The Farm Credit System last month released its first quarter 2020 Quarterly Financial Information Statement, which stated that during March, “as a result of the unprecedented global COVID-19 pandemic and the instability in the global financial markets, the [FCS] issued short-term debt securities as necessary.” Actually, the FCS’s issuance of these short-term securities, called discount notes, nearly doubled during the first quarter, rising by $17 billion between the end of 2019 and March 31, 2020. That increase accounted for 80 percent of the FCS’s first quarter rise in total system-wide debt outstanding. Rather than lending all of those funds, the FCS boosted its cash position by $13 billion, and its investments and federal funds sold by another $2.7 billion.
Although the FCS did not explicitly state why it increased its cash and liquid investments so substantially, it did note “investors’ willingness to purchase long-term fixed-rate non-callable debt and callable debt during this period declined.” In effect, the FCS wisely chose to boost its liquidity by selling very short debt and depositing those funds at the Federal Reserve because it could then meet future loan demand and bond maturities by drawing down its cash position rather than selling longer-term debt at relatively high yields.
CoBank’s first-quarter investor presentation includes on page 13 a chart―Farm Credit System Spreads to U.S. Treasuries―showing how sharply the interest rate spread of FCS securities over Treasuries has widened in recent weeks, especially at the longer end of the yield curve. That widening, reminiscent of the even greater widening that occurred in the aftermath of the 2008 financial crisis, reflects increased investor concern about the FCS’s creditworthiness. The wider the spread, though, the less competitive the FCS is in competing against commercial banks for new loans.
The FCS most likely will maintain this very defensive liquidity position―in effect, insurance against illiquidity―until the interest rate spread of FCS debt over Treasuries shrinks to a more typical range. How long that will take will be a function in part of how well the farm economy performs in the coming months. The recent widening of this spread, and the FCS’s response to it differs quite dramatically from how the FCS responded during the 2008 financial crisis. During that crisis, the FCS was much less aggressive in building up its cash position while, surprisingly, reducing its short-term funding with discount notes.
That crisis, though, led to the creation in 2014 of the $10 billion line-of-credit that the FCS Insurance Fund has with the Treasury Department’s Federal Financing Bank. That line, which has never been drawn down, supposedly would be tapped only if the Insurance Fund needed cash to resolve an insolvent FCS bank or association. It is possible that the FCS, perhaps at the direction of the Farm Credit Administration or the Treasury Department, has built up its cash position to reduce the likelihood of having to draw on the line of credit. Possibly, though, the line-of-credit will be tapped if doing so would signal to the financial markets that taxpayers still stand behind FCS debt; that signal would likely lead to a narrowing of the FCS-Treasury spread, thereby enhancing the FCS’s competitiveness against its taxpaying competition.