Statement before the subcommittee on conservation, credit, energy and research.
Statement by Mr. Bob Frazee, President and CEO
MidAtlantic Farm Credit, Westminster, Maryland
Before the Subcommittee on Conservation, Credit, Energy and Research
House Committee on Agriculture
June 11, 2009
Mr. Chairman and members of the subcommittee, thank you for the opportunity to testify today on behalf of the Farm Credit System. My name is Bob Frazee, and I am President and CEO of MidAtlantic Farm Credit. MidAtlantic is a part of the nationwide Farm Credit System. My remarks today will provide some background on the Farm Credit System, comments on current credit conditions and the impact of recent financial market disruptions, and discuss how we are working to meet the credit needs of agriculture in the geographic area served by my institution.
Background on the Farm Credit System
Established in 1916, the Farm Credit System is a unique set of 95 private institutions, including five funding banks (four Farm Credit Banks and one Agricultural Credit Bank) and direct-lending associations, all of which are cooperatively owned by farmers, ranchers, agricultural cooperatives, rural utilities and others in rural America. We are chartered by the Federal government to provide credit and other related financial services to our owners and others consistent with the eligibility criteria set out in the Farm Credit Act.
MidAtlantic is one of these 95 Farm Credit cooperatives. We are owned by more than 10,500 farmers that borrow from us in the states of Maryland, Delaware, and parts of West Virginia, Virginia, and Pennsylvania. As President and CEO, I report to a 23 member Board of Directors. Twenty-one of these directors are farmers elected by the members of the cooperative. MidAtlantic is required to have at least one appointed outside director that has financial experience, and we have chosen to have two. In no case are employees allowed to serve as directors.
There are 90 independently operated Farm Credit associations like MidAtlantic serving agriculture throughout the United States and Puerto Rico. Every Farm Credit association is organized as a cooperative that is owned and governed by its farmer-members. Our Board of Directors is responsible for establishing our institution’s capitalization plan consistent with Federal regulations and for ensuring that management makes available loan products and financially related services appropriate to the unique needs of agriculture in the geographic territory that we serve.
Each Farm Credit association obtains funds for our lending programs from one of five wholesale Farm Credit banks. At MidAtlantic, we get our funding from AgFirst Farm Credit Bank (headquartered in Columbia, SC), which is cooperatively owned by twenty-two local associations. The five System banks own the Federal Farm Credit Banks Funding Corporation (located in Jersey City, NJ), which, as agents for the banks, markets to the investing public the Systemwide debt securities that are used to fund the operations of all Farm Credit System institutions. Unlike commercial banks, Farm Credit institutions do not have access to insured deposits guaranteed by the FDIC and backed by the U.S. Treasury as a source of funding for our operations.
Regulatory Oversight by the Farm Credit Administration
All Farm Credit institutions are regulated by the Farm Credit Administration (FCA), which was created by Congress and is subject to this committee’s oversight. The Farm Credit Administration is an arm’s-length, independent safety and soundness regulator. FCA’s three board members are nominated by the President and confirmed by the Senate. The FCA has all of the oversight and enforcement powers that every other Federal financial regulatory institution has to ensure that Farm Credit institutions operate in a safe and sound manner. In some instances, FCA has more authority than other comparable Federal regulators.
I compliment this committee for its instrumental role in reconfiguring the FCA in the mid-eighties. The decisions made by this committee shaped the System’s regulator, providing a regulatory framework second to none among Federal financial institution regulators. Should this Congress move forward with reforms for other financial regulators, we ask that you vigorously resist any proposal to include FCA in those efforts. I strongly believe the Agriculture Committees have done an excellent job providing the appropriate statutory framework and ongoing oversight of FCA. Including FCA in a financial institution regulatory reform effort likely would cause serious repercussions for agriculture in what already is a difficult and stressful environment. Simply put, let’s not fix what isn’t broken.
The Farm Credit System’s mission, ownership structure and authorizing legislation is unique among financial institutions. For farmers, ranchers and the cooperatives that they rely on, it is critically important that our safety and soundness regulator understands our unique mission and what it takes to be successful in accomplishing it. Changing this would threaten our ability to accomplish the mission set out for us by this Committee in the Farm Credit Act.
