Debt or Payment Restructuring

Policy Tool: Farm Credit System Capital Corporation

Policy Area: Credit Programs, Debt or Payment Restructuring

What It Is: The Farm Credit Corporation was a separate entity of the Farm Credit System rechartered to: (1) direct the pooling and allocation of System risk capital, (2) purchase, restructure and/or dispose of distressed System assets, and (3) manage the use and repayment of any eventual federal assistance.

Objective: The Capital Corporation was intended to serve as the mechanism for allocating risk funds and federal assistance as needed to maintain the System's integrity.

When Used: The Capital Corporation was chartered originally to facilitate movement of the System's capital assistance to, and management of, distressed assets in the Spokane and Omaha Farm Credit Districts. With the passage of the 1985 Farm Credit Amendment Act, its role was expanded to ensure that the System's own capital would be fully utilized before any federal assistance would be provided.

Experience: In its implementation, the Capital Corporation experienced considerable delays and resistance in establishing guidelines for withdrawing capital from contributing districts and in developing uniform credit standards and control procedures. The Agricultural Credit Act of 1987 replaced the Capital Corporation with the Farm Credit System Assistance Corporation. The precedent for assistance to the System was established at its inception when government funds were used to capitalize the System.


Policy Tool: Interest Buy-Down

Policy Area: Credit Programs, Debt or Payment Restructuring

What It Is: An interest rate buy-down involves an interest rate reduction on existing loans with the government paying a portion of the cost.

Objective: To improve a producer's financial position by reducing interest cost.

When Used: An interest rate buy-down provided for in the 1985 farm bill allowed FmHA to pay 50 percent of the total cost of reducing the interest rate to the qualified borrower, up to a maximum of 4 percentage points. The 1990 farm bill maintained the 4 percent buy-down, but permitted FmHA to pay the total cost. The buy-down is to be used only if there is no alternative way to project a positive cash flow. The duration of the buy-down may not exceed three years. A number of states also have implemented interest buy-down programs to assist financially distressed farmers and ranchers.

Experience: Interest rate buy-downs can be used to restructure debt held by private lenders when there is a reasonable chance the borrower can recover. The program also has been used to reduce the workload for an overburdened FmHA by leaving debt servicing in the hands of private lenders. Lender participation has been less than might have been anticipated because of the requirement to accept a lower rate of return. State programs have encountered considerably higher costs than had been anticipated.


Policy Tool: Loan Mediation

Policy Area: Credit Programs, Debt or Payment Restructuring

What It Is: Loan mediation is a process that brings borrowers and creditors together with a neutral third-party mediator to resolve loan problems before they reach the point that the only options are foreclosure or legal action.

Objective: To resolve borrower/creditor disputes more quickly and with less cost than litigation. Because the mediation process is not adversarial, it is better suited to resolving disputes without destroying the relationship between the disputants.

When Used: The Agricultural Credit Act of 1987 provided funding to develop statewide mediation programs, subject to state approval, with the USDA and FmHA monitoring the programs. Several states already had established programs prior to the passage of the Agricultural Credit Act. Participation in non-binding mediation may be voluntary or mandatory depending upon individual state legislation. Eligibility for federal funding has been on a matching basis and requires that the programs be certified by FmHA.

Experience: Because the mediation process, unlike arbitration, is non-binding on participants, the programs have been generally well accepted by both lenders and borrowers. An analysis by FmHA indicated that mediation programs have saved the government from two to three times the amount spent to fund the programs.


Policy Tool: Mandatory Debt Restructuring

Policy Area: Credit Programs

What It Is: Prior to foreclosing on a distressed loan, some lenders are required to evaluate possible restructuring alternatives and to restructure those loans whenever restructuring would be a less costly alternative than foreclosure.

Objective: To minimize the amount of loan losses and the number of displaced farmers that would result from foreclosure.

When Used: The Agricultural Credit Act of 1987 requires FmHA and all Federal Land Bank Associations, Production Credit Associations, and other financing institutions that discount with the Farm Credit Banks to restructure distressed loans if restructuring would be less costly than foreclosure.

