June 20, 2001, Wednesday
CAPITOL HILL HEARING TESTIMONY
COMMITTEE: HOUSE AGRICULTURE
SUBCOMMITTEE: CONSERVATION, CREDIT, RURAL DEVELOPMENT AND RESEARCH

TESTIMONY-BY: HENRY D. EDELMAN, PRESIDENT AND CEO
FARMER MAC

FARMER MAC FEDERAL AGRICULTURAL MORTGAGE CORPORATION
Statement of Henry D. Edelman, President and CEO
before the Subcommittee on Conservation, Credit, Rural Development, and Research
Committee on Agriculture
United States House of Representatives
June 20, 2001
Washington, DC

Mr. Chairman, distinguished members of the Subcommittee, my name is Henry Edelman. I am the President and Chief Executive Officer of Farmer Mac. It is an honor to appear before this Subcommittee to offer testimony on these important and timely matters - credit conditions, and agricultural credit industry activities and programs to deliver credit to farmers and ranchers in the United States and Farmer Mac's role in that process.

I am pleased to appear before you today as the CEO of a strong and growing company rapidly advancing in our Congressional mission of operating an efficient secondary market for agricultural mortgages. Reflecting back to 1995, when we appeared before Congress and requested urgently-needed changes to Farmer Mac's original charter, I am pleased to report that Farmer Mac's recent successes, effective programs and strong current condition were all made possible by your support and foresight and the consequent passage of significant reform legislation - the Farm Credit System Reform Act of 1996. We have worked hard in the intervening years to justify the confidence Congress placed in Farmer Mac, as an important contributor to a stable and competitive mortgage credit delivery system for agricultural borrowers.

Today, thousands of farmers and ranchers have more than $3.1 billion of agricultural mortgages that back securities guaranteed by Farmer Mac. We are actively supporting mortgage lenders large and small, in all sectors of the agricultural credit industry, with effective programs and products. Since passage of the reform legislation in 1996, Farmer Mac has contributed to lender liquidity, capital adequacy, and increasingly competitive rates and loan products for farmers and ranchers seeking mortgage funds. By the end of 1996, Farmer Mac was able to report its first year of profitable operations since its creation in 1988; its performance has improved each and every year since, reflecting the soundness of its new operating structure. Over the same period, Farmer Mac increased its capital from about $12 million at the end of 1995 to over $1 00 million at the end of 2000 and satisfied every condition set forth by Congress in the 1996 legislation to ensure its continuing safe and sound operation.

Over the last five years we have not only put together programs that have appealed increasingly to both agricultural lenders and the farm borrowers they serve, but also broadened the acceptance of Farmer Mac to all sectors of the agricultural credit industry. During that period, commercial banks, Farm Credit System (FCS) institutions and insurance company lenders have become more aware of Farmer Mac and gained a better understanding of the benefits of Farmer Mac's secondary market operations and credit enhancements for agricultural mortgages. In so doing, agricultural mortgage lenders have shared with us many of the challenges they face and we have worked to help find solutions that provide them with effective access to a more competitive and stable mortgage market. At the same time, we also developed important new relationships with institutions in all sectors of the credit industry. We believe that we have made a great deal of progress since 1996, yet we know there is much more to be done before the industry reaches the level of efficiency and financial sophistication that exists today in the residential home mortgage market.

As you requested, I shall take the next few minutes to summarize the state of agricultural credit as we see it, comment on Farmer Mac's agricultural mortgage programs and activities under the 1996 reform legislation, and suggest a few general legislative proposals that this Committee might wish to consider.