Fulfilling Farm Credit’s Mission of Serving Agriculture and Rural America
MidAtlantic Farm Credit, like all Farm Credit System institutions, focuses on accomplishing the mission established for us by Congress: to serve agriculture and rural America. We do not take our Congressional charge lightly. Our cooperative structure and governance is designed specifically to ensure that our lending and financially related service activities are driven by the needs of our farmer-members and to ensure that there is a reliable and competitive credit source available to agriculture that farmers own and control. Our practice is to engage our customers in a consultative lending relationship, using our accumulated expertise and knowledge of agriculture and finance to craft long term lending relationships that are often delivered across the farmer’s kitchen table
We understand that farming isn’t a short-term investment for our member-borrowers. Our cooperative structure allows us to work with our farmer-owners with an approach that is not focused on achieving quarterly returns to impress investing stockholders. We know that when we work with our customer-owners to help them achieve success in their business, our business will succeed as well. Our lending relationship with our member-borrowers is based on constructive credit over the long haul — we do not enter and exit agricultural lending as farm profitability waxes and wanes.
Distributing Profits to Farmers through Patronage
Our commitment to our farmer-members’ business success is demonstrated further by the fact that we share our profits directly through patronage dividends with the farmers that borrow from us. Each year, the MidAtlantic board of directors makes a determination based on our profitability and financial strength as to what portion of our net earnings will be returned directly to the farmer-members that own our institution.
In just the past four years, MidAtlantic has sent back over $110 million dollars in earnings as patronage dividends to the member-borrowers of our cooperative. During the same period, the Farm Credit System in total has returned some $2.6 billion to our customer-owners. That is money that stays in agriculture and rural America and helps our members be successful.
Farm Credit’s Financial Strength
I am pleased to report that the Farm Credit System remains very strong financially. At the end of April, the Federal Farm Credit Banks Funding Corporation reported the System’s combined financial results for the first quarter of 2009. Net income earned was $615 million with total loans of about $162.3 billion. The System provided almost $1 billion in new credit to agriculture during the first three months of this year. Reflective of the overall economy and growing stress in certain segments of the farm economy, we are seeing demand for credit decline as farmers become wary of expanding operations, purchasing new equipment, or taking on additional risk at this time of economic weakness.
Current Conditions in Agriculture
I also am pleased to report to you that MidAtlantic Farm Credit has not changed its lending standards in response to the current financial and economic disruption. This is particularly important to farmers in that there are now fewer choices of agricultural lenders available.
Let me give you some highlights regarding what we are seeing in MidAtlantic’s territory when it comes to the local farm economy and credit conditions.
Poultry represents 21% of our portfolio. For several years, the industry has been increasing production. In 2008, it found itself in a position of high production costs plus high levels of inventory. This resulted in significant cash flow losses for the integrators, who reduced production and conserved cash. We have been working with individual borrowers to help maintain their cash flow during these times of lower prices. We expect the industry will work through the current distressed environment and return to profitability.
Cash Grains represents 19% of our portfolio. Demand for local grain continues to be good, but is highly dependent on poultry production. Demand for grain continues to keep land in production, but pressures from development and environmental concerns will continue to challenge producers.
Dairy is 11% of our portfolio. Low milk prices and high input costs throughout 2008 have resulted in numerous herd sales within our territory. We have contacted all of our dairy borrowers individually (most recently in April) explaining the options for sustaining their business. Milk prices will be determined by cow numbers, total milk production and dairy exports. Slaughter for the year is 12% above last year and we hope that the positive signs in milk futures will mean higher prices in the next six months.
In addition to the key sectors mentioned above, we also serve operations that produce fruit, vegetables, livestock, as well as those involved in timber and forestry, nursery and greenhouse, and equine operations. Where operations touch the housing industry, we expect to see some stress occurring.
A Commitment to Serving Young, Beginning and Small Farmers
The Farm Credit System’s commitment to agriculture not only extends to these typical farming operations, but also to those young, beginning, and small farmers who may need some assistance as they start out in agriculture. Every Farm Credit association has programs in place targeted specifically at meeting the needs of three special categories of borrowers, those that are young, those that are just beginning in farming, and those that are small farmers. At MidAtlantic Farm Credit, we call ours the “Start Right” Young, Beginning, Small, and Minority Farmer program.
The Start Right program offers lower interest rates, while maintaining our credit standards. In fact, since last April, we’ve written over $45 million of new loans to Young, Beginning, Small and Minority Borrowers in our territory. In addition, we are now piloting a national online business-planning course targeted at young, beginning, and small farmers. This is part of our commitment to training future farmers the good credit habits and skills that will help make them successful business people in the future. This program encourages skill attainment by integrating training with access to lower rates.