Experience: The debt restructuring requirement has resulted in significant loan write-offs by FmHA and the Cooperative Farm Credit System. However, these write-off losses also would have occurred in the event of a foreclosure, and the legal costs and borrower displacement that would have resulted from foreclosure have been reduced.


Policy Tool: Principal and Interest Deferrals

Policy Area: Credit Programs, Debt or Payment Restructuring

What It Is: Principal deferrals -- borrowers are not required to make principal payments on part or all of the debt for a designated time period but are required to pay interest. Interest deferrals -- borrowers are not required to make interest payments on part or all of the debt for a designated time period but interest would accrue and be added to the debt.

Objective: To allow a borrower with cash flow problems time to restructure debt or recover from adverse economic pressure.

When Used: Used when adverse economic conditions are expected to be temporary or time is needed to restructure the operation to alleviate cash flow problems. Most private lenders do not defer interest but roll it into the principal of the loan. This policy results from legal limitations on the collection of interest that is past due for longer than a specific period. FmHA uses a combination of a principal deferral and interest waiver in its debt adjustment program. If it is necessary for the operation to meet cash flow requirements, a qualified FmHA borrower may defer a portion of the principal for up to five years and accrue no interest on the deferred portion.

Experience: Principal deferrals have tended to be used by private lenders in conjunction with disaster clauses tied to low production levels or commodity prices. They have provided a temporary solution to temporary financial problems. When problems are of a long-term nature, deferrals may simply be delaying the inevitable.


Policy Tool: Principal and Interest Waivers

Policy Area: Credit Programs, Debt or Payment Restructuring

What It Is: Principal and interest waivers are a forgiveness of some portion of a borrower's debt obligation.

Objective: To minimize losses and/or stabilize asset markets.

When Used: FmHA's debt adjustment program combines a deferral of principal with a waiver of the interest on the deferred principal for up to five years. Private lenders have written down principal and accrued interest to minimize losses when they feel the borrower can adequately service the remaining debt.

Experience: Principal and interest waivers have been used as a means of minimizing long-run losses when adverse economic pressures reduce borrowers' ability to service debt and widespread foreclosures would disrupt asset markets. The borrower must have a reasonable chance of financial solvency with debt waivers. There has been a hesitancy to utilize this option in anticipation that financial conditions might improve. Waivers have, therefore, been a last resort option.


Policy Tool: Principal Buy-Down

Policy Area: Credit Programs, Debt or Payment Restructuring

What It Is: A principal buy-down is a reduction or forgiveness of part of a borrower's debt in return for some form of compensation.

Objective: To reduce loan levels in line with lower asset values and to reduce farmers' debt servicing requirements.

When Used: Used when economic conditions are such that a reduction in total debt is the only way a farm can remain solvent and the farm's liquidation would have a politically unacceptable impact on asset markets. Since September 1984, FmHA has been allowed to issue guarantees of up to 90 percent of loans classified as substandard by the lender's supervising agency. To be eligible for the program, the lender is required to write-down at least 10 percent of the loan principal or a present value equivalent interest rate write-down. The borrower also has to be able to project the ability to cash flow the restructured loan.

Experience: In a case in which the potential losses are reduced, private lenders have been willing, in some instances, to write-down part of the outstanding principal and restructure a borrower's payments in exchange for a FmHA guarantee on the remaining debt. Because the principal must be reduced to the point that the loan will cash flow and the guarantee can be for no more than 90 percent of the reduced principal, the program has not been widely used.


Policy Tool: Two-Tier Debt Restructuring

Policy Area: Credit Programs, Debt or Payment Restructuring

What It Is: The program would involve classifying a borrower's debt into two tiers. Tier-one debt is the debt the borrower could reasonably repay over the next five years, under "normal" conditions, with payment made on principal and interest at the current market rate. Tier-two debt would be all remaining debt and would carry a minimum interest rate requiring no principal payments. The amount of tier-two debt equal to the principal payment on tier- one debt would shift to tier-one, each year, until all of the restructured debt was repaid.

Objective: To restructure debt based on the repayment ability of the operation.

