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No CoBank Oversight Leaves Co-Op Devastated

The Farm Credit System (FCS), a $333 billion giant in agricultural lending, plays by different rules. Unlike rural community banks and other financial institutions, which answer to an alphabet soup of agencies, Farm Credit institutions answer primarily to the Farm Credit Administration (FCA). The FCA doesn’t do much by way of enforcement, leaving Farm Credit associations across the country to mostly regulate themselves. But shady activity is happening under the noses of Farm Credit institutions all across the country.

Farm Credit East in Connecticut. Capital Farm Credit in Texas. And third time’s the charm: CoBank.

Ashby, Minnesota is home to Ashby Farmers Cooperative Elevator, a cooperative with a financial relationship with CoBank, one of the FCS’s banks, and the only FCS institution permitted to lend to cooperatives. Unfortunately for members of the Ashby Farmers Cooperative Elevator, the cooperative has hit tough times. Its long-time manager, Jerry Hennessey, “is alleged to have stolen some $2 million in at least the past 10 years, a time when he was known to go on safaris and other expensive big-game hunting trips.”

That’s a lot of money lost, meaning a lot of farmers and producers harmed. For any business or cooperative, it’s up to its partners – including its lender – to be vigilant and conduct due diligence. So what could CoBank have done to prevent this?

According to the attorney tasked with picking up the pieces of this disaster, “A co-op is not required to conduct an annual financial audit, although the bank’s lender, CoBank, could have required one.” And now CoBank is out $8 million.

Why didn’t CoBank require an audit of its clearly troubled, cash-strapped customer?

CoBank is a massive financial institution, with more than $131 billion in total assets. “CoBank is massive, maybe it let one slip through the cracks,” its defenders might say. But if CoBank is so big that it can’t pay proper attention to its customers, then should it be that size at all?

And even more troubling is that CoBank, with its size and resources, should have been able to perform an audit to see whether something was amiss at Ashby Farmers Cooperative Elevator. This wasn’t just a simple oversight by a small Farm Credit association – this was a massive blunder by the biggest, most well-equipped Farm Credit institution. If CoBank is letting things slip, then what’s happening at the smaller associations that don’t have nearly the same resources?

You’d think that after the first few instances of fraud or less-than-savory dealings, the FCS, and FCA, would buckle down and investigate the shady activity at Farm Credit associations. But now this issue has spread to larger Farm Credit institutions.

REGULATORY CALENDAR – PART I: Does FCS Really Face “Regulatory Burden?”

The Farm Credit System (FCS) is a massive, nearly $330 billion institution that would be the seventh largest bank in the country, if it had the same stringent regulation that other financial institutions have. It doesn’t – instead, it is regulated by the Farm Credit Administration (FCA), which routinely fails to crack down on some of the FCS’s worst offenses.

But to its credit, the FCA has published its plan for new regulations and policy initiatives that it will introduce or develop within the next year. That’s where the kudos ends.

The regulations it plans to introduce – or has already introduced and will develop further – aren’t great. But one regulation – oddly enough, on “Regulatory Burden” –  is in its final stage before implementation.

First, its premise is laughable. If anything, the FCA should be putting out a call for more ideas to implement through regulation, not fewer. The FCS is already wildly underregulated, allowing it to make ridiculous loans for server “farms,” twist the law to justify de facto deposit-taking accounts and extend loans for property under the flimsiest of pretenses.

But FCS institutions are taking advantage of this call to reduce “regulatory burden.” As part of the regulatory implementation process, the public may submit comments on the proposed rule before it is finalized, and CoBank, the System’s largest institution with hundreds of billions in assets, has thrown in its two cents.

Among the many regulations that CoBank considers “burdensome” is one concerning financial crimes, how to report them and when to report them. The long and short of it: CoBank wants to use one fewer form for reporting financial crimes. And it wants to use just one form for “any known or suspected criminal activity involving a financial transaction in which the institution was used as a conduit for such criminal activity (such as money laundering/structuring schemes)” where the reporting threshold is $5,000.