One of these farmers is 27-year old Jeremy Larimore, who now owns a small poultry farm on Maryland’s Eastern Shore, along with 30 acres of grain and soybeans. Jeremy didn’t grow up on a farm, but he worked on farms owned by his uncles, and he realized early that that’s what he wanted to do. Seven years ago, when he was twenty, Jeremy wanted to buy a used combine so that he could do some custom harvesting for his neighbors, bringing him closer to his dream. Farm Credit helped him finance the combine.
Jeremy’s Farm Credit loan officer was impressed with Jeremy’s drive and business sense. The two stayed in touch for years, talking about how Jeremy could purchase his own farm. In 2005, when Jeremy was just 24, the opportunity arose for him to purchase 33 acres with four poultry houses on it. Jeremy has said that without Farm Credit, he would still be dreaming of buying that farm.
Today, Jeremy leases an additional 100 acres, for a total of 133, and his four poultry houses account for about 90,000 chickens per flock. He’s currently talking to his loan officer about opportunities for buying more land.
When it comes to serving the needs of small farmers, the Farm Credit System stands out. Recently, the American Bankers Association released its report on “farm bank” performance in 2008. They indicated that the 2,247 banks that met their definition of a “farm bank” had some $32.8 billion in credit outstanding in small farm loans (those with an original loan size of less than or equal to $500,000). In comparison, the 90 associations of the Farm Credit System had slightly more than $58 billion of similar sized loans outstanding at the end of 2008.
Even if we are to look just at the new credit extended in 2008, the System clearly continues to demonstrate its commitment to the next generation of farmers. Farm Credit institutions provided new loans and commitments totaling almost $12 billion to beginning farmers last year (those with 10 or fewer years experience). USDA’s FSA beginning farmer loan programs totaled $1.24 billion in fiscal year 2008. Unfortunately, there is no comparable data available from commercial banks since they are not required to collect this same data.
USDA Programs and Farmer Mac Help Farm Credit Serve Agriculture
At MidAtlantic we make significant use of USDA’s Farm Service Agency (FSA) loan guarantees to support our lending. We are pleased that our experience and excellent credit management practices have allowed us to be recognized as an FSA preferred lender. At the end of May, we had over $74 million in our portfolio that had FSA guarantees. We believe about 60% of all System associations are FSA preferred lenders.
The guarantees available through FSA are an important tool that allows us to serve higher risk credits that might not otherwise meet our underwriting standards. The Farm Credit Act requires that we focus our resources on meeting the needs of credit worthy borrowers. The FSA guarantees permit us to reach some individuals that we might not otherwise be able to serve. In fact, in the story I just mentioned about Jeremy Larimore, we used both FSA direct money, as well as an FSA guarantee to make the loan work.
Another USDA program which benefits our farmer-members is the Risk Management Agency’s (RMA) crop insurance program. Crop insurance is an important tool for our farmer-members to use in mitigating the risk in their operations. MidAtlantic writes almost 25% of the crop insurance policies in Maryland. Last year, we paid out $10.3 million in claims.
These two programs are very important tools in ensuring that we can stay with borrowers in stressful times—especially those who are just getting started and likely have inadequate equity, as well as those that have experienced losses due to adverse weather or economic conditions.
One other tool that this committee has made available to agricultural lenders is the Federal Agricultural Mortgage Corporation or Farmer Mac. At MidAtlantic we have used Farmer Mac to help us manage the risk of portfolio concentration in certain agricultural sectors and to help manage our capital position. At the end of 2008, we had almost $16 million in loans in Farmer Mac’s long-term standby program, all of which are 100% guaranteed. Farmer Mac serves an important function for our institution, and we look forward to continuing to utilize it in the future.
In addition to the tools mentioned above, Farm Credit institutions also work with many commercial banks of all sizes. When your focus is on meeting the needs of the customer, reaching out to a competitor easily morphs into finding partnerships that work for the customer. These relationships allow us to better manage risk and permit us to provide the customer with what they need to succeed. When there are services that our borrowers need that they can’t get from us it makes sense for us to partner with others who can provide those services. We have worked with local commercial banks on loan participations. We have both bought these participations, and sold them. This allows us to diversify our portfolio, manage our risk, and continue to serve our marketplace.
Farm Credit institutions also work with many commercial banks as we participate in the pilot program established by the Farm Credit Administration that permits System institutions to make mission-related investments. Many of our borrowers, especially the young ones, depend on off-farm employment to help pay the bills as they get started in agriculture. Permitting Farm Credit institutions to help rural communities by making mission-related investments just makes good sense especially now when so many other sources of investment funds have evaporated.