When Used: The program was first proposed by the American Farm Bureau in 1985 to deal with the existing financial crisis in agriculture. Any new short-term operating debt would be scheduled for repayment within each production and/or marketing year or offset by a minimum inventory of 120 percent of the loan for crops and 130 percent of the loan for livestock. Approval for new debt would require demonstration of repayment capacity in addition to the repayment requirements of the two-tier program. If a financial analysis reveals that no reasonable solution exists for a farmer's financial problems and that profitability is not possible through the two- tier debt restructuring, then partial or total liquidation of the operation would occur.

Experience: This proposal has not been tried in agriculture. It is similar in philosophy to existing practices involving delinquent foreign debt.


Government Loans

Policy Tool: Beginning Farmer Programs

Policy Area:Credit Programs, Government Loans

What It Is: Direct government loans and/or government agency guarantees of loans made by private lenders to beginning farmers.

Objective: To help beginning farmers with limited resources get started in business by offering more favorable terms and loan amounts than would be available from private lenders in the case of direct loans or by encouraging private lenders to make loans they would not make without a loan guarantee.

When Used: Beginning farmer loan programs are offered by FmHA and by several states. Interest rates and equity requirements on direct loans are usually lower than would be required by private lenders. Repayment periods are also often longer than normal market terms to reduce debt servicing requirements. Government guarantees of loans made by private lenders have generally also involved interest subsidies. Direct loan and guaranteed loan program eligibility requirements have usually been subject to age and experience limits.

Experience: Such programs are politically popular because they are aimed at helping people with limited resources get started in business. They also address the entrance barrier created by increasing capital requirements, as well as the concern that the average age of the farm population continues to grow older.


Policy Tool: Borrower Education Requirements

Policy Area: Credit Programs, Government Loans

What It Is: FmHA direct or guaranteed farm loan program borrowers would be required to participate in approved farm and financial management training until they reached a specified level of demonstrated knowledge of the subject matter.

Objective: To improve borrower's management skills and business performance and to reduce related credit problems.

When Used: FmHA was directed to start a borrower education program in the 1990 farm bill. The programs would be offered by existing organizations such as the agricultural extension service or community colleges with borrowers being loaned the funds for tuition. Programs would be required to cover specified subject matter and be approved by FmHA. Participation could be waived if the borrower was certified by FmHA to have demonstrated some minimum level of competence and knowledge regarding the required subject matter.

Experience: None. This program has not yet been implemented.


Policy Tool: Direct Government Loans

Policy Area: Credit Programs, Government Loans

What It Is: Direct government loans involve a government agency lending money to specified categories of borrowers for specific purposes. Frequently, such loans are subsidized and made at an interest rate that is less than either the cost to the government or the market rate of interest for comparable loans from private lenders.

Objective: To provide loan funds for purposes deemed to be in the public interest to borrowers who cannot obtain financing either in adequate amounts or at reasonable terms from private lenders.

When Used: FmHA has been the federal government's agricultural lending agency. Several states have also initiated agricultural loan programs. FmHA makes both farm operating and farm ownership loans. Interest rates on these loans are tied to the government's cost of borrowing and are thus lower than comparable conventional loans. A special limited resource loan program exists for farmers whose financial condition is such that they cannot afford to pay the normal interest rate. These loans are made primarily to farmers and ranchers who cannot qualify for adequate financing from other lenders and are not intended to supplant or compete with credit available from conventional lending sources. They are intended to bear the financial and market risk that conventional lenders are unwilling or unable to bear.

Experience: In the early 1980s, the government's share of total producer loans increased to the point that there was concern regarding government credit becoming the major source of agricultural credit. Concerns still exist concerning the effect of political influence on loans made by government agencies. Yet, Congress favors the government credit option because the loan is an asset as opposed to a direct government outlay. Foreclosure on government loans has been difficult and subject to strong political resistance.


Policy Tool: Economic Emergency Loan Program

Policy Area: Credit Programs, Government Loans

What It Is: Economic emergency loans are government loans intended for farmers who are suffering economic hardships due to national or regional economic stress, or from general tightening of credit, high costs of production, or low farm product prices.