2000 was the third consecutive year when prices for core agricultural commodities were at levels that prompted Congress to provide additional income support to farmers to avert serious economic stress. Conditions likely to place continued stress on the U.S. agricultural sector persist in 2001, with reports of strong or expanding production in many countries, low commodity prices, and weak market demand worldwide for major field crops. In USDA's most recent forecast report, the value of crop production for 2001 had fallen about $3.7 billion just from the January forecast, while the forecast for the livestock sector rose about $6.7 billion. Despite the low prices for most major commodities, cash receipts from sales during 2000 rose $7.4 billion above the 1999 level to $196.0 billion. Offsetting the increase in cash receipts was a $7.6 billion increase in cash farm expenses. Total net cash farm income, as reported by the USDA, remained relatively strong at $56.4 billion in 2000, above the 1990-2000 average of $54.8 billion and up from $54.6 billion in 1999. Without taking into account the additional $5.5 billion provided for agriculture in the budget resolution for fiscal year 2001 but not yet authorized, USDA estimates that net cash farm income will drop during FY 2001 to $52.4 billion. The higher net cash income in 2000 was attributable primarily to continuing government support payments, now estimated by USDA at $22.9 billion for the year, compared to $20.6 billion in 1999 and $12.2 billion in 1998. The final numbers for fiscal year 2001 will be much clearer after Congress acts to distribute the budgeted funds to agriculture.

How did these conditions affect agricultural mortgages? As reported by USDA, farm real estate debt, the component of agricultural debt potentially eligible for the Farmer Mac secondary market, increased to $97.3 billion during 2000, up from $94.2 billion in 1999, and is projected to rise to $98.6 billion during 2001. Each commercial lending sector maintained or increased its share of the agricultural mortgage market during 2000 and agricultural lenders reported profitable performance, good loan quality (with some recent increases in delinquent and non-accrual loans), and liquidity adequate to support lending activities during 2000. In addition, the value of good farmland was stable or slightly higher in most regions of the nation during 2000.

While the facts I have referred to thus far would suggest stability and strength in agricultural mortgage credit, this view based on many assumptions; the numbers do not tell the whole story. First, this healthy picture is due, in considerable measure, to Congressional intervention with record direct payments to the agricultural sector during the last few years. Second, many lenders are experiencing increased risk concentrations with the agricultural mortgages they hold in their portfolios, due in large measure to economic stress in the agricultural sector, and they are actively seeking outlets to diversify this risk. This is accompanied by reports of rising delinquencies, which we are also experiencing at Farmer Mac, and a slowing of the rate of growth in agricultural mortgage originations. In addition, farm debt repayment capacity, which compares farmers' actual debt levels with the amount of debt they could repay from current annual income, is expected to rise according to USDA from 61 percent in 2000 to 65 percent in 2001. These numbers indicate that farmers are likely to have more difficulty making timely interest and principal payments on their debt. Lastly, as risk has increased, a number of lenders have become increasingly capital constrained and have tightened underwriting requirements that make it difficult or impossible for some farmers who urgently need credit to obtain it with competitive rates and terms.

We believe that there are steps that can be taken by the lending sector to supplement the support provided by Congress and so minimize the potential for current stresses on farmers and ranchers to precipitate serious credit problems. I will comment on these shortly.

As I noted in my opening comment, the 1996 reform legislation dealt very effectively with the statutory limitations that had constrained Farmer Mac's development up to that time and provided the authorities Farmer Mac needed to move forward aggressively in the development of an efficient secondary market for agricultural mortgages. This legislation enabled Farmer Mac to transition into a profitable, growth-oriented corporation with strong financial support in the capital markets. It also enabled Farmer Mac to offer effective and competitive programs and mortgage products to agricultural lenders and the farmers and ranchers they serve. (Please refer to Appendices I and 11 to this testimony for a description of Farmer Mac's programs and the status of the Corporation's development through March 31, 2001.) We are proud to be able to report to this Subcommittee that Farmer Mac has responded to the opportunity Congress it through the enactment of the 1996 legislative reforms: we have listened closely to provided agricultural credit providers and users, and provided them with effective programs and products to support the mortgage credit needs of farmers and ranchers.

In addition, since 1996 Farmer Mac has focused on fortifying its financial strength through the retention of earnings and the sale of stock to investors to build its regulatory capital and stockholders' equity levels to more than $ 1 00 million by the end of the first quarter of 2001. Farmer Mac has been in compliance continuously with the regulatory capital standards Congress established for it in 1992 and has cooperated with the FCA on the development of its risk-based capital regulation, which was published recently as a final rule in the Federal Register. We are currently working with the FCA to understand fully the operation of the risk-based capital regulation. Until we have had an adequate opportunity to work through this process with the FCA, we will not be in a position to comment on the regulation. However, we would like to reserve the right to come back to this Subcommittee at an appropriate time to discuss the regulation if issues exist after we have completed our discussions with the FCA.

