Summary
In the late 1990s, GAO found that the Federal Agricultural Mortgage Corporation (Farmer Mac), a federal government-sponsored enterprise, had significant assets in nonmission investments and analyzed its long-term viability. Recently, Congress asked GAO to report on Farmer Mac's (1) financial condition, (2) mission, (3) corporate governance, and (4) oversight provided by the Farm Credit Administration (FCA).
Farmer Mac's income has increased since 1999, and its capital continues to exceed required levels. At the same time, we identified trends that indicated a more complex risk profile. For example, its off-balance sheet standby agreements have grown 350 percent in 3 years and comprise nearly 50 percent of Farmer Mac's total loans. To date, the underlying loans have been performing better than the on-balance sheet loans. However, if rapid growth in standby agreements continues, and Farmer Mac were to undergo stressful economic conditions, it could face substantial funding liquidity risk. Farmer Mac has risk management systems in place, but certain aspects of its risk management capacity have not kept pace with its increasingly complex portfolio. For example, the loans used in the loss estimation model have characteristics that differ from Farmer Mac's portfolio both with respect to geographic distribution and interest rate terms. In addition, although Farmer Mac has maintained sufficient liquidity to support its loan purchase and guarantee activity, it has lacked a formal contingency plan to address potential liquidity needs under stressful agricultural economic conditions. Since our 1999 report, Farmer Mac has significantly reduced the ratio of nonmission investments and correspondingly increased its mission activities--providing long-term credit to farmers and ranchers at stable interest rates. These activities include loan purchases, guarantees, and commitments related to agricultural mortgages. However, there is geographic and lender concentration in the loan and guarantee portfolio, and the overall impact of the activities on the agricultural real estate market is unclear. Farmer Mac's enabling legislation lacks specific or measurable mission-related criteria that would allow for a meaningful assessment of its mission achievement. In addition, the depth and liquidity of the current market for agricultural mortgage backed securities (AMBS) is unknown because Farmer Mac's strategy of holding AMBS has been a contributing factor in limiting the development of a liquid, secondary market for these securities. The Sarbanes-Oxley Act of 2002 and the proposed New York Stock Exchange (NYSE) listing standards are both applicable to Farmer Mac because its securities are publicly traded and listed on the NYSE. However, Farmer Mac's efforts to meet the new standards regarding an independent board could be limited by its statutory board structure. Under its statute, two-thirds of the board's directors are elected by institutions that have a business relationship with Farmer Mac and own the only two classes of voting stock. Since 2002, FCA enhanced oversight of Farmer Mac by performing a more thorough annual safety and soundness examination, and by proposing liquidity standards and regulatory limits for nonmission investments. However, FCA still faces challenges, including limitations in its tools to analyze capital and credit risk, as well as the lack of criteria and procedures to assess and report on Farmer Mac's mission achievement.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change
from "In process" to "Implemented" or "Not implemented" based on our follow up work.
Director:
Team:
Phone:
Davi M. D'agostino
Government Accountability Office: Financial Markets and Community Investment
No phone on record
Matters for Congressional Consideration
Recommendation: Congress may wish to consider establishing clearer mission goals for Farmer Mac with respect to the agricultural real estate market to allow for a meaningful assessment of whether Farmer Mac had achieved its public policy goals.
Status: Not Implemented
Comments: Congress has not passed any recent legislation affecting Farmer Mac.
Recommendation: Congress may wish to consider allowing FCA more flexibility in establishing capital standards that are commensurate with Farmer Mac's changing risk profile and in setting minimum capital requirements.
Status: Not Implemented
Comments: Congress has not passed any recent legislation affecting Farmer Mac.
Recommendation: If Congress intends for Farmer Mac to operate in a cooperative manner and maintain its current board structure of Class A and Class B stock, it may wish to consider making Farmer Mac a true cooperative entity like the Federal Home Loan Bank System, and rescind Farmer Mac's authority to issue Class C stock. However, if Congress intends for Farmer Mac to operate as a publicly traded company, it may wish to consider amending (1) Farmer Mac's board structure to ensure an independent board and independent and competent audit committee and (2) the structure of Farmer Mac's Class C common stock to include a one share, one vote principle to provide the opportunity to better reflect all shareholder interests.
Status: Not Implemented
Comments: Congress has not passed any recent legislation affecting Farmer Mac.