Objective: To make credit available to farmers suffering financial hardship as a result of the negative impact of economic forces beyond their control.

When Used: The program was created in 1978 and administered by the FmHA primarily to refinance debts and provide operating expenses to continue farming. Loans were made regardless of whether financing could be obtained elsewhere. New loans under this program have not been made since 1984.

Experience: The program made billions of dollars of subsidized credit available at a time when real interest rates were low to negative. In many respects, it exacerbated the problem by deferring normal market adjustments, holding excess resources in agriculture, and artificially supporting asset values. When farm income began to turn down in the mid-1970s, farmers who were only marginally successful (even in good times) and farmers who had inadequate repayment capacity found credit markets tightening up. At the same time, the land market was relatively tight, and there were successful operators who would have purchased assets if the market had been allowed to force unsuccessful operators out of farming. Instead, the economic emergency loan program was created on the basis that the problem was short run. The result was that asset values were artificially supported and the eventual market collapse was more severe and disruptive than it would have been otherwise.


Policy Tool: Emergency Disaster Loan Program

Policy Area: Credit Programs, Government Loans

What It Is: The emergency disaster loan program is a government loan program that makes credit available to farmers in areas devastated by natural disasters.

Objective: To help farmers recover from the effects of natural disasters.

When Used: FmHA makes disaster loans in locations designated as disaster areas by the President or by the Secretary of Agriculture. These loans can be made to compensate for (1) actual physical losses directly related to the disaster, (2) annual production expenses and other needs arising from natural disasters if the borrower has, when available, some "all-risk" crop insurance coverage, and (3) major adjustments in the farming operation necessitated by a disaster.

Experience: Emergency disaster loans have been used to help farmers recover from losses experienced as the result of natural disasters. Interest rates on disaster loans are based on the government's cost of borrowing for those able to qualify for credit elsewhere and subsidized to farmers who are unable to obtain credit elsewhere.


Policy Tool: Guaranteed Loans

Policy Area: Credit Programs, Government Loans

What It Is: Guaranteed loans involve a government agency agreeing to protect a private lender against some or all potential losses resulting from borrower default.

Objective: To encourage private lenders to make and service loans they would not make without a loan guarantee.

When Used: Guaranteed loans are used to encourage private lenders to make, service, or restructure loans to borrowers who exceed the lender's risk requirements. They also have been used to encourage lenders to make loans to start-up businesses and minorities. FmHA and RDA can guarantee both short-term and long-term loans made by private lenders. The loans are funded and serviced by the private lender subject to FmHA or RDA approval. Guarantees can generally be extended for up to 90 percent of the loan amount. Loan guarantees have political appeal because they are low cost in the short-run and because the funds flow through the private sector.

Experience: Guarantees have been moderately effective in encouraging lenders to make new loans. Many lenders feel the return from this type of loan is not worth the time and red tape involved in meeting the terms of the guarantee provisions. There is also some concern about how the terms of the guarantee would be interpreted in the event of borrower default. The greatest use of loan guarantees has been to restructure existing loans to avoid or reduce potential losses. Lenders also have used loan guarantees when financing ventures or enterprises with which they have limited experience or when the size of the loan involved puts a significant portion of the institution's capital at risk. Some lenders use loan guarantees as a means of servicing borrowers who would otherwise exceed the institution's legal lending limit. Others use guaranteed loans to increase profits by discounting the guaranteed portion into secondary markets.


Policy Tool: Rural Development Administration

Policy Area: Credit Programs, Government Loans

What It Is: The Rural Development Administration (RDA) involved the creation of a new federal lending agency by separating the activities of the FmHA into an agricultural agency and a rural development agency. RDA assumes responsibility for FmHA's water and sewer, community facility, and business and industrial loan programs.

Objective: To create a catalyst agency for directing federal assistance to rural areas from federal agencies and for fostering cooperation with the states on rural development programs.

When Used: The creation of RDA in 1992 was authorized by the 1990 farm bill. Its activities initially involve a transfer of existing programs and appropriations out of FmHA. To date, administrative and regional offices have been opened but no funds have been appropriated to hire field staff. Credit analysis, therefore, is being handled by FmHA personnel through a memorandum of understanding.

