Agricultural Credit
Jim Monke

The federal government has a long history of providing credit assistance to farmers, either directly, with guarantees, or through institutions designed to fill gaps in rural markets. These institutions include the Farm Credit System (FCS), which is a network of borrower-owned lending institutions operating as a government-sponsored enterprise, and the USDA Farm Service Agency (FSA), which makes or guarantees loans to farmers who cannot qualify at other lenders. Special bankruptcy provisions (Chapter 12) help family farmers work through debt problems and continue farming, sometimes avoiding foreclosure.

In an unprecedented move, Farm Credit Services of America (FCSA) accepted an offer to be purchased by Rabobank, a private banking company from the Netherlands. FCSA serves Iowa, Nebraska, South Dakota, and Wyoming. The announcement on July 30, 2004, is generating congressional interest, and needs to be approved by the Farm Credit Administration before FCSA can leave the Farm Credit System.

Several bills proposed in the 108th Congress address agricultural credit. Chapter 12 expired on January 1, 2004. H.R. 3540, H.R. 3542, and S. 1920 would extend the sunset provision of Chapter 12; H.R. 975 is a comprehensive bankruptcy reform bill that would make Chapter 12 permanent. The Senate passed S. 1920 in 2003, but the House substituted H.R. 975 when it took up S. 1920 in January 2004. No conference committee action has begun. Separately, regarding taxes, S. 1263 would exempt commercial banks from paying taxes on agricultural real estate loans.

Farmer Mac, the secondary market for agricultural loans, received congressional interest following a GAO report about fulfilling its government-sponsored mission.

Lending Institutions

Five types of lenders make credit available to agriculture, the first two of which are more or less affiliated with the federal government: the Farm Credit System (FCS), USDA Farm Service Agency (FSA), commercial banks, life insurance companies, and individuals and others.

Commercial banks lend the largest portion of the farm sector's total debt (39%), followed by the Farm Credit System (30%), individuals and others (21%), life insurance companies (6%), and the Farm Service Agency (4%). Separating real estate and non-real estate loans, the FCS has the largest share of real estate loans (36%), and commercial banks have the largest share of non-real estate loans (48%).

The Farm Credit System (FCS) is a network of borrower-owned lending institutions operating as a government-sponsored enterprise (GSE); however, it is not a government agency or guaranteed by the U.S. government. Congress established the system in 1916 to provide a dependable and affordable source of credit to rural areas at a time when many lenders avoided farm loans. Five large banks provide funds to 97 credit associations that, in turn, make loans to eligible borrowers who must meet standard creditworthiness requirements. FCS funds its loan portfolio with bonds sold in capital markets (see CRS Report RS21278).

USDA's Farm Service Agency (FSA) makes direct loans to farmers who cannot qualify at other lenders. FSA also guarantees timely payment of principal and interest on some loans made by commercial lenders. FSA loans finance farm real estate, annual operating expenses, and recovery from emergencies. FSA is referred to as a lender of last resort because it makes direct loans to family farms unable to obtain credit from other lenders. Some loans are made at a subsidized interest rate. To qualify for an FSA guaranteed or direct loan, farmers must have enough cash flow to make payments. FSA receives an annual appropriation (called the loan subsidy) to cover interest rate discounts and anticipated loan defaults. The amount of loans that can be made (loan authority) is larger.

Commercial banks lend to farmers through both small community banks and large multi-bank institutions. Another category of lenders is "individuals and others." This category consists of seller-financed and personal loans, including the captive financing units of equipment dealers and input suppliers. Life insurance companies historically also have looked to farm real estate mortgages for diversification.

Credit-worthy farmers generally have adequate access to loans, mostly from the largest suppliers -- commercial banks, FCS, and merchants and dealers. USDA projected that commercial bank loan volume would increase about 2.7% in 2003, and FCS loans by 6.9%. General financial conditions should allow more growth in 2004.

Farmers' Balance Sheets

USDA expects total farm debt to rise by 2.5% in 2004, reaching $206 billion. About 40% of farmers have farm debt, and 60% have either farm or nonfarm debts. While current debt levels surpass the previous record from 1984, debt-to-asset ratios for the sector have been relatively stable for the past decade. Total farm assets are expected to rise by 3.1% in 2004, reaching $1.4 trillion and resulting in a 14.7% debt-to-asset ratio. Because increases in debt typically have been offset by larger gains in farm asset values (primarily land), farm equity has risen. Economists attribute much of the continued growth in land values to government payments, especially when commodity prices and farm incomes were lower during 1998-2002.