Recommendations for Executive Action
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to address weaknesses in its loan loss estimation model, which could affect the reasonableness and adequacy of the loan loss allowance, through including current data on farm loan payment, delinquency, and valuation for the loans included in the estimation model so that the estimation process reflects current loan and economic conditions.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: In 2005, Farmer Mac migrated fully to a new loan loss estimation model. This model is based entirely on historical loan loss data from Farmer Mac's loan portfolios. This corrected the weakness that we had identified in which Farmer Mac was using data from the Farm Credit Bank of Texas to estimate its loan losses, which was not representative of Farmer Mac's portfolio.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to address weaknesses in its loan loss estimation model, which could affect the reasonableness and adequacy of the loan loss allowance, through exploring other data sources that are relevant to Farmer Mac's current portfolio for estimating probability, amounts, and distribution of credit losses in its estimation model.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: Farmer Mac has explored using its own data as a source for estimating credit losses in its estimation model. At the end of 2005, Farmer Mac has migrated fully to a new loan loss estimation model. Unlike the old model that used data solely from the Farm Credit Bank of Texas, this new model uses loan loss data from Farmer Mac's own loan portfolios.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to address weaknesses in its loan loss estimation model, which could affect the reasonableness and adequacy of the loan loss allowance, through improving documentation of the results of the model compared to actual portfolio and economic conditions, and of the reconciliation to the amounts recorded in the financial statements.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: As of the end of 2005, Farmer Mac has fully migrated to the new loan loss estimation model. This new model follows the practice of using actual charge off data from the past few years. Documentation of results of the model compared to actual portfolio and of the reconciliation to the amounts recorded in the financial statements is consistent with GAAP requirements.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to continue to reduce its credit risk by improving its documentation of policies and procedures, and management's actions and judgments by continuing to gather documentation supporting management's assessment of loans approved using underwriting standard 9, including quantification and evaluation of compensating risk factors, and develop a process for utilizing such information in the management decision process for future exceptions and for estimating credit losses.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: Farmer Mac has continued to gather documentation supporting underwriting decisions and generally has made progress in enhancing its documentation. When Farmer Mac approves a loan using underwriting standard 9, it includes documentation of compensating strength of the borrower. Specific loan losses are addressed through the new loan loan estimation model that uses Farmer Mac loan loss data.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to continue to reduce its credit risk by improving its documentation of policies and procedures, and management's actions and judgments by improving documentation supporting and quantifying the effect of extracting specific loan loss estimates from the overall loss estimate to determine whether this approach differs materially from estimating specific loan losses separately.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: Farmer Mac has continued to gather documentation supporting underwriting decisions. Issues regarding specific loan losses are addressed through the new loan loss estimation model implemented at the end of 2005.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to reevaluate its current strategy of holding agricultural mortgage-backed securities in portfolio and issuing debt to obtain funding.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: According to Farmer Mac, this recommendation has been fully implemented. Farmer Mac has reevaluated its strategy and decided that the company would continue using its current strategy.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to develop a contingency funding liquidity plan to address potential vulnerabilities in less favorable capital markets conditions and liquidity needs arising from the rapid growth of standby agreements.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: According to Farmer Mac, it has adopted a contingency funding and liquidity plan in August 2003. The plan established new 60-day minimum and 90-day target liquidity policy in February 2004.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to improve the quality of its prepayment model to ensure accurate interest rate risk measurements.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: For the past two years, Farmer Mac has been using a new prepayment model for the adjustable-rate segment of its portfolio. This model was custom built by Andrew Davidson & Co., an industry-recognized prepayment expert, based on Farmer Mac's own payment history experience. The model has been incorporated into Farmer Mac's own ALM system.
Recommendation: To help ensure that Farmer Mac's management can properly identify, manage, and control risks, it should ensure that it has adequate staff resources and technical skills to improve its analysis of capital adequacy to help ensure that capital would meet the needs of increasing and potential credit risks and growth.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: A new capital adequacy model was approved by the board of directors in August 2003. According to Farmer Mac, credit risk takes into account actual loss rates and model considers potential future growth.
Recommendation: Although the Farmer Mac board has taken steps to strengthen its corporate governance practices, the Chairman, Farmer Mac, should further enhance those practices by reevaluating stock option levels and vesting period to ensure that they are not excessive in relation to comparable industry standards for vesting and waiting period for stock options.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: The Farmer Mac Board received executive compensation studies in connection with establishing compensation in August 2004 and again in June 2005 in connection with annual compensation decisions.
Recommendation: Although the Farmer Mac board has taken steps to strengthen its corporate governance practices, the Chairman, Farmer Mac, should further enhance those practices by better communicating the criteria for identifying and selecting director nominees and the process to nominate directors among the directors.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: At its April 2005 meeting, the Board confirmed that it believes the nomination process is transparent and understood by all members. As of June 2004, Farmer Mac's Board has reviewed, and confirmed by unanimous resolution, that all of its members understand the nomination process and consider it to be transparent. Also, Farmer Mac and its counsel believe the nomination process is fully and fairly disclosed in its Proxy Statement, which is reviewed and approved by the entire Board. Farmer Mac worked with corporate governance advisors to verify that the Board nomination process complies with applicable laws and regulations and is fully understood by the Board members.
Recommendation: Although the Farmer Mac board has taken steps to strengthen its corporate governance practices, the Chairman, Farmer Mac, should further enhance those practices by formalizing executive management succession plan and communicate plan with all board members to provide transparency.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: According to one Farmer Mac official, the board of directors established a formal executive management succession plan at its June 2004 meeting. In addition, the board of directors will review the executive management succession plan at its June 2005 meeting and on an annual basis thereafter.
