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Farmer Mac: Some Progress Made, but Greater Attention to Risk Management, Mission, and Corporate Governance Is Needed

GAO-04-116 Published: Oct 16, 2003. Publicly Released: Oct 16, 2003.
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Highlights

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).

Recommendations

Matter for Congressional Consideration

Matter Status Comments
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.
Closed – Not Implemented
Congress has not passed any recent legislation affecting Farmer Mac.
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.
Closed – Not Implemented
Congress has not passed any recent legislation affecting Farmer Mac.
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.
Closed – Not Implemented
Congress has not passed any recent legislation affecting Farmer Mac.

Recommendations for Executive Action

Agency Affected Recommendation Status
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Federal Agricultural Mortgage Corporation (Farmer Mac) 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.
Closed – Implemented
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.
Farm Credit Administration 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.
Closed – Implemented
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.
Farm Credit Administration 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.
Closed – Implemented
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.
Farm Credit Administration 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.
Closed – Implemented
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.
Farm Credit Administration 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.
Closed – Implemented
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.
Farm Credit Administration 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.
Closed – Implemented
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.

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