It’s rich for CoBank to issue a comment on burdensome paperwork. This sort of paperwork for suspected money laundering exists, in the first place, to prevent money laundering and other financial crimes. And yet, under CoBank’s watch as the supervisory bank, Farm Credit East likely aided in money laundering by “creating a shell corporation to funnel federal money.”

The watchdog fell asleep, and now it’s asking for a treat?

The premise of the regulation – an ineffectual regulator asking for ways to become even more useless – is already ridiculous. But seriously entertaining the ideas of an entity that fell asleep at the wheel, ideas that are directly related to one of its more recent and egregious offenses? That’s a bit too much.

Fortunately, Congress has the power to act. Congress has the power to review the rule under the Congressional Review Act to see whether the regulation is merited. If it isn’t, then it may repeal it. And in the case of the FCA, which has sat on its hands while the FCS strays so far from its path, “reducing regulatory burden” is the opposite of what it needs – for all our sakes.

Is FCA Finally on the Right Track with Oversight?

On October 2, the Farm Credit Administration (FCA), the Farm Credit System’s regulator (FCS), publicly posted a memorandum outlining its National Oversight Program (NOP).

Longtime readers of Reform Farm Credit would expect this memo to simply be a blank sheet of paper. The FCA has an abysmal record for oversight, allowing Farm Credit to flagrantly violate the spirit of the Farm Credit Act by allowing it to lend to large telecoms, public companies building “server farms” and consumers in the market for luxury housing.

But counter to expectations, it outlines a surprisingly coherent approach to oversight for the next fiscal year. Drafted by the Director of the Office for Examination, the memo calls for the FCA to be aware of the precarious commodities market that may contribute to System instability.

And just as important, the memo recognizes that some Farm Credit institutions have let too much slip through the cracks. It acknowledges that “FCA and the System have noted a limited, but increased incidence of internal control weaknesses that led to credit losses, increased operating expenses, and increased reputation risk. Many of the conditions underlying these events are directly related to inadequate internal controls. In other cases, strong controls existed, but individuals were still able to circumvent controls.”

“Internal control weaknesses?” “Increased reputation risk?” These euphemistic turns of phrase are grating, but at least it acknowledges that there is a problem with internal controls, and that this problem has a direct impact: potentially illegal activity undertaken by Farm Credit East in creating shell entities for one of its clients, and the “irregularities” in Lone Star Ag Credit’s accounting, to name just two.

It’s refreshing to see someone in the FCA actually push it to do its job, even if for selfish reasons (“reputation risk”). But what sort of solution does the NOP offer?

“We support System efforts to strengthen controls and encourage every institution to dedicate staff and audit resources to ensure a strong internal controls environment — starting with the board of directors to provide the proper ‘tone at the top.’”

Good! The right tone needs to be established at the top – one that emphasizes service for its own sake, and one that puts farmers, ranchers and producers first and foremost. Although Farm Credit institutions probably don’t care for this proposed approach (the House version of the Farm Bill would have repealed a limit on compensation for FCS board directors), it’s important to see that it has even been suggested.

The FCA board has not yet approved this plan. If it does, then it will have taken its first step toward becoming an actual oversight agency, rather than a captured one. And if it doesn’t – well, business as usual will continue with Farm Credit. And America’s farmers, ranchers and producers can’t and shouldn’t tolerate business as usual.

REGULATORY CALENDAR – PART II: How Will the FCA Help Farmers with Non-accrual Loans?

Reform Farm Credit has already taken a look at the FCA’s proposed regulation on reducing regulatory burden. Among other regulations the FCA is rolling out this year is one on new “criteria for reinstating non-accrual loans”

A non-accrual loan is a loan which is not generating its established interest rate due to nonpayment by the borrower. As you can imagine, regulating these is of the utmost importance: farmers, ranchers and producers with loans in non-accrual are in dire financial straits, and they need support from the System as long as is possible, even if that means the FCS does not make as much off of the loan.

