Pub. 4 2015 Issue 1

l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s 22 BERT ELY’S FARM CREDIT WATCH ® SHEDDING LIGHT ON THE FARM CREDIT SYSTEM, AMERICA’S LEAST KNOWN GSE ©2014 Bert Ely Loan fraud strikes FCS association? Details are still sketchy, but Farm Credit Services Southwest (Southwest), which serves most of Arizona as well as California’s Imperial Valley, has been hit by an accounting scandal so severe that Southwest eliminated the links on its website to its prior financial statements. Worse, the Farm Credit Administration (FCA), the FCS regulator, has removed the links on its website to all the call reports Southwest filed after 2009. According to an update Southwest posted on its website last month, the Southwest board determined that Southwest financial statements issued since 2009 “can no longer be relied upon. Accordingly, the Association expects to restate such financial Statements.” In the seventeen years that I have been writing the FCW, I have never seen such an announcement. Southwest further stated that “during the third quarter of 2014, Association management noted a sudden significant increase in the level of delinquent loans affecting an identifiable portion of the Association’s lending portfolio. An in-depth investigation is currently being conducted regarding the cause of this unexpected increase, including the potential for fraud, internal and/or external.” Southwest, in an attempt to reassure its borrower/stockholders, stated that “these [restatement] amounts are not expected to exceed 25 per cent of total members’ equity... [and are] the result of a material weakness in certain internal controls.” Southwest, headquartered near Phoenix, had $1.04 billion of assets at June 30, 2014, according to call report data I downloaded before the FCA pulled Southwest’s call reports. Interestingly, according to the most recent of the currently available call reports, Southwest had $1.09 billion of assets at the end of 2009, which means that Southwest shrank slightly from the end of 2009 to mid-2014. Its loan book also shrank over that period, from $1.03 billion to $956 million. However, Southwest’s net worth rose from $127 million to $190 million, which indicates that it was profitable over that period of time. If the accounting restatement results in a loss equal to 25% of Southwest’s net worth, that suggests that the recently discovered loan problems entail a credit loss in the range of $50 million, or about 5% of its outstanding loans at June 30, 2014. On that date, Southwest had $16.7 million of nonaccrual loans and a loss reserve of just $3.2 million, which gives an idea of the magnitude of the lending problems that have been uncovered. In the FCS’s Information Statement for the third quarter of 2014, a note on the FCS’s financial statements, reported that its financial statements for the “quarter ended September 30, 2014 includes an out-of-period adjustment to the provision for loan losses for $42 million and the transfer of $49 million in loans to nonaccrual status.” Of course, if there was widespread loan fraud within Southwest, compounded by weak internal controls, then the hit on Southwest’s net worth could be much worse. A recent news report indicates that a large dairy operation in a Chapter 11 bankruptcy proceeding owes Southwest approximately $19 million. According to a Bankruptcy Court filing, the debtor blames its problems on a “2011 milk crisis.” If Southwest was a heavy lender to dairies, dairy loans may be a key element of Southwest’s problems as dairy loans have caused significant losses at other FCS associations,. The big unanswered question so far is who on Southwest’s management team was responsible for these lending problems and the breakdown of internal controls? I could find no news reports about Southwest’s problems, but a May