By Bert Ely
The FCS’s uninsured deposits
Although not widely known outside rural America, Farm Credit System associations hold substantial amounts of uninsured deposits. These deposits usually represent that portion of an FCS loan that has been drawn down by a borrower but not yet spent. Instead, the borrowed funds are recorded in an account at the borrower’s FCS association while the borrowed funds are on deposit in the FCS bank which funds the association. This arrangement enables the borrower to earn some interest to partially offset loan interest. As such, these borrowed-but-not-yet-disbursed funds are an asset of the borrower and, importantly, a liability of the FCS.
While the funds the FCS borrows in the capital markets through the Federal Farm Credit Banks Funding Corporation are protected from any loss by the Farm Credit System Insurance Corporation, that insurance protection does not extend to deposits in FCS institutions. Therefore, should the FCS bank holding deposits in the form of undisbursed loan proceeds become insolvent and is placed in a receivership, the borrower/owner of those funds could suffer a loss. The total amount of these uninsured deposits, or whatever they should be called, is not insignificant. As discussed below, at the end of 2023, these deposits totaled $6.3 billion, spread across three of the four FCS banks.
FCS institutions are not authorized to accept deposits in the manner that banks do, but years ago the Farm Credit Administration and the Treasury Department constructed a legal justification for the manner in which deposits can be accepted by FCS associations, as follows:
- First, the Farm Credit Act permits each of the four FCS banks to issue bonds, both individually as well as collectively, through the Federal Farm Credit Banks Funding Corporation. Second, in 1990, the Treasury Department issued a letter to the Farm Credit Administration exempting FCS banks from key provisions of the Securities Exchange Act of 1934. This exemption permits each FCS bank to sell bonds directly to FCS member/borrowers as well as to FCS employees and retirees, without providing the disclosures usually associated with the sale of securities.
- An FCS association acts as agent in selling the bonds issued by the FCS bank that funds the association. Funds deposited with an association are immediately forwarded to its FCS bank to purchase the bank’s bonds with a face value equal to the amount deposited with the association. Consequently, the association has no liability for the deposits it accepts. The Treasury letter required that purchasers of these bonds (effectively FCS depositors) be given “printed materials [that] clearly state that the [farm credit bank] and not the association is the issuer” of the bonds, that the bonds “are not direct obligations of the United States,” and that the bonds “are in no way insured or guaranteed as to principal or interest by the United States or any governmental entity.”
It is highly unlikely that FCS “depositors” understand that they effectively have purchased an uninsured FCS bond.
Deposits held by three of the four FCS are as follows:
- “Member investment bonds” issued by AgriBank had grown to $3.96 billion by the end of 2023, more than four times the $939 million of such bonds outstanding at the end of 2016.
- At the end of 2023, CoBank had $2.34 billion of uninsured “cash investment services payable,” up from $1.03 billion three years earlier and $1.5 billion at the end of 2016. CoBank noted that these payables mature within a year but if such a bond can be redeemed overnight it effectively functions as a demand deposit.
- Deposits at the Farm Credit Bank of Texas, labeled Payable to Associations for Cash Management, totaled $43.67 million at the end of 2023, up substantially from $31.26 million at the end of 2021. The Texas bank calls this product Farm Cash Management, or FCM, which it describes as “a short-term investment account that automatically invests your excess funds and pays you a return, similar to a money market account.”
- AgFirst does not appear to offer these bonds, or an equivalent cash management account. Presumably, then, the associations AgFirst funds cannot accept deposits in connection with whatever cash management services they offer to their member/borrowers. Whether this, in fact, is the case has not been determined.
The FCS’s deposit-taking began in 1990 when the Treasury Department authorized the FCS banks to fund their balance sheets directly with farmers to complement funds raised through the FCS Funding Corporation. Today, however, more associations, in coordination with the FCS banks, are using that authorization for an entirely different purpose—to compete against commercial banks in offering cash-management services. Offering cash-management services is not why Congress created the FCS.
If added together, the FCS’s total deposits at the end of 2023 would only rank it about the 220th-largest bank in the country, measured in terms of total domestic deposits. In terms of uninsured deposits, though, the FCS would rank much higher on that list as most domestic deposits, even in the largest banks, are FDIC-insured or fully protected against any loss if the bank is too big to fail.
Congress will have an opportunity in the upcoming Farm Bill to address the possible systemic consequences to the FCS, to agriculture and to rural America if FCS borrowers with undrawn balances on their FCS lines of credit, become nervous about their ability to draw down on those balances should the FCS experience financial difficulties. Farmers and ranchers suddenly unable to obtain funds they are committed to repay would be very damaging not only to those borrowers, but to all of agriculture and to rural America, too.
FCA board adopts an “innovation philosophy”
On January 30, at the Farm Credit Annual Meeting, FCA Board Chairman and CEO Vincent Logan outlined four priorities that the FCA board has agreed upon to help prepare the agency for the future.
Logan’s most interesting priority is preparing both the FCA and FCS institutions for financial innovations. To that end, the FCA board adopted a policy statement setting out the FCA’s innovation philosophy. The innovations Logan is considering could possibly be highly problematic for bankers and need to be closely monitored.
The following phrase in the first paragraph of the statement, “the FCA is responsible for ensuring that . . . system institutions focus on serving all creditworthy borrowers . . .” should ring very loud alarm bells within the banking industry and in Congress given the competitive advantages FCS lenders enjoy by virtue of the very favorable tax treatment they receive under the Farm Credit Act, especially on their ag real estate lending, and their relatively cheap funding due to their GSE status.
Since commercial banks have always focused on serving creditworthy borrowers, as should any lender, what public purpose is served by a taxpayer-subsidized government lender providing credit to farmers and ranchers who can readily borrow from tax-paying banks? Put another way, since Congress created the Department of Agriculture’s Farm Service Agency to provide credit to marginally creditworthy farmers and ranchers, what public purpose does the FCS serve today?
What happens to the FCS if there is another ag crisis?
It has been almost four decades since America’s last ag crisis, which effectively bankrupted the FCS. Hopefully there will never be another ag crisis, but should one occur, this question will immediately arise: Can the Farm Credit System Insurance Corporation fully protect investors in FCS debt against any loss or disruption in the payment, when due, of interest and principal on that debt?
Congress created the FCSIC in 1987 to enhance the financial integrity of the FCS by ensuring the timely payment of principal and interest on FCS debt issued by the FCS’s financing arm, the Federal Farm Credit Banks Funding Corporation; FCSIC is the FCS’s equivalent of the FDIC. At the end of 2023, the FCS had $367 billion of FCSIC-insured debt outstanding; the FCSIC’s fund balance or capital was $7.46 billion, just 2.03% of the debt it insured. While that percentage is higher than the comparable ratio for the FDIC’s Deposit Insurance Fund, the FCSIC’s capital could turn out to be a pretty thin loss cushion if agriculture and rural America experience an ag crisis comparable to the last crisis.
If an ag crisis does erupt that causes material losses to FCS institutions, especially among the smaller associations, the FCA most likely will respond as it has in the past, which would be to merge financially impaired associations into larger and presumably stronger associations. These mergers would, though, lead to a FCSIC with fewer, yet far larger insurance risks, an actuarial weakness that should raise congressional concerns about the long-term financial viability of the FCSIC. The ag committees need to address this issue before another ag crisis erupts.
In the meantime, in the spirit of its new innovation philosophy, the FCA board should adopt a fifth innovation priority—determining what the FCA should do to prepare the FCSIC for resolving a large, troubled FCS association as the number of associations continues to shrink.
Editor’s note: If you have questions for Bert, feel free to email him at [email protected].
