Farm Credit Watch: Does Ken Auer fully understand the FCS’s tax advantages?

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Ken Auer is president of the Farm Credit Council, the FCS trade association that lobbies on behalf of the FCS and its constituent Farm Credit banks and associations.  During the 2013-14 period, the Council’s Political Action Committee raised $1.08 million and contributed $935,000 to candidates for federal office. Those contributions give the Council, and therefore the FCS, a lot of clout in Congress and especially with members of the House and Senate Agriculture Committees as the FCS fights to protect its tax exemptions while opposing the ABA’s request for periodic congressional oversight hearings of FCS activities. The ABA letter requesting hearings can be found here.  A similar letter was sent to the House Agriculture Committee.

In the April 15 issue of Brownfield Ag News, Auer asserted that “the FCS does pay federal taxes, but has special tax provisions and does not pay many state taxes.” Auer is right that the FCS “does not pay many state taxes,” but he grossly misrepresented the extent to which the FCS is exempt from the federal corporate income tax, or perhaps he does not understand the magnitude of that exemption. The FCS’s largest tax break is its exemption from federal income taxes on profits earned on real estate lending; FCS real estate loans are carried on the books of Federal Land Credit Associations (FLCAs). All but two FLCAs are subsidiaries of the FCS’s 74 Agricultural Credit Associations (ACAs) that cover almost all of the country. Each ACA also has a Production Credit Association (PCA) subsidiary that holds its non-real estate loans; PCA profits are subject to federal income taxes. Understandably, the ACAs have a powerful financial incentive to maximize the profitability of their tax-exempt FLCA subsidiary while minimizing the income of their federally taxable PCA subsidiary.

According to the FCS’s annual Information Statement for 2014, the FCS’s “nontaxable entities;” principally the FLCAs, effectively reduced the FCS’s federal tax bill by $1.26 billion, or 73%. The comparable reductions were $1.23 billion and 72% in 2013 and $1.09 billion and 72% in 2012. This federal income tax reduction gives a lie in Auer’s statement to Brownfield Ag News that “there is NO federal or taxpayer money involved in the [FCS].” The FCS’s federal income savings are financially equivalent to the U.S. Treasury Department sending checks in those amounts to the FCS. Additionally, the FCS has a $10 billion line-of-credit at the Treasury. Perhaps Auer does understand the magnitude of the FCS’s tax subsidy, but does not want to publicly admit it, especially since the FCS increasingly tilts toward lending to larger borrowers and investor-owned utilities rather than to young, beginning, and small (YBS) farmers the FCS is supposed to focus on serving.

The FCA’s double-standard on enforcement actions

Like the bank regulators, the Farm Credit Administration (FCA) takes enforcement actions against FCS institutions for various reasons. Unlike the bank regulators, though, the FCA does not publish its enforcement orders nor does it even name the FCS institutions subject to those orders. However, these institutions (usually FCS direct-lending associations) do disclose the existence of those orders in their quarterly and annual reports to their members. It takes a lot of work, though, to identify those institutions. Presumably the FCA fears dire consequences if it names names, yet the FCA does not hesitate to name the individuals it has barred from serving, without the FCA’s consent, “as a director, officer, or employee of any FCS institution.” Rarely, though, are individuals prohibited from working in the FCS – over the last decade, just four persons have been subject to a prohibition order.

Although the FCA does not name the institutions subject to enforcement orders, it does provide some data regarding those orders. That data, though, is not clear-cut. For instance, the FCS’s 2014 annual Information Statement reported that at the end of 2014, the FCA “had entered into written agreements with three Associations who assets totaled $1.191 billion, as compared with eight Associations whose assets totaled $4.803 billion as of December 31, 2013.” On the surface, that decline looks pretty good. However, a March 31, 2015, report issued by the FCA’s Inspector General (IG) on the FCA’s special supervision and enforcement processes paints a more disturbing picture.

According to the FCA’s IG, during the fiscal year ended September 30, 2014, eight FCS institutions were under enforcement orders and three were subject to “special supervision,” which is one step away from an enforcement action. Assuming all eleven are FCS associations, this means that approximately one of every seven FCS associations experienced supervisory issues during fiscal year 2014, a time of exceptionally good economic conditions in American agriculture. Ten of the eleven associations’ “areas of concern” involved management issues and nine related to asset quality. Clearly some associations generated both management and asset quality concerns.

Especially troubling is how long it takes the FCA to resolve supervisory issues.  Eight institutions falling within the scope of the IG’s report were “under enforcement [that] ranged from one and a half to five years, with an average of 39 months” – over three years! It appears from data in the FCS annual Information Statements that most of these associations are relatively small – well under $1 billion in total assets, which raises this question: Why does it take the FCA so long to get these problems resolved? Further, the FCA has had to take numerous formal supervisory actions against some of these associations – six over 46 months in one case and five over 60 months in another case. Possibly some of these associations have been resolved through mergers with stronger associations. Putting a spotlight on these problem associations, by publicizing their enforcement orders, would help greatly to reduce these problems. The new FCA Chairman, Ken Spearman, should so order.

The FCS Southwest saga continues

FCS Southwest, which serves most of Arizona plus California’s Imperial Valley, announced last October that due to “a sudden significant increase in the level of delinquent loans” it would have to restate its financial results. At the same time, the FCA removed from its website all call reports Southwest had filed since 2010. That financial restatement process still has not been completed. The FCA website simply states that a “data correction is underway [for Southwest] and data not available at this time.” In February, Southwest announced its intent to merge with Farm Credit West, a large California FCS association. Shortly thereafter, Farm Credit West’s CEO assumed the CEO position at Southwest and the two associations began “operating under a joint management agreement.”

Almost certainly, the FCA engineered a shotgun marriage of Southwest into Farm Credit West, but that deal cannot be closed until each association’s borrower/stockholders approve it; August 1, 2015, is the anticipated merger date. However, they cannot vote on the deal until due diligence has been completed and “detailed disclosure documents [have been] provided to each stockholder.” Of course, Southwest’s financial restatement must be completed before the disclosure documents can be finalized. In the meantime, a criminal investigation reportedly is underway at Southwest related to fraudulent transactions that led to the “sudden significant increase” in delinquent loans.