Serving the Vital Needs of Rural Communities and Global Markets
Lending to companies that serve the needs of rural communities in the energy, communications, and water industries is a growing part of Farm Credit’s overall business. Customers in these industries include rural electric generation and transmission cooperatives, electric distribution cooperatives, independent power producers, rural local exchange carriers, wireless provides, cable television system, and water and waste water companies. Farm Credit loans to these customers increased to $14.2 billion at the end of the first quarter this year from $10.8 billion at the end of 2007.
Much of the loan growth to these customers came as the broader debt capital markets contracted as part of the overall financial market crisis. The Farm Credit System, primarily through CoBank (the one Farm Credit bank that operates as an Agricultural Credit Bank) has increased its lending to these customers ensuring that a continued flow of competitively priced credit is available to them. The System’s ability to expand financing to these customers has been critical as many of them, electric co-ops especially, have been forced to modernize facilities and expand operations as demand for electricity has boomed across rural areas.
Similarly, as global credit markets contracted, demand for credit around the world to purchase U.S. agricultural export products increased. Loans made by CoBank to facilitate the export of U.S. farm products increased from $2.1 billion at the end of 2007 to $4.5 billion at March 31, 2009.
Impact of Financial Market Disruptions
Because the Farm Credit System relies on our access to the financial markets for the funds we need to make credit available to our borrowers, a disruption in the efficient operation of those markets can adversely impact agriculture. Over the last year the nation’s financial markets have changed dramatically and this has impacted not only our cost of funds but also the term of the funds that are available.
At this time last year of our nation’s grain marketing cooperatives were faced with the need to meet unprecedented levels of margin requirements due to the volatility of commodity prices. They turned to the Farm Credit System because they knew we could access the capital markets to get them the credit they needed at a moment’s notice. Farm Credit increased its borrowing from the market by $21 billion through the first half of 2008 just to meet these and other needs. The market understood our financial strength and our unique status as agriculture’s GSE. Margin calls were met and what could have been a disastrous situation was averted because of that access to the financial markets.
The dynamic of the financial markets changed quickly late last summer in some very unusual ways. While the Federal conservatorship of Fannie Mae and Freddie Mac had disastrous impacts on their equity holders, it positioned them in the debt markets as having greater links to the Federal government, and ironically created the perception in the eyes of investors that they are a less risky credit. This was underscored further when the Treasury made available a direct line of credit for Freddie Mac and Fannie Mae as well as their sister housing GSE the Federal Home Loan Bank System.
Then utilizing direct backing through the FDIC, the Federal government provided commercial banks the ability to issue debt that essentially has a direct Federal guarantee standing behind it. These same banks also have Treasury’s backing of the FDIC to facilitate them generating loanable funds through bank deposits. And this Federal FDIC backstop has just been expanded substantially.
Complicating the national and international debt markets even further has been the heavy issuance of U.S. Treasury securities to finance our Nation’s deficit and the substantial increase in foreign government backed debt hitting the markets and competing for investors. We have seen the investment banking sector collapse that we had relied on to facilitate transactions between sellers and buyers of debt. The severe economic stress also has resulted in very few investors being interested in term debt that exceeds three years in maturity.
While we continue to access the funding we need to serve our marketplace, the changes and disruptions in the national financial markets have markedly changed the landscape for us. Decreased access to longer-term debt and pricing volatility has presented a challenge. While the environment has settled since the beginning of 2009, it would be a mistake to conclude that we are back to normal. The Farm Credit securities margin spread over 5-year U.S. Treasury bonds makes the point:
Pre-2007 norm 32 basis points 0.32%
Fall 2008 peak 215 basis points 2.15%
April 2009 92 basis points 0.92%
The result is that farmers seeking to reduce the volatility of their interest expense by locking in longer-term, fixed rate loans at low rates do not have options that are available to the average homeowner. Low cost home mortgage rates are available to homeowners because of direct government intervention targeted at helping them. The Federal Reserve action to purchase mortgage-backed securities has improved pricing in the home mortgage market, but similar action is not being taken to address the needs of agriculture.
To summarize, commercial banks have been extended a direct Federal guarantee on their debt issuance and access to Federal capital support. The housing GSEs have enhanced support from the Treasury to facilitate their access to the debt markets. Actions are being taken to facilitate the liquidity of mortgage-backed securities. Farm Credit institutions have no such guarantee, no access to capital support, no explicit borrowing line with Treasury and no Federal backstop for our insurance fund.