But right now, all an FCS institution needs to do to return a loan to accrual status – to squeeze more money out of a vulnerable farmer, rancher or producer – is to affirm that “no reasonable doubt remains regarding the willingness and ability of the borrower to perform in accordance with the contractual terms of the loan agreement.”

Finally, the FCA is cracking down on this lax, imbalanced standard. The FCA has announced that the goal of the proposed regulation is to “provide more objective criteria related to the reasonable doubt of the borrower’s willingness and ability to pay.”

Good. The FCS needs to be held accountable, and that extends to its interactions with its customers. The financial success of too many farmers – especially young, beginning and small farmers – is held captive by the whims of whichever Farm Credit association they’re tethered to. And if that association wants to make more interest on a loan from a farmer in an uncertain financial position, all it needs to do is say that there is no reasonable doubt that the borrower can’t pay. But if the FCA’s proposed regulation goes through, that association won’t be able to lean on that vague standard. It will have to prove it according to objective, transparent criteria.

For once, it looks like the FCA is doing its job to hold the FCS accountable. But this is only the beginning – the regulation has not been finalized, and any attempt by the FCA at actual enforcement will face opposition from the FCS. Lawmakers, take note and keep a watchful eye: for once, the regulator is trying to regulate and keep the FCS on the right path. Please make sure it follows through.

 

 

REGULATORY CALENDAR- PART III: Will the FCA Farm Credit’s Appraiser Problem?

The Farm Credit Administration (FCA), the regulator of the Farm Credit System (FCS), has announced that it will be rolling out new regulations through 2019 to address pressing issues, including reducing regulatory burden and instituting new criteria for restoring problem loans. Among these many proposed regulations is one on appraisals.

This proposed regulation “would consider whether changes in appraisal regulations are necessary in light of changing and economic conditions.” Times are tough, economic conditions may not be stable, and it may be necessary – for a number of reasons – for the FCA to change its appraisal regulations. Let’s hope it uses this opportunity to fix a glaring, structural problem with Farm Credit.

A short primer on appraisals: when a customer wants to purchase a property, the financial institution working with the customer will hire an appraiser to determine the property’s value. If that financial institution wants to issue a mortgage to the customer for that property, it will use the value determined by the appraiser for that purpose.

Financial institutions subject to the Dodd-Frank Act – major financial legislation – must either contract with an independent appraiser, or must have appropriate firewalls in order to prevent conflicts of interest. Otherwise, an appraiser who has substantial ties to the financial institution could be put into a situation where their livelihood depends on their providing an appraisal that is favorable to the financial institution.

The FCS doesn’t have to follow this policy at all. In fact, the FCS holds fast to its current system of using in-house appraisers – appraisers that are employees of the Farm Credit institutions for which they appraise properties – without appropriate firewalls. Unlike other financial institutions, Farm Credit institutions do not have to contract with an independent appraiser, or even have the same firewalls other financial institutions have to have in place.

And that creates a slew of conflicts of interest: Farm Credit’s appraisers may face pressure to change their appraisals so that it positively affects the Farm Credit institution’s bottom line. And that isn’t just likelihood, it’s reality – LoneStar ACA, a Farm Credit association in Texas, is still undergoing an audit for its “appraisal and accounting irregularities affecting a segment of the Association’s lending portfolio.”

Reform Farm Credit has explained the FCS’s appraisal problem before, looking at the details of which laws must be changed and how. This new regulation, however, is a strong opportunity for policymakers to make headway on a problem that could be a spark in the FCS’s haystack. Policymakers – including farmers, ranchers, producers and anyone else reliant on credit for agriculture – need to voice their concerns about FCS appraisers’ conflicts of interest and the need for independence and transparency. The FCS will be held accountable, even if the FCA needs a push.