The 1996 legislation enabled Farmer Mac to develop and offer to agricultural lenders mortgage credit enhancement programs that have contributed materially to lender competitiveness and mortgage availability. Although at $3.1 billion of guarantees outstanding Farmer Mac still represents only a small fraction of the agricultural mortgage market, we have developed effective working relationships with lenders in all sectors of the industry. The relationships we have established with those lenders, including the Farm Credit System, commercial banks and insurance company lenders, should continue the expansion of the Farmer Mac secondary market. The process now underway should ultimately move lenders away from dependence on mortgage portfolio management strategies, which tend to limit borrowers to less competitive, shorter-term mortgage interest rates while exposing lenders to concentrated credit risks, and toward greater reliance on mortgage securitization, which pen-nits borrowers greater choice and allows lenders to reduce credit concentrations. As has been proven in the residential sector, this process will benefit both lenders and borrowers in the agricultural sector; Farmer Mac is proud to be the intermediary in this beneficial evolution.

On a related matter, I would also like to comment on the USDA guaranteed loan I programs, which were extensively revised by Congress in the 1996 farm bill. As you know, we purchase Farm Service Agency (FSA) guaranteed loans in our Farmer Mac 11 program and therefore have had the opportunity to observe at first hand the operation of the revised FSA programs. In most respects, we believe that the changes made in 1996 have contributed to a more streamlined and financially sound guaranteed loan program. Many of the lenders we work with report that the administrative processing of guaranteed loans has improved greatly and that changes in loan limits and the allocation of funds have added much needed flexibility to the programs. Nevertheless, we believe that the programs could be reformed further to provide eligible borrowers with greater access to long-term fixed rate loans at more competitive rates of interest.

The primary policy goal for agricultural credit over the next decade should be for the entire industry to achieve a greater level of parity with the residential mortgage market with regard to financing techniques and structures that support highly competitive mortgage products for farmers and ranchers. By integrating in their daily operations the mortgage securitization and similar credit enhancements available through the Farmer Mac secondary market, agricultural lenders can move away from the cloistered world of portfolio lending. The financial services industry of the 21^st century will be one based on the allocation of functions to those players who perform them best. As agricultural lenders increase their focus on the strategic goal of receiving riskless fee income for performing the functions in which they are the true experts - loan origination and servicing - they will be safer, sounder and better suited to the delivery of lower interest rates to farmers, ranchers and rural homeowners. We at Farmer Mac are dedicated to aiding and supporting lenders in that transition and we believe that our secondary mortgage market has reached the stage where the contribution we make is meaningful and real.

Credit legislation should be framed to support the continuing evolution of the agricultural credit industry toward the strategic goal I have mentioned. This could be accomplished by reference to the Farmer Mac secondary market rates as a benchmark for fairness and efficiency of loans directly made or guaranteed by the USDA; sale and securitization would be a logical but not compulsory consequence. As applied to those loans, such an approach would open opportunities for farm borrowers to have greater access to long-term fixed rate loans and for variable interest loans to be standardized and tied to published indices. Realistic limits on spreads above those indices could reduce credit expenses significantly for many of these borrowers, provide greater opportunities for them to remain in fanning, and maintain the competitiveness of their farming operations while restricting the government's exposure to losses on those loans. At the same time, adequate lender profits must be preserved to ensure effective competition among lenders and provide borrowers with ready access to multiple lending sources. In addition, adjustments to Farmer Mac's statutory charter with a view toward reducing or eliminating certain limitations devised some twelve years ago, and toward updating Farmer Mac's business authorities consistent with the evolution of the financial markets generally and the agricultural and rural credit sectors in particular, could contribute to achieving the goal. This could include, for example, expanding the definition of loans eligible for the Farmer Mac secondary market to include rural development loans or rural small business loans, so far as there is no efficient secondary market for them today and Farmer Mac is qualified and able to expand its market to include them.

These ideas are preliminary, but are submitted for consideration by the members and staffs of this Subcommittee. We welcome the opportunity to discuss our ideas further with you, Mr. Chairman, and with the other members of the Subcommittee at your request.

Thank you for providing us with this opportunity to address the Subcommittee on these important issues today. I would be pleased to answer any questions at this time.

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