Annual Stockholders’ Report
Last year, I began my report with the proverb “May you live in interesting times”.
What was I thinking? I don’t think any of us even began to imagine what lay ahead of us.
Tonight, I’m intentionally not leading with a catchy proverb. What I will do is focus on one of the elements of our mission statement “…to be dependable in good times and bad…” and share with you a perspective on what’s happened, what’s happening and what all of that means for MidAtlantic and you.
When we met last year, Bear Stearns had just collapsed under the weight of its sub-prime mortgage loan investments and related credit commitments. The federal government engineered the sale of the company, literally during a weekend, and made loans and guarantees available that induced J.P. Morgan Chase to come to the rescue. The financial storm clouds that had been growing made their first strike in bringing down a major U.S. investment bank. As the year has shown, this was just the beginning of a much bigger storm.
The unraveling of risky mortgage loans and the complex securitization and credit default structures that were connected with those loans caused the financial storm clouds to grow. In the summer, nervous speculation about the risks of Fannie Mae and Freddie Mac became panicked reality. In late July, former Treasury Secretary Paulsen sought and received emergency authorities from Congress to support Fannie and Freddie in the unlikely event assistance was needed. In September, the unlikely became likely. The full force of the financial equivalent of a category 5 hurricane had hit. Over the course of just a few weeks, threatening clouds turned into pummeling storms that rocked the world’s largest and most venerable financial institutions. The bankruptcy of Lehman Brothers in September unleashed new fears about the stability of the U.S. and global financial systems. The collapse of institutions of long standing and strong reputation caused fear among investors world wide. Credit markets dried up as private capital fled to safe, short term investments.
Governments around the world rushed to action to promote the stability of the financial markets. Our own government led the charge. Unprecedented fiscal stimulus was sought by the Bush administration and approved by the Congress. Coincident with that, the Federal Reserve injected massive liquidity into the financial system; it lowered short term rates and began buying securities. The Obama administration and a new Congress have approved an emergency economic stimulus package, while the Fed has expanded its purchases of securities to provide liquidity in the markets. We’re in the midst of rebuilding the global financial system. While the panic of last fall has abated, there’s still unease and uncertainty in the marketplace. Are we focusing on the right problems? Are we taking the right actions? These are questions that are being asked and debated. Only time will tell.
Let’s talk about the implications of this for Farm Credit. First let me set some context. The Farm Credit System is a GSE (which is the acronym for Government Sponsored Enterprise). One of the crucial features of being a GSE is special access to the public debt markets. We were the first GSE, established in 1916 to ensure that farmers and ranchers had access to a steady supply of sound and constructive credit. The model was successful and other GSEs have since been established over the years to support public policy purposes, the most notable of these being Fannie Mae and Freddie Mac for housing. We pale in size to them. We have just over $200 billion in assets; Fannie and Freddie combined have over $5.3 trillion in loans and guarantees. That’s over 25 times the size of the Farm Credit System. There’s also another striking difference; we’re a cooperative and are owned by the people who use us.
Last fall’s credit crunch raised the cost of debt for all institutions that raise money in the financial markets. We were no exception; we saw our costs rise and the availability of longer term debt (by longer term, I mean anything over 3 years) virtually dry up. This happened in spite of our strong financial performance and our credit worthiness as an institution. Even so, we were able to fund all of our loan commitments as well as make new loans to new credit worthy customers. We continue to be able to do that today, thanks to our access as a GSE.
So, you might ask, where are we?
Agriculture on the whole is financially sound. Net farm income for 2008 declined to $77.3 billion but is still $5.5 billion over the 10 year average. Farm debt repayment capacity is strong. The balance sheet for the industry is stronger than at any point since 1960. That being said, it has experienced unprecedented volatility in commodity prices and input costs. Last summer, a barrel of oil traded from over $140. Today, its’ just under $50. Milk checks today are half of what they were a year ago. Think about what you could’ve contracted your corn or beans for this time last year, or last summer and what you actually got in the fall. And what if you were feeding that grain to livestock or poultry? Depending on where you ended up, your own financial condition could be much better or much worse than the average for the industry. All that’s to say that for those of us in the business of financing agriculture, we recognize there will be financial pressures and credit stress for some of our borrowers over the coming months.
The Farm Credit System on whole is financially sound. We earned record net income in 2008 of $2.9 billion, maintained capital at 12 % and boosted our allowance for loan and lease losses in recognition of general economic stress and emerging credit risk. The System’s credit quality continues to be strong but is beginning to show signs of slippage. We came through a challenging period of instability in the debt markets last fall and met our commitments to our borrowers. MidAtlantic, as one of 90 Farm Credit retail associations that serve this country, continues to achieve strong financial performance; our CFO will provide you more detail on that later this evening.
The next question is, what are we doing?