Recent strength in farm income generally has given farmers more capacity to repay their loans or borrow new funds. However, in the past year, the sector's use of its debt repayment capacity (measured as the actual debt relative to the maximum feasible debt) rose to 60% in 2004 from 54% in 2003. Some farmers may experience financial stress due to individually high debt and personal conditions.

Appropriation for FSA Farm Loan Programs

The USDA Farm Service Agency has a smaller loan authorization amount for FY2004 than in FY2003 under the omnibus appropriations act (P.L. 108-199). Although the Administration requested a smaller appropriation, the conference agreement made cuts beyond the Administration's request. In FY2003, FSA's appropriation provided authority to make $3.94 billion in direct and guaranteed loans. The FY2004 appropriation allows $3.26 billion of loan authority. Three-fourths of the $680 million reduction in total loan authority is in the guaranteed, unsubsidized operating loan account. Heavy demand for certain loan programs is causing FSA to anticipate possible funding constraints later in FY2004.

For FY2005, the Administration requests an appropriation of $161.2 million to subsidize the cost of making $3.8 billion in FSA loans. Thus, while the request for loan authority increases by $557 million from the FY2004 level, the loan subsidy amount would decrease by $34.2 million (Table 1). Most of the proposed increase in loan authority is a $456 million increase in unsubsidized guaranteed farm ownership loans (an increase of nearly 50%, to $1.4 billion in FY2005). These unsubsidized guaranteed loans can be made with relatively little increase in appropriations compared to changes in subsidized or direct loans. Nearly all of the proposed decrease in the loan subsidy is in direct farm ownership and direct farm operating loans, although the loan authorization for these loans would increase.

Table 1. FSA Loan Programs: Appropriation and Loan Authorization: FY2004 Appropriation and FY2005 Request

($ millions)

USDA Farm Service Agency's Farm Loan Program	FY2004 (P.L. 108-199)		FY2005 (Admin. request)
	Appropriation (loan subsidy)	Loan authorization	Requested loan subsidy	Loan authorization
Farm ownership loans (FO)	33.6	1,079.2	18.1	1,600.0
Operating loans (OL)	163.0	2,083.8	139.8	2,116.3
Indian tribe land acquisition	0.0	2.0	0.1	2.0
Emergency loans	0.0	0.0	3.2	25.0
Boll weevil eradication	0.0	100.0	0.0	60.0
Total	196.7	3,162.9	161.2	3,803.3

Note: totals may not add due to rounding.

Bankruptcy: Chapter 12

In response to the farm financial downturn of the early 1980s, Congress added chapter 12 to the Bankruptcy Code in 1986. It has special provisions for farmers compared with other bankruptcy chapters, strengthening farmers' bargaining position with creditors. Chapter 12 is more about reorganization of debt than bankruptcy because it allows secured debts to be written down to the fair-market value of the collateral and repaid at lower interest rates over extended periods. Chapter 12 is seen by many as a policy response to the social stigma attached to family farm failures during the Great Depression. It gives struggling farmers another chance to reorganize and repay their debts, rather than forcing them into liquidation and off the farm.

Chapter 12 has succeeded in keeping some farmers in business and has encouraged informal lender-farmer settlements out of court. But it has increased costs on society by encouraging inefficient farmers who would otherwise liquidate to remain in business, and allowing efficient farmers who could otherwise continue to farm to charge off part of their debts. Bankruptcy costs include the legal fees of liquidation or reorganization, and efficiency costs from continuing to use labor and capital in otherwise inefficient enterprises.

Policy Issues for Congress

Acquisition of Farm Credit Services of America by Rabobank. On July 30, 2004, Farm Credit Services of America (FCSA), an association the Farm Credit System (the "system"), accepted an offer to be purchased by Rabobank. FCSA serves Iowa, Nebraska, South Dakota, and Wyoming. Rabobank is a private Dutch banking cooperative with a long history of agricultural lending in the Netherlands, and has made recent smaller moves into farm-level lending in the United States.

This type of buyout of a Farm Credit System institution by a private entity is unprecedented, but allowed under statute (12 U.S.C. 2279d) and regulations (12 C.F.R. 611.1200-1290) of the Farm Credit Act.

If the offer is approved, FCSA would give up its affiliation with the system. Rabobank would buy the stock of the farmer shareholders for $600 million and pay the system's insurance fund an "exit fee" estimated at $800 million. The FCA approval process, stock holder votes, and waiting periods are expected to take at least seven months. FCA would issue new lending charters for the region if FCSA leaves the system.

Congress may become interested in the buyout, especially given concerns by some farmers over the future of the Farm Credit System generally and in the FCSA region. The Farm Credit Council, the system's lobbying arm, opposes the acquisition. The American Bankers Association asserts that the buyout weakens the system's mission.

For more information, see CRS Report RS21919(pdf), Leaving the Farm Credit System: The Future of Farm Credit Services of America.

