Pub. 6 2011-2012 Issue 3

www.nebankers.org 24 Extraordinary Service for Extraordinary Members. Bert Ely’s FARM CREDIT WATCH ® Shedding Light on the Farm Credit System, America’s Least Known GSE © 2011 Bert Ely S&P Reaffirms FCS Is a Government Entity W HEN STANDARD & POOR’S downgradedU.S. Treasury debt earlier this month to AA+, it also lowered the Farm Credit System’s long-term debt rating to AA+ with the outlook for that rating revised to negative. This Farm Credit System (FCS) credit downgrade reaffirmed the clear linkage S&P drew between the FCS and the federal gov- ernment when on July 15 it put both entities on “CreditWatch Negative.” No longer can FCS partisans deny that the creditworthiness of FCS debt, like all government-sponsored enterprise (GSE) debt, is primarily dependent on the credit standing of the federal government; the federal government has and will continue to come to the rescue of a financially troubled GSE, as it did for the FCS in 1987. Despite that credit downgrade, the subsequent flight to Treasury debt dur- ing the recent market turmoil dropped Treasury yields to record lows, which led to lower secondary-market yields on FCS debt. According to an Aug. 11 article posted on Agriculture.com, yields on variousmaturities of FCS debt first ticked up a few basis points after the S&P downgrade and then declined below where yields had been prior to the downgrade. This tracking of FCS debt yields with yields on U.S. Treasur- ies further confirms how closely tied the FCS is to the federal government—a tie that works to the competitive disad- vantage of banks and other tax-paying competitors of the FCS. FCS Profits Near Record High FCS net income was a near-record $982 million for the second quarter of 2011, down from $1.004 billion in the first quarter of 2011 due to amodest de- cline in loans outstanding. The lending drop was “primarily due to decreases in production and intermediate-term loans and agribusiness loans offset in part by an increase in real estate mortgage loans.” Real estate lending “increased primarily due to strong demand for cropland and competitive interest rates on loan products.” That is a euphemistic way of saying that the FCS continues to benefit from the rela- tively greater competitive advantage it has as a real estate lender because its profits on real estate lending are com- pletely tax exempt while its profits on non-real estate lending are exempt only from state income taxes. Key to FCS profit growth in recent years has been its steadily wider net interest spread. From 1.99 percent in 2008 and 2.43 percent in 2009, this spread widened to 2.61 percent last year, to 2.64 percent in the first quarter of this year, and to 2.66 percent in the second quarter. The FCS press release announcing its second-quarter 2011 financial results stated that “the in- creases in the net interest spread were primarily attributable to the [FCS’] ability to more quickly reprice [its] outstanding debt in the lower interest rate environment and to adjustments in loan pricing to better reflect credit risk and market conditions.” More specifically, the FCS was able “to lower [its] cost of funds relative to [its] assets, which did not reprice as quickly.” During the 12-month period end- ing June 30, 2011, the FCS called debt totaling $52.8 billion (47 percent of its Systemwide Debt Securities on June 30, 2010, with more than a year to maturity), including $20 billion called during the first half of 2011. While warning that “the positive impact on the net interest spread that the [FCS] has experienced over the last several years from calling Systemwide Debt Securities will likely diminish,” the recent plunge in longer-term Treasury yields to 50-year lows will likely lead to the FCS calling additional debt for refunding at lower interest rates. Such actions will make it even harder for taxpaying lenders to compete against the taxpayer-subsidized FCS. FCS credit quality dropped some- what during the first half of 2011, with non-performing loans rising from 1.93 percent of loans outstanding at the end of 2010 to 2.04 percent of outstanding loans on June 30, 2011. Despite that increase, the FCS held its allowance for loan losses constant while trimming its provision for loan losses to $234 million for the first half of 2011 from $351 million for the second half of 2010. That reduction accounted for 56 percent of the FCS’ increase in pre-tax profits from the second half of 2010 to the first half of 2011. Time will tell if the FCS has gotten ahead of itself in reduc- ing its loan-loss provision and failing to increase its allowance for loan losses. FCA Triple-Counts YBS Lending One FCS statutory obligation is to make a special effort to lend to young,