Experience: The creation of RDA has been embroiled in congressional debates over appropriations between those who favored its creation and those who wanted its activities to remain under FmHA. Another factor in the debate was opposition to RDA from those opposing the creation of a new agency at a time when the USDA is under pressure to streamline its operations and reduce its number of field offices.


Government Regulation and Intervention

Policy Tool: Chapter 12 Bankruptcy

Policy Area: Credit Policy, Government Regulation and Intervention

What It Is: A business reorganization chapter of the federal bankruptcy code designed exclusively for family farmers.

Objective: To provide a streamlined procedure for farm business reorganization that would allow financially distressed family farms to remain in business if they can present a plan that would demonstrate how they could service their debts if the debts were written down to the value of the underlying collateral and if creditors were stayed from pursuing legal action to collect their loans.

When Used: The Family Farm Bankruptcy Act went into effect on November 27, 1986, and will sunset on October 1, 1993, unless extended by legislative action. Chapter 12 is available only to family-held agricultural operations, including family-held corporations, with the stipulation that at least 50 percent of the operation must be family held and stock or securities cannot be publicly traded. Protection under the Act is available to agricultural operations with up to $1.5 million in secured debt, provided the families who hold controlling interest in the operation receive at least 50 percent of their gross income from the operation and at least 80 percent of the family secured debt is involved in the operation, exclusive of debt related to family residences. A debtor seeking Chapter 12 protection has 90 days from filing to submit a reorgani- zation plan to the bankruptcy court, and the judge is required to act on the plan within 45 days after receiving it. The judge may approve a reorganization plan, even if some creditors do not agree to it, provided the plan appears to be in the best interest of all concerned. If the plan is approved, the debtor will be under court supervision for three to five years. The debtor remains in charge of the agricultural operation, and a court-appointed trustee ensures that payments are made according to the plan and that no fraud or mismanagement occurs.

Experience: Chapter 12 has resulted in a significant amount of farm debt being discharged and has allowed many farmers to remain in business that would have otherwise been forced to liquidate as a result of lender collection action. It has also served as a bargaining lever for farm debtors by encouraging lenders to agree to debt restructuring rather than face the additional costs that would result from bankruptcy.


Policy Tool: Farm Credit Administration (FCA)

Policy Area: Credit Programs, Government Regulation and Intervention

What It Is: FCA is the regulatory agency for the Farm Credit System.

Objective: To establish regulatory standards for the performance of the System.

When Used: FCA has existed throughout the life of the Farm Credit System. Until the enactment of the 1985 Farm Credit Amendments Act, FCA performed regulatory, public relations, and advocacy functions. This Act materially strengthened FCA's regulatory role and eliminated its member-controlled board of directors.

Experience: Despite changes in its function over time, FCA continued to serve important advocacy and public relations functions for the Farm Credit System and had limited regulatory powers compared to the regulatory agencies for other financial institutions. Establishing lending policies and standards was considerably more decentralized. When the farm credit crisis developed in the 1980s, FCA was criticized for not having provided adequate regulatory guidance and control. Its regulatory function was, therefore, materially strengthened, with the producer control structure severed.


Policy Tool: Farm Credit System Insurance Corporation

Policy Area: Credit Programs, Government Regulation and Intervention

What It Is: The Farm Credit System Insurance Corporation is a separate entity of the Farm Credit System and was chartered to develop and administer a pool of risk capital to ensure the timely payment of principal and interest on notes, bonds, debentures, and other obligations of participating Farm Credit System institutions.

Objective: To ensure the financial integrity of financial instruments issued by the Farm Credit System Funding Corporation and to guard against the need for future federal financial assistance.

When Used: The Farm Credit System Insurance Corporation was mandated by the Agricultural Credit Act of 1987 in conjunction with a financial assistance package establishing federal aid to prevent the System from collapsing. The fund is to begin insuring obligations in January 1993.

Experience: The Insurance Corporation was established on January 6, 1988, and was initially capitalized by the FCA revolving fund. Beginning in 1989 each System bank was insured and subject to the law governing the Insurance Corporation and its powers. The initial premium payments began in 1990 with payments based on the accruing and nonaccruing loan volume of each bank for the previous year.


