (OAEM), or less than satisfactory. Each of the other three FCS banks indicated that they had “special mention” loans outstanding with some of the associations they fund. AgriBank had $1.17 billion of such loans outstanding at Sept. 30, 2019, up $100 million from Dec. 31, 2018. At Sept. 30, 2019, the Farm Credit Bank of Texas reported that a $231.2 million loan had a special mention classification.

Finally, CoBank reported $2.2 billion in special mention loans as of Sept. 30, 2019, to two of the associations it funds and that it held a $471 million participation in a loan made by the Farm Credit Bank of Texas to one of the associations that bank funds. CoBank stated that the “Special mention classifications primarily reflect internal control and other operational weaknesses at these associations, some of which were material weaknesses.” That statement should ring loud alarm bells at the FCA and on Capitol Hill.

Actions the FCA, Congress must take to strengthen FCS credit quality

It is clear from the events described above and the stressful conditions farmers, ranchers and agribusinesses have experienced in recent years, a circumstance likely to continue, that the FCS will experience financial distress for at least the next few years. While it is unlikely that American agriculture or the FCS will suffer a financial trauma comparable to what occurred during the 1970s, the coming years could be the toughest years the FCS has experienced since then.

Before conditions worsen further the FCA must become more aggressive in its safety-and-soundness supervision of FCS institutions, including monitoring the lending relationship between the associations and the FCS banks that fund them. To that end, the FCA needs to abandon its longstanding practice of not publishing its enforcement orders and other regulatory actions. Although an FCA policy statement states that “final enforcement orders, formal agreements and conditions imposed in writing … be disclosed to the FCS and the public,” that statement includes a classic catch 22—disclosure will not occur if the FCA’s Office of General Counsel “determines that a disclosure adversely affects a civil or criminal investigation.”

Publishing enforcement actions would put the member/borrowers, i.e., the owners of a regulatory sanction association, on notice that there are problems in their association that must be addressed. The bank regulatory agencies have long published their enforcement orders, without fear of compromising any investigation.

The number of troubled associations, as evidenced by the FIRS ratings and the increased reporting of special mention loans from FCS banks to FCS associations, should raise questions about the supervisory capabilities of the four banks. As explained in an ABA whitepaper in August, “Restructuring the Farm Credit System—why now and how to do it,” the time has come to simplify the structure of the FCS by abolishing the four banks, empowering FCS associations to obtain their funding directly from the Federal Farm Credit Banks Funding Corporation, and strengthening the regulatory and supervisory powers of the FCA so that it becomes a more effective regulator and ceases being an enabler for the FCS.

Congress needs to address the regulatory issues within the FCS, before conditions worsen further, and to begin the task of restructuring the FCS. For a more in-depth analysis of issues in this “Farm Credit Watch,” read ABA’s whitepaper, “The Farm Credit SystemResolving its growing credit-quality problems while strengthening its regulation,” released this month.

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