Pub. 8 2019 Issue 5

September/October 2019 25 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 basis, the average acre of farmland then lost over one-third of its market value, leading to thousands of farm bankruptcies, the failure of several hundred agricultural banks, and such severe losses among FCS institutions that Congress had to bail out the FCS in 1987. 2 The 1987 bailout of the FCS led to significant consolidation within the FCS, with the overall number of FCS entities shrinking from 845 at the end of 1984 (37 banks and the rest associations lending directly to farmers and ranchers) to 196 on July 1, 1999, including the consolation of the regional cooperative banks into CoBank, which today has the exclusive authority within the FCS to lend to cooperatively owned agricultural businesses and rural utilities. 3 The FCS today Today, the FCS has just four regional banks, including CoBank, and 69 associations. The last FCS bank merger occurred on January 1, 2012, when U.S. AgBank merged into CoBank. Here is the link to a map of the territories served by the four banks (https://www.fca.gov/bank-oversight/fcs- directory-map ) The principal function of the FCS banks, other than CoBank, is to act as funding intermediaries between the Funding Corporation, which raises funds by selling in the capital markets notes and bonds known as the Systemwide Debt Securities. That is the debt guaranteed by the FCSIC. The Funding Corporation lends those funds to the four banks, with each bank in turn relending funds to the associations that are members of that bank. By being the dominant creditor of the associations it has lent to, each bank provides some financial oversight of those associations. That oversight supposedly complements the regulatory oversight and periodic safety-and-soundness examinations carried out by the FCS’s regulator, the Farm Credit Administration (FCA). Despite that duplicative oversight, or perhaps because of it, two FCS associations experienced significant financial difficulties in recent years. Farm Credit Services Southwest (FCSSW), which was funded by CoBank, stated in its 2014 Annual Report that it had had to restate its financial statements back to 2009 due to a sudden increase in delinquent loans resulting from potential fraud and “material weaknesses in internal controls related to credit origination, administration, and servicing procedures. 4 ” FCSSW subsequently merged into another FCS association, Farm Credit West, most likely at the insistence of the FCA. In August 2017, Lone Star Ag Credit, headquartered in Fort Worth, Texas, and funded and overseen by the Farm Credit Bank of Texas, issued a “Notification of Non-Reliance on Previously Issued Financial Statements” for 2016 and the first quarter of 2017 due to just-discovered “appraisal and accounting irregularities. 5 ” Unlike FCSSW, Lone Star was not forced into a merger (as of the publication of this paper). The diagram on page 5 of the 2018 annual information statement issued by the Funding Corporation 6 shows the relationship of the various types of FCS institutions with each other while the diagram on page 6 illustrates the flow of funds from investors in Systemwide Debt Securities issued by the Funding Corporation to FCS borrowers and the ultimate repayment of those funds to investors resulting from loan repayments by FCS borrowers. This map ( https://www.fca.gov/template-fca/ bank/20180101InstitutionTerritoryMap.pdf) shows the territories served by the 69 associations now in operation. 7 The tremendous variation in the size of the areas served parallels the enormous asset-size differential among FCS associations. As of March 31, 2019, the associations ranged from total assets of $29.88 billion (Farm Credit Services of America, which serves four states) and $23.71 billion (Farm Credit Mid- America, which serves all or portions of four states) to Delta ACA, which serves just five counties in southeast Arkansas, with $49 million of assets. The combined assets of all FCS institutions have grown steadily, rising from $214 billion at the end of 2008 to $261 billion at the end of 2013 to $349 billion on March 31, 2019, about the size as Bank of New York Mellon, the United States’ eleventh largest financial holding company. Despite the tremendous degree of consolidation within the FCS over the last 30 years, the FCS has retained its two-tier structure, with the four banks funding a declining number of associations, from 78 at the beginning of 2014 to 69 today. Further consolidation among the remaining four FCS banks is unlikely because of a little-known feature of FCS debt issued by the Funding Corporation – each additional bank merger would further weaken the joint-and-several liability the remaining banks would have for the Systemwide Debt Securities issued by the Funding Corporation. That is, if an FCS bank cannot pay the interest due on the funds it has borrowed from the Funding Corporation or repay the borrowed funds when due and the FCSIC lacks the funds to pay what is due, then the other three banks are jointly liable for that debt. 8 The next FCS bank merger, should it occur, would further weaken the joint-and-severally-liable feature now backing FCS debt by reducing to two the number of other banks liable for a troubled bank’s obligations if that bank could not meet its debt obligations in a timely manner. Each of the remaining banks would have to shoulder a larger portion of the defaulting bank’s debt, thereby increasing the likelihood that the other banks would default – all the dominoes would quickly topple. Most interestingly, the joint-and-several liability feature backstopping debt issued by the Funding Corporation does not extend to the FCS associations. While each bank “is authorized, under certain circumstances, to require its affiliated associations and certain other equity holders to purchase additional bank equity subject to certain limits and conditions . . . only the banks, and not the associations, are jointly and severally liable for the repayment of Systemwide Debt Securities. 9 ”