Recommendation: Although the Farmer Mac board has taken steps to strengthen its corporate governance practices, the Chairman, Farmer Mac, should further enhance those practices by providing consistent training on governance and Farmer Mac related topics to all board members to increase directors' understanding of risks facing the corporation.
Agency Affected: Federal Agricultural Mortgage Corporation (Farmer Mac)
Status: Implemented
Comments: The board members received director professionalism training from corporate governance experts at the law firm of Shearman & Sterling, LLP in December 2004. The Board receives regular governance briefings from FCA. In December 2003, Farmer Mac's Board of Directors began an annual formal training program including consultation and participation with outside counsel. Board members participated in an eight-hour training program on Director Professionalism presented by the National Association of Corporate Directors. In addition to this training, on a regular basis Board members will receive more detailed briefings on specific Farmer Mac related subjects from the Farm Credit Administration and Farmer Mac management. Three recent examples of briefings by management include: (1) a review of Farmer Mac debt issuance and investment strategy; (2) a review of Farmer Mac interest rate risks and ALM strategy; and (3) a review of Farmer Mac's derivatives strategies and the advantages and disadvantages of using such instruments.
Recommendation: Finally, to improve the quality and effectiveness of FCA's oversight of Farmer Mac, the FCA should continue to obtain more relevant and current data on farm loan behavior used in the risk-based capital model and consider more flexible modeling approaches to credit risk, such as those used by OFHEO for regulatory purposes or the Federal Housing Administration (FHA) for evaluating actuarial soundness.
Agency Affected: Farm Credit Administration
Status: Implemented
Comments: On March 31, 2007, FCA adopted revised risk-based capital model rule (3052-AC17) that established specific proxy values for loans with missing or anomalous or ambiguous data and required the application of known data on Long-term Standby Purchase Commitment loans in the model. In addition, FCA is continuing to improve the flexibility of the modeling approaches with a proposed rule (3052-AC36)that would allow the model to recognize credit risk on nonprogram assets similar to the method applied by OFHEO. This rule will be published in May 2008.
Recommendation: Finally, to improve the quality and effectiveness of FCA's oversight of Farmer Mac, the FCA should continue to improve and formalize off-site monitoring of Farmer Mac, including reviews of Farmer Mac's regulatory reporting.
Agency Affected: Farm Credit Administration
Status: Implemented
Comments: FCA has completed a White Paper recommending adoption of certain Office of Federal Housing Enterprise Oversight methods and parameters. In addition, FCA adopted the revised risk-based capital stress test (RBCST) rule on April 3, 2007. The revised rule is intended to improve the RBCST's output (Farmer Mac's regulatory minimum risk-based capital level. Farmer Mac is required to have a qualified, independent external auditor review its implementation of the risk-based capital stress test every 3 years and submit a copy of the auditor's opinon to FCA. Furthermore, FCA reviews Farmer Mac's annual and quarterly reports that are required by SEC , as well as the Uniform Call Reports required by FCA. The director of the Oversight of the Secondary Market Office meets regularly with Farmer Mac amangement and its board of directors.
Recommendation: Finally, to improve the quality and effectiveness of FCA's oversight of Farmer Mac, the FCA should continue create a plan to implement actions currently under consideration to reduce potential safety and soundness issues that may arise from capital arbitrage activities of Farmer Mac and FCS institutions.
Agency Affected: Farm Credit Administration
Status: Implemented
Comments: The FCA board of directors adopted a final rule on capital adequacy risk-weighting for the Farm Credit System in May 2005. The final rule was published in the Federal Register on June 17, 2005 (see FR 35336). The rule affirms FCA's authority to modify the risk-weighting requirements for any asset or off-balance sheet obligation. In addition, issues pertaining to ratings based approach to capital adequacy measurement and leverage rations are being addressed in a background paper FCA is developing on Basel II Capital Accord and its application to the Farm Credit System to ensure that Farmer Mac and the Farm Credit System institutions hold an appropriate level of capital relative to agricultural mortgage risk.
Recommendation: Finally, to improve the quality and effectiveness of FCA's oversight of Farmer Mac, the FCA should examine how other secondary market regulators developed regulations to require the GSEs to obtain a government risk credit ratings from nationally recognized statistical rating agencies.
Agency Affected: Farm Credit Administration
Status: Implemented
Comments: FCA has completed a White Paper, in which it recommended that FCA take no immediate regulatory action to require Farmer Mac to obtain a credit rating.
Recommendation: Finally, to improve the quality and effectiveness of FCA's oversight of Farmer Mac, the FCA should assess and report on the impact Farmer Mac's activities has on the agricultural real estate lending market.
Agency Affected: Farm Credit Administration
Status: Implemented
Comments: FCA has assessed the impact of Farmer Mac's activities on the agricultural real estate lending market. The results are reported in "The Effect of Farmer Mac on the Agricultural Real Estate Lending Market" dated June 2007. FCA concluded that Farmer Mac has made progress toward the accomplishment of its mission and it is providing valuable benefits to those institutions that participate in its core programs. However,Farmer Mac has had only a modest effect on the agricultural mortgage market because of its small market share.