Chapter 12 Extension. Chapter 12 expired on January 1, 2004, and its renewal is now captured in the debate between the House and Senate over bankruptcy reform, even though the Chapter 12 provisions are not controversial.

Congress has been considering comprehensive bankruptcy reform for several years. H.R. 975 (passed on March 19, 2003) addresses consumer bankruptcy, small business bankruptcy, and Chapter 12 (see CRS Report RL31783). But the Senate has not yet considered the bill during the 108th Congress. For Chapter 12, H.R. 975 would make the law permanent, expand eligibility by raising the debt limit from $1.5 million to $3.237 million, require only 50% (instead 80%) of debt to come from the farming operation, allow the requirement for 50% of income to be from farming to apply to one of three years preceding filing instead of just the immediately preceding year, and extend benefits to family fishermen. H.R. 975 is very similar to bills passed by both the House and Senate during the 107th Congress (H.R. 333), but omits the Schumer Amendment which prevents discharge of liability for wilful violation of protective orders and violent protests, including those against reproductive health services.

To keep Chapter 12 active, the Senate passed a bill (S. 1920) by unanimous consent on November 25, 2003, to extend Chapter 12 another six months (until July 1, 2004). Two House bills (H.R. 3540 and H.R. 3542) were introduced to extend Chapter 12 (by one year and six months, respectively), but no action was taken before the first session ended, and thus Chapter 12 expired on January 1, 2004.

On January 28, 2004, the House took up S. 1920 with an amendment in the nature of a substitute consisting of the text of H.R. 975, including an amendment to make Chapter 12 retroactive to January 1, 2004. This version passed the House by a vote of 265-99, and House conferees were appointed. The Senate has not taken action for a conference committee.

Background on Chapter 12 Sunsets. When Chapter 12 was enacted in 1986, it contained a sunset provision of October 1, 1993. Congress subsequently has renewed the law ten times with temporary extensions (for a list, see the appendix to a USDA report). The most recent renewal, P.L. 108-73, enacted on August 15, 2003, retroactively extended chapter 12 for six months (until January 1, 2004). The law had expired on July 1, 2003, following a six-month extension from the beginning of the year (P.L. 107-377). Although such extensions usually have been enacted without significant opposition, such frequent sunset dates create uncertainty for producers and lenders, especially when the provision expires without action to extend the law.

Farmer Mac Investigation. Farmer Mac is the secondary market for agricultural loans and is part of the Farm Credit System. An October 2003 GAO report recommended that Congress consider legislation that would establish clearer goals for Farmer Mac. GAO also found concerns with risk management practices (including geographic concentration), lack of secondary market development, and lack of independence in Farmer Mac's board of directors. Since the report, questions arose whether new financial instruments (a certain type of swaps) created by Farmer Mac are reducing insurance premiums paid to the Farm Credit System's insurance fund without any corresponding reduction in risk exposure. On June 2, 2004, the House Agriculture Committee held a hearing about these issues.

Taxes on Agricultural Loans. On June 13, 2003, Senator Hagel introduced S. 1263, the Rural Economic Investment Act. The bill would exempt commercial banks from paying taxes on income from loans secured by agricultural real estate, including residential loans in rural areas with fewer than 2,500 people. Proponents say the bill would boost rural development and give commercial banks equal treatment for tax exemptions long available to the Farm Credit System (12 U.S.C. 2098). Critics say such exemptions are not warranted since agriculture no longer faces a credit constraint and other industries do not receive such preferential treatment.

Implementing the 2002 Farm Bill. The 2002 farm bill (P.L. 107-171) authorizes USDA lending programs through 2007 (Title V), subject to annual appropriations. The new law allows FSA to lend more to beginning farmers for down payments, and creates a pilot program to guarantee seller-financed land contracts. Losses due to USDA-imposed quarantines now qualify for emergency loans. Delinquent shared appreciation agreements (SAAs) may be reamortized for up to 25 years.

CRS Products

CRS Report RS21278, Farm Credit System.
CRS Report RS21145(pdf), Shared Appreciation Agreements on USDA Farm Loans.
CRS Report RS21919(pdf), Leaving the Farm Credit System, The Future of Farm Credit Services of America.
CRS Report RS20742, Chapter 12 of the U.S. Bankruptcy Code.

Other Resources

American Bankers Association (ABA) Center for Agricultural and Rural Banking

USDA Economic Research Service briefing rooms on lenders and financial markets, farm sector balance sheets, and farm bankruptcies.

USDA Economic Research Service report on Farm Bankruptcies and Exits.

CRS Contact: Jim Monke (7-9664)

Page last updated August 24, 2004.

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