Policy Tool: Foreclosure Moratorium

Policy Area: Credit Programs, Government Regulation and Intervention

What It Is: Foreclosure moratoria forces lenders to stop foreclosures on agriculture-related loans.

Objective: To temporarily relieve the financial obligations of financially pressed borrowers with excessive debt.

When Used: Moratoria were applied under the Frazier-Lemke Act in the 1930s to bankruptcy proceedings. The moratorium was applied to real estate mortgage loans. In recent years, various states have also instituted temporary moratoria on farm foreclosures. FmHA was prohibited from foreclosing on borrowers from May 1983 through November 1985 as a result of the Coleman vs. Block lawsuit.

Experience: During the Frazier-Lemke Act moratorium in the 1930s, a farm was appraised and the courts granted a stay of proceedings for three years, during which time the farmer retained possession of the property and paid rent for its use. Within three years, the farmer could pay the appraised value and redeem the property. If the property was not redeemed, it would be sold to satisfy the debt against it and the farmer would not be held liable for loan amounts greater than the appraised value of the property or its sale price. The various moratoria imposed on or by the FmHA have simply been stays of foreclosure. The farmer was given time to restructure debt and service the loan obligations.


Policy Tool: Warehousing Farm Assets, Agriculture Conservation Corporation

Policy Area: Credit Programs, Government Regulation and Intervention

What It Is: A proposal to form a government corporation to purchase assets (land and equipment) from problem farm loans at a "fair" market value. Assets acquired under the program would either be retired or later resold or leased back to farmers.

Objective: To stabilize the value of agricultural assets and to prevent further erosion of farmers' equity and lenders' collateral values.

When Used: An Agricultural Conservation Corporation was proposed as a limited life program to be used when adverse economic conditions result in large numbers of foreclosures and voluntary liquidations. The program would support asset values by taking surplus assets off the market.

Experience: None. The program has not been implemented. The concept appeared to be rejected based on the potential for extensive government ownership of farmland and equipment.


Secondary Financial Markets

Policy Tool: Secondary Markets for Agricultural Loans

Policy Area: Credit Programs, Secondary Financial Markets

What It Is: Secondary markets involve the originating lender selling loans or claims on agricultural loans to investors. In its most limited sense, the process involves a direct transaction between the original lender and an investor. A potential exists for greater liquidity when brokers act as middlemen to facilitate the sale of loans or loan participations to investors. An extension would be to establish an agricultural credit corporation to pool loans and sell negotiable pooled participations (or mortgage bonds) to investors.

Objective: To add liquidity, spread lending risks, and broaden the market for agricultural loans.

When Used: Existing secondary markets for agricultural loans include the sale of farm mortgage loans by originating lenders to life insurance companies. There is a highly developed secondary market for FmHA guaranteed loans through brokers. Commercial banks have long used the sale of loan participations to correspondent banks as a means of funding agricultural loans. The Farm Credit Banks can also discount short- and intermediate- term agricultural loans from commercial banks and agricultural credit corporations. These are funded by the sale of consolidated Farm Credit System bonds and notes. Major banks have also used bankers' acceptances as a means of marketing agricultural loans in established secondary markets.

Experience: The Farm Credit Banks, correspondent banking relationships, and secondary markets for bankers acceptances and government guaranteed loans provide several alternatives for marketing short- and intermediate-term agricultural loans. Secondary markets for farm real estate loans are not nearly so well developed. Most farm mortgages sold by originating lenders to insurance companies are on a prearranged basis. The Federal Agricultural Mortgage Corporation was authorized by the Agricultural Credit Act of 1987. "Farmer Mac" provides a secondary market for farm real estate mortgages, rural housing loans, and the guaranteed portion of FmHA loans. Although loan pools have been created, Farmer Mac has been less active than anticipated. The program involves the creation of a government- backed agricultural credit corporation to pool farm mortgages and sell pooled participations or mortgage bonds in a manner similar to the Federal National Mortgage Corporation which buys residential mortgages.