Congress  established Farmer Mac with a mission to create a secondary market—a  financial market for buying and selling loans, individually or by  securitizing them—in agricultural real estate and rural housing loans, and  improve the availability of agricultural mortgage credit. Of  that total, nearly $3.1 billion was in off-balance sheet standby and similar  agreements. In other words, at a time when either the agricultural  sector is severely depressed or interest rates are falling, Farmer Mac could  be required to purchase large amounts of impaired or defaulted loans  under the agreements, thus subjecting Farmer Mac to increased funding  liquidity risks and the potential for reduced earnings. Disagreements about the Extent of Coverage of Treasury’s Line of Credit Could Generate Uncertainty

Now I want to focus on an issue involving Farmer Mac’s $1.5 billion line of  credit with Treasury that could impact the corporation’s long-term  financial condition. In a comment letter dated June 13, 1997, and submitted to FCA in  connection with a proposed regulation on conservatorship and  receivership for Farmer Mac (1997 Treasury letter), Treasury stated “…we  have ‘serious questions’ as to whether the Treasury would be obligated to  make advances to Farmer Mac to allow it to perform on its guarantee with  respect to securities held in its own portfolio—-that is, where the Farmer  Mac guarantee essentially runs to Farmer Mac itself.” The 1997 Treasury  letter indicated that if the purchase of obligations extended to guaranteed  securities held by Farmer Mac this would belie the fact that the securities  are not backed by the full faith and credit of the United States, since a loan  to Farmer Mac to fulfill the guarantee would benefit holders of Farmer  Mac’s general debt obligations. Mission-related Activities Have Increased, but the Impact of Activities on Agricultural Real Estate Market Is Unclear

Before I go into whether Farmer Mac’s activities have had an impact on  the agricultural real estate loan market, I want to point out that the  enabling legislation contains only broad statements of the corporation’s  mission and purpose. Our attempt to determine the extent to which Farmer Mac had met its  public policy mission led us to conclude that although Farmer Mac has  increased its mission-related activities since our previous review, the  public benefits derived from these activities are not clear. Farmer Mac stated that this strategy  would lower funding costs and increase profitability but as a result, the  depth and liquidity of the secondary market for AMBS is unknown. While standby agreements provide greater lending  capacity for those institutions, they also lower the amount of capital  lending institutions are required to hold against their loans. However, Farmer Mac’s business  activities are concentrated among a small number of business partners and  its portfolio is concentrated largely in the western United States. Farmer Mac’s Board of Directors May Not Reflect All Shareholder Interests, Be Fully Independent, or Use Clear and Transparent Processes

Before discussing governance issues at Farmer Mac, I want to describe  how Farmer Mac’s board of directors is structured in federal law. Under  this structure, Farmer Mac resembles a cooperative. For this reason, the board may face difficulties  representing the interests of all shareholders. FCA Has Taken Steps to Enhance Oversight of Farmer Mac, but Faces Challenges That Could Limit the Effectiveness of Its Oversight

During our 2003 review, we noted that FCA had begun strengthening its  oversight of Farmer Mac by doing a more comprehensive safety and  soundness examination and undertaking initiatives to expand its  regulatory framework. However, we found that FCA continued to face significant challenges in  sustaining and improving its oversight and more remained to be done to  improve its off-site monitoring, assessment of risk-based capital, and  mission oversight. We also identified a number of issues related to the  data used in and structure of FCA’s risk-based capital model, but the  overall impact these issues have on the estimate of risk-based capital for  Farmer Mac’s credit risk is uncertain. We recommended in our report  that Farmer Mac strengthen its risk management and corporate  governance practices and reevaluate its strategies to carry out its mission.
Why GAO Did This Study

This testimony is based on GAO's October 2003 report, Farmer Mac: Some Progress Made, but Greater Attention to Risk Management, Mission, and Corporate Governance Is Needed (GAO-04-116). GAO's testimony presents a brief overview of Farmer Mac and discusses issues raised in its 2003 report, including Farmer Mac's risk management practices and line of credit with Treasury, mission related activities, board structure, and oversight, which is provided by the Farm Credit Administration (FCA).

What GAO Found

Farmer Mac, a government-sponsored enterprise (GSE), was established to provide a secondary market for agricultural real estate and rural housing loans and to increase agricultural mortgage credit. In 2003, GAO reported that several aspects of Farmer Mac's financial risk management practices had not kept pace with its increasing risk profile. First, Farmer Mac had $3.1 billion in off-balance-sheet commitments and other agreements that could obligate it to buy the underlying loans or cover related losses under certain conditions. Farmer Mac and the Farm Credit System institutions that participate in the agreements are required to hold far less capital than is otherwise required. Because Farmer Mac's loan activities are concentrated in a small number of financial institutions and in the West, the risk is not reduced while less capital is required to be held. Under stressful agricultural economic conditions, Farmer Mac could be required to purchase large amounts of impaired or defaulted loans if large amounts of the commitments were exercised. Second, the coverage of Farmer Mac's $1.5 billion line of credit with the U.S. Treasury was controversial, as the entities disagreed on whether the securities it has issued and kept in its portfolio would be eligible. Third, GAO reported that while Farmer Mac had increased its mission-related activities since its 1999 report, their impact on the agricultural real estate market was unclear. The effects were difficult to measure partly because Farmer Mac's statute lacks specific mission goals. For this and other reasons, GAO concluded that the public benefits derived from Farmer Mac's activities are not clear. Finally, for profitability reasons, Farmer Mac had a strategy of holding securities it issued in its portfolio instead of selling them to investors in the capital markets. As a result, the depth and liquidity of the market for Farmer Mac's securities is unknown. Farmer Mac's board structure, set in federal law, may make it difficult to ensure that the board fully represents the interests of all shareholders and meets independence and other requirements. The board structure contains elements of both a cooperative and an investor-owned publicly traded company. For example, two-thirds of the board members do business with Farmer Mac and hold the only voting stock, while the common stock holders have no vote. GAO also identified challenges FCA faced in its oversight of Farmer Mac, including a lack of specific criteria for measuring how well it was achieving its mission. Although FCA had taken steps to improve its safety and soundness oversight, more needs to be done to improve its offsite monitoring and assessment of risk-based capital. Farmer Mac and FCA have efforts underway to address many of GAO's recommendations and it was too early to assess them.