In January, the Farm Credit Administration proposed two potentially significant regulations that could have mixed effects on the FCS, and on farmers, ranchers, agricultural businesses and rural America. Bankers and producers should carefully assess these proposals and comment accordingly to the FCA.
One proposal would significantly enhance the financial transparency of the FCS’s direct-lending associations while the other proposal, dealing with limits on the amortization periods for FCS loans, could weaken FCS credit quality, indirectly harming farmers and ranchers. The Federal Register notifications for these proposed changes, at the above links, include instructions on how to file a comment with the FCA.
While characterized as presenting “shareholders and investors” with more information about the financial condition of an FCS bank combined with its member associations, the District Financial Reporting proposal should go further in providing information to the member/borrowers of FCS associations about the financial performance and condition of their association. Comments on this proposal are due by March 9
Currently, FCS member/borrowers can access online the quarterly call reports their association files with the FCA as well as quarterly and annual reports and financial statements accessible through the association’s website. Limited information about each association also is available in a table each FCS bank now publishes quarterly for the associations it funds. That table, which sets out each association’s regulatory capital ratio, non-performing loans as a percent of total loans and return on average assets, enables association members to compare that limited information with the other associations funded by that bank.
What is especially noteworthy about this proposal is that it is being issued by the FCA at the request of the four FCS banks. Although not stated as such, the banks apparently believe that association borrower/stockholders need more information about the performance of their association in a format that permits a more extensive comparison of association financial results within the bank’s district than is currently feasible. Although merely implied, the proposed regulation presumably would permit greater comparison of association data across all FCS associations.
Especially significant is the statement that a summary of the “district loan portfolio,” i.e., the loans of the district’s associations, would discuss “concentration risks and significant changes in credit quality, nonperforming assets, past due loans, loan loss allowances and reserves, and loan aging within the district as compared to previous years.” In order for this data to be at all meaningful, it would have to be presented in a tabular format to enable a comparative analysis of all the associations in that district as well as across the country. Such comparability has become increasingly important as the FCS experiences growing credit-quality problems, as I discussed in a recent white paper, “The Farm Credit System—Resolve Its Growing Credit-Quality Problems While Strengthening Its Regulation.”
The FCA should go further, though, in improving the financial transparency of the FCS’s four districts as well as individual associations by starting to publicize enforcement actions taken against individual banks and associations, just as the bank regulators have done for years. The third-quarter 2019 financial reports issued by the FCS banks indicated that all four banks had loans outstanding to an unstated number of associations they fund that merited a “special mention;” i.e., that unnamed associations had “internal control and other operational weaknesses … some of which were material weaknesses.” Association borrower/stockholders need to know if their association is one of the troubled ones. During this time of increased financial stress in agriculture and rural America, investors in FCS debt need to know how widespread financial problems are within the FCS. The FCA needs to share that information by disclosing its enforcement orders.
The other regulatory revision, labeled Amortization Limits, has been proposed by the FCA at the request of the Farm Credit Council, the trade association for FCS banks and associations. That makes the proposed regulation automatically suspect. Comments are due by March 23.
The council stated that the loan authorities of the Production Credit Associations (PCA) and Agricultural Credit Associations (ACA), which own the PCAs, “should be updated to reflect current [FCS] structure.” The heart of the proposed rule would “address factors that FCA expects direct lenders to consider as they develop credit underwriting standards and amortization schedules for loans that amortize over a period that is longer than their term to maturity;” i.e., a loan with a balloon payment.
The proposed rule would repeal several limitations on loan amortization periods. Instead, the FCA “views loan amortization as a credit underwriting issue, not a legal authority issue.” But the FCA added this cautionary note: the amortization period should not extend beyond the useful life of the asset being financed. The FCA goes on to note that the proposed rule “provides [FCS] institutions wide latitude to develop credit underwriting parameters that meet their borrowers’ needs for different types of loan products.” The FCA then adds that this regulatory framework would enable each FCS “direct lender association to tailor its loan underwriting standards to its own structure and operations.” What that statement means is anyone’s guess.
This is a very dangerous proposal because it would give FCS associations greater latitude to agree to longer amortization periods, even though the FCA states that “one of the purposes of this provision is to preclude short- or intermediate-term loans from being continually refinanced at maturity.” The consequence of this rules change could be the exact opposite as FCS lenders make loans more affordable for farmers by offering longer amortization periods, leading to larger balances (i.e., the balloon) to refinance when the loan matures.
Granting longer amortization periods is especially dangerous during this time of low interest rates when 58.7 percent of all FCS loans outstanding at Sept. 30, 2019, will reprice within one year and another 25.5 percent will reprice within one to five years. Given that interest rates are much more likely to rise over the next few years than decrease, farmers who have overextended themselves through dangerously long amortization periods could face serious cash-flow challenges when rates finally begin to rise. Those challenges would quickly clobber the FCS.