Let me take a few minutes to share just a few of the things we’re doing to ensure that we remain dependable in good times and bad.
Internal controls over financial reporting – We are deeply committed to clear, accurate and transparent financial reporting. We publish our audited financials on time. We have voluntarily implemented many of the requirements associated with Sarbanes-Oxley because we thought they represented best practices for the financial services industry. We follow the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We have continued our long standing engagement with PricewaterhouseCoopers to audit our financial statements and provide its independent opinion on the adequacy of internal controls. Just to give you an indication of what that means, I signed a 9 page letter that had 65 warranties and representations before PwC would issue its opinion on our annual financial statements. Our commitment is serious.
Liquidity – We plan for a rainy day. The System has established a liquidity standard minimum of 90 days. That’s to say that if there were an emergency that did not allow us to access the capital markets, we could continue to fund for 90 days. In light of what happened last year, we deliberately raised our actual liquidity levels to 177 days as of December 31, 2008. Now that may not sound like a lot, but in the financial world that can be almost an eternity. It allows us to fund your needs while seeking alternative funding sources.
Farm Credit System Insurance Corporation (FCSIC) – We believe in self help solutions to managing our business risks. Many of you may recall that we experienced our own credit crisis in the Farm Credit System in the 1980’s. We were bailed out by the government and we paid it all back, with interest. In keeping with the traditional modesty in the ag community we haven’t said much about that. As a part of that bailout, our regulator was strengthened and we established an independent insurance fund. That fund is administered by FCSIC and is available to ensure repayment to investors. It’s not been needed, but it’s there. Part of the interest you pay us goes to pay premiums to support that fund.
Managing credit risk – One of the lessons in the meltdown of loans and financial institutions over the past couple of years is that there’s a duty to manage the risk of individual loans as well as the combined risk of all loans. Each loan is a building block that ultimately makes up the financial house that customers rely on. Here’s how we do that. On the front end, we develop underwriting standards with an eye toward making loans that borrowers can reasonably be expected to repay. We’ve not changed our underwriting standards…because we didn’t loosen them to begin with. Once the loan is made, we work with borrowers on a case by case basis should problems arise. The other thing we do is make sure that we have a financially sound institution. We pay close attention to making sure we have adequate loan loss reserves and capital to support the risk in our loan portfolio. We retain some of our earnings to ensure stability of the association. I heard from many of you as I traveled through the area last fall…and you said…I want to know will I get the credit I need next spring?
Reputation Risk management – Warren Buffett said it well—“A good reputation takes twenty years to build and twenty minutes to ruin. If you think about it like that, you’ll do things differently.” A casualty of the financial markets turmoil has been the destruction of long standing reputations. Early last year, the Farm Credit System embarked on an effort to better understand where we stand with the people who depend on us. We conducted a national survey of customers, trade groups, investors, policy makers and regulators. We used an internationally recognized firm, Reputation Institute, which conducts an annual global survey of the reputations of the 600 largest companies in the world. We were pleased with what we learned; we scored higher than the leading company in the world, Toyota. We were humbled as well; we know that we have a duty to govern and manage to ensure that we maintain our reputation. If you think reputation isn’t important, ask yourself how willing you are to do business with the companies that have made the financial news in the last year.
Start Right – It’s easy to lose sight in the doom and gloom of the economy that real people, every day, are making decisions about entering farming. We’ve thought about that and our Board made a tangible commitment to helping new farmers get established by establishing the Start Right program. You might remember my introducing Start Right to you at last year’s annual meeting. The response has been exceptional: we’ve committed over $30 million toward loans with reduced initial rates that are targeted toward young, beginning and minority farmers to help purchase equipment, livestock, and land or implement environmental best management practices. We don’t compromise on our credit standards, but, we do work to put together financing packages to help people get off to a good start. Start Right’s about more than loans…it’s also about providing mentoring and education to give new farmers the support they need to be successful over the long term.
Valley merger – We were pleased that our neighbor, Valley Farm Credit, chose us to be their partner last year. We were even more pleased when you, our member owners, supported the Boards’ analysis and recommendation to merge. We’ve committed to going about the process of implementing the merger in much the same way as we approached our original merger in 2000. We’re working to make it seamless with an eye toward making our institution and the service we provide you safer, stronger and better in the long run.
There’s much, much more that we’re doing but I think these items give you some perspective on what we’re doing to ensure that we remain true to the vision of our founders in 1916. We are actively working to make sure that agriculture and rural America has access to a source of sound and reliable credit.
These are challenging days…for the world, our country and most importantly for the people who wake up every day, go about their work trying to build a better life for themselves, their families and their communities. People like you.
As we work through these times, know that we at MidAtlantic are partnering across the Farm Credit System to make sure that we can partner with you to have access to the credit you need. After all, it’s our mission…to be dependable in good times and bad.