Capital Farm Credit Showcases Farm Credit Merger Problem

The Farm Credit System (FCS) is supposed to serve the entire country through its local associations, which are supposed to make sure that farmers, ranchers and producers have access to credit from a local source. That local source – the association – can best serve the needs of its clients because it’s close by; it understands the local economic pressures, the community and can keep an eye on things.

But what happens if the associations aren’t local to their clients?

Bad news. Last week, a rancher in Montana with a 16-year relationship with Capital Farm Credit in Texas was found to have committed wire fraud by fabricating the number of cattle he owned across his multiple operations in Oklahoma, Texas, Wyoming and Montana.

“Starting in 2015, Hartley began to inflate the amount of cattle he was running on those properties,” Drover’s Magazine reports. “Auditors from Capital Farm Credit attempted to schedule an inspection of Hartley’s cattle in July 2017. A month later the vice president of lending for Capital Farm Credit flew to the Wyoming ranch to inspect the cattle.”

It’s difficult for any credit institution to make sure the farmers and ranchers they serve are giving the right information. But it’s even harder to verify that information if the institution’s employees have to fly over a few states to get to the client.

Why is Capital Farm Credit setting itself up for failure? Capital Farm Credit serves all of Texas, and it was providing credit for the rancher’s ranch in Wyoming. Why wasn’t the ranch in Wyoming using credit from Farm Credit Services of America or Western AgCredit, both of which have branches in Wyoming? Wouldn’t it make more sense for a Wyoming ranch to have a Wyoming source of credit so that the lender can check in on the operation more easily? Why was Capital Farm Credit, under the jurisdiction of the Farm Credit Bank of Texas, making loans for operations outside of its jurisdiction?

To make matters worse, this is the second instance of “irregularities” from a Farm Credit institution in Texas. Lone Star ACA is still working through its “appraisal and accounting irregularities” once it discovered them more than a year ago.

The likelihood of missing irregularities is greater when the Farm Credit institution providing the credit isn’t local. And that’s the result of dozens of mergers between FCS associations since the 1980s. Since then, Farm Credit’s 900 associations have shrunk to only 80. Those associations, like Farm Credit Services of America, are gargantuan: Farm Credit Services of America has more than $28 billion in total assets.

While the associations get larger and larger, less and less attention is paid to local farmers, ranchers and producers that need guidance, and more importantly, credit. That’s especially the case with young, beginning and small farmers who often don’t get the attention they need from Farm Credit, even though it’s legally required to help them.

Congress can address this issue head-on: one, it can launch an investigation into the Farm Credit Bank of Texas to determine why it has failed in its oversight of its associations; and two, it can work on legislation to prevent further mergers between Farm Credit institutions so that they can actually serve their local farmers, ranchers and producers.

Farm Credit: Don’t Leave Young, Beginning and Small Farmers Behind

The Farm Credit System (FCS), as a government-sponsored enterprise (GSE) tasked with providing reliable access to credit for all American farmers, ranchers and producers, has special mandates. Arguably the most important mandate for the FCS is to provide reliable access to credit for young, beginning and small (YBS) farmers, ranchers and producers. The law is abundantly clear on this“Each Federal land bank association and production credit association shall prepare a program for furnishing sound and constructive credit and related services to young, beginning, and small farmers and ranchers.” Continue Reading

Lone Star ACA, a Farm Credit System (FCS) Association in Texas, Is In a Whole Heap of Trouble.

Last year it issued a Notification of Non-Reliance on Previously Issued Financial Statements, which is as bad as it sounds. Financial statements from 2016 and the first quarter of 2017 were to be disregarded and no longer relied upon due to, in Lone Star’s words, “appraisal and accounting irregularities.” Continue Reading

Thank You Senate For Passing a Farm Bill!

Every five years, Congress revisits the federal government’s agricultural policy. The House has passed its version of the Farm Bill already, and Reform Farm Credit is proud to congratulate the Senate on passing its own version as well!

The Senate deserves huge credit for this Farm Bill because it holds the Farm Credit System (FCS) accountable and makes it more secure and reliable. Continue Reading

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