Despite the fact that we have had no assistance from the government throughout these times of extreme stress in the financial markets, we are very proud to report to you that we have not had to deny a single farmer, cooperative or other eligible borrower access to credit because we could not access the Nation’s money markets. This is testament to the financial strength that the System has carefully built up during good times through cautious lending and the accumulation of appropriate capital reserves.
Trust has been built with our investors, who know that the Farm Credit System has never failed to meet its obligations. They are secure in the knowledge that System management and directors are intent on preserving this fine organization to ensure that farmers will continue to own and govern their credit source through their cooperative in the future. However, Farm Credit’s operational prudence notwithstanding, last fall’s financial market turmoil demonstrated to us that our ability to access the necessary funding to meet our mission to agriculture and rural America may be at risk if circumstances beyond our control disrupt our market access.
Loan Restructuring Available for Farm Credit’s Farmer-Owners
As economic stress increases in agriculture we stand ready to work with our customers as they deal with their individual challenges. Farm Credit System institutions have operated with specific “borrower rights” requirements for over twenty years. We are required to follow “least cost” restructuring requirements for farmers that can’t meet the terms of their loans. In addition, if a farmer that applies for a loan or one that has a loan with us is faced with a credit decision they believe is adverse to them, they have a specific right to appeal that decision before a credit review committee that must involve a local elected farmer-director from the board of their institution.
You have probably heard us say that Farm Credit serves agriculture in good times and in bad. Borrower rights are one of the ways that we serve our marketplace when the environment is more bad than good.
I’ll give you a recent example of this: for years, MidAtlantic has had a lending relationship with a customer whose business is sensitive to the general economy and in particular the housing industry. Although this business was well managed, it began to experience the financial stresses that came with the downturn in the housing industry in 2006. As you might imagine, those stresses have continued and grown.
In response, MidAtlantic has worked with this borrower by employing a variety of tools from our borrower’s rights guidelines: we have advanced additional monies during this time, provided principal forbearance, and relaxed the financial covenants that had been placed on the account. Our goal in taking these actions has been to help this account return to profitability.
As recently as last month, we completely reworked the credit, advancing more new money for the purchase of equipment, and working with the borrower to help them secure funds from the Pennsylvania Machinery and Equipment Loan Fund (MELF), as well as a USDA Business and Industry Guarantee.
We assume, and we hope, that the housing industry will turn around. In the interim, what we’ve done for the borrower — and what the borrower has done for themselves — has given them an opportunity to stay in business during an extremely challenging down cycle. This company has a strong management team, they have implemented efficiencies that are serving them well now and will serve them even better when things do improve.
At Farm Credit, we know that the economy, markets and commodity prices are cyclical. That comes with 93 years of experience. When we say we’re there in good times and in bad times, we mean it.
The Farm Credit System is financially stable, economically vital, and serving its mission for agriculture and rural America well. We continue to make credit available to all segments of agriculture including commercial producers as well as young, beginning and small farmers. We have stepped up our lending to vital rural infrastructure companies. There is no taxpayer support of the Farm Credit System. There are no federal dollars invested in the Farm Credit System. We even pay for the expense of being regulated by the federal government through an assessment on all Farm Credit System institutions.
As a network of agricultural and rural lending cooperatives owned by the farmers, cooperatives, and rural utilities that borrow from us, we have the built in oversight mechanism of our owners holding our feet to the fire to keep service quality high. We understand that Farm Credit’s success depends on our customers’ success. To continue serving our mission, we must have continued, effective access across all terms to the national debt markets and an independent, arm’s-length regulator that comprehends the unique requirements of agriculture.
I am testifying to you as a leader of a nationwide lending institution in a climate of lapsed supervision by regulators and mistrust of institutional intent. But it should not surprise you that I am reporting on our successes and service to mission. The Agriculture Committee understands why the Farm Credit System exists, and our continued success is due in part to the fact that this Committee had the foresight to change our structure more than 20 years ago while strengthening our regulatory oversight to ensure our safety and soundness.
We are proud of our commitment to rural America. We have maintained our focus and continually work to meet our mission. Certain parts of agriculture are facing some challenging economic times that may test the resolve of many. We urge that you continue to monitor this situation closely and continue to provide both FSA and Rural Development at USDA with the funding resources and flexibility they need so that an adequate guaranteed loan program remains available. And we urge that you continue to monitor the Federal programs that are being put in place to address the upheaval among commercial banks and the disruption of the money markets to ensure that agriculture is not disadvantaged in its access to the Nation’s money markets
Mr. Chairman, thank you again for the opportunity to testify today on behalf of MidAtlantic Farm Credit and the Farm Credit System. I will be pleased to respond to your questions.