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Testimony of

**Frank A. Pinto**

**Pennsylvania Association of Community Bankers**

On behalf of the

Independent Community Bankers of America

and

America's Community Bankers

Before the

**Congress of the United States**

**House of Representatives**

**Subcommittee on Conservation, Credit, Energy, and Research**

**of the**

**Committee on Agriculture**

Hearing on

**"The Availability of Credit in Rural America"**

March 27, 2007

Washington, D.C.

**Statement of Frank A. Pinto**

Good afternoon. Chairman Holden, Ranking Member Lucas, and Members of
the Subcommittee. I appreciate being invited to testify on the important
topic of credit availability in rural America. It is an honor to be here
this afternoon representing the Independent Community Bankers of America
(ICBA[^1]) and America's Community Bankers (ACB[^2]). My name is Frank
A. Pinto. I currently serve as President of the Pennsylvania Association
of Community Bankers (PACB[^3]). PACB is affiliated with both ACB and
ICBA, and in 2005-6 I served on ACB's Board of Directors.

Our testimony this morning is divided into three sections.

**Section one** discusses the role of community banks serving rural
areas and the availability of credit in rural America.

**Section two** discusses proposals and activities of the Farm Credit
System and the reasons why we object to what we quite frankly see as a
very unconstructive, dangerous and overreaching agenda.

**Section three** discusses some of our concerns with the FCS's
regulator, the Farm Credit Administration (FCA) and suggests that
reforms are needed.

Our testimony also explains that the FCS is pursuing broad expansion
powers in the legislative arena while at the same time the FCA has
scheduled agenda items on the regulatory docket that would allow FCS to
broadly finance non-farm credit needs and provide financially related
services. The FCS is in essence pursuing a strategy of 'double-dipping'
in an effort to become commercial banks while retaining government
sponsored enterprise (GSE) status and advantages.

Mr. Chairman, community banks are very involved in providing credit to
rural America. We have listed the benefits that community banks bring to
local and rural areas. These benefits to rural America compare well
against the rapidly consolidating number of Farm Credit System
institutions, many of which are no longer locally-based, but rather
regionally based. It is important to understand the important role that
community banks play in rural America because it directly factors into
the question of credit availability in rural America.

**Section I -- Credit in Rural America**

**Community Banks Benefit Rural America**

-   Community banks focus attention on the needs of local families,
    businesses, and farmers.

-   Community banks channel their loans to the neighborhoods where their
    depositors live and work, helping to keep local communities vibrant
    and growing. They do not take deposits from one state and lend in
    other states.

-   Community bank officers are generally accessible to their customers
    on site. They are often headquartered at locations close to their
    daily customer dealings.

-   Community bank officers are typically deeply involved in local
    community affairs and are physically and emotionally attached to the
    communities where their bank and branches are located. Community
    bankers are involved with their local school boards, hospitals, and
    involved in economic and community planning initiatives.

-   Many community banks are willing to consider character, family
    history and discretionary spending in making loans.

-   Community banks offer nimble decision-making on business loans with
    decisions made locally rather than needing loan approval from a
    headquarters office far removed from the community.

-   Because community banks are themselves small businesses, they
    understand the needs of small business owners. Their core concern is
    lending to small businesses, farms and consumers.

**Serving Rural America in Good Times and Bad**

The commercial banking industry is the largest single sector provider of
credit to American agriculture, supplying nearly forty percent of
agriculture's credit needs. Community banks have consistently been the
largest provider of agricultural credit within the commercial banking
sector.

In fact, more so than any other lender segment, including the FCS,
community bankers serve their rural customers in both good times and
bad. Community banks have no other option than to stick with their
customers through thick and thin as their bank's success is tied to the
success of their communities. This fact was painfully evident during the
agricultural credit crisis of the 1980s when hundreds of community banks
were allowed to fail while the FCS received a federal bailout through a
\$4 billion line of credit to the U.S. Treasury.

In addition, community bankers are often the catalysts for developing
and attracting new and expanded businesses opportunities within their
communities to ensure the long-term economic viability of their
communities.

**The Availability of Credit in Rural America**

To understand the availability of credit in rural areas it is helpful to
know how many community banks serve rural America. There are
approximately 8,500 community banks in the U.S. Eighty percent of these
banks, nearly 6,800 institutions, are in cities of less than 50,000
people, or what some would call non-metropolitan areas.

![](media/image3.wmf)Nearly seventy percent of all community banks,
approximately 5,800, are located in communities of less than 20,000
people. Slightly less than 5,000 banks, or fifty-seven percent, are in
communities of less than 10,000 people. Approximately 3,800 banks, about
forty-five percent, are in towns of less than 5,000 people. Over thirty
percent of all community banks, approximately 2,700 institutions, are in
communities of less than 2,500. Thousands of community banks serve
smaller, remote, rural areas.

These statistics reveal that there are numerous financial institutions
that are ready, willing and able to continue serving the credit needs of
rural America. The thousands of community banks serving rural areas
provide a substantial and unique delivery system of credit for rural
customers. **These numbers do not include the additional thousands of
bank branches that serve rural areas, nor do they count other
non-governmental lenders such as finance companies, insurance companies,
credit unions, and others.**

**Survey Results**

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The ICBA recently conducted a survey to over 1,000 randomly selected
rural bankers geographically dispersed across all regions of the U.S.
Approximately three hundred bankers returned responses to our survey,
more than three times the number of lenders within the FCS. These
bankers are keenly aware of the credit needs of rural communities since
they finance commercial businesses, farmers and ranchers, and consumers
every day. The findings provide the Members of the Subcommittee clear
answers to questions regarding the availability of credit in rural
areas.

When specifically asked the question: *"Is there a lack of credit
available in your marketplace, Yes or No?"* **one hundred percent of the
respondents answered "NO".**

![](media/image2.wmf)**[Survey Findings]{.underline}**

1.  **There is No Lack of Credit in Rural America**

2.  **There is No Lack of Competition in rural America**

Approximately two-thirds of the banks in our survey reported having
*five **or more** competitors in their local marketplace*.

The vast majority of respondents also observed that adoption of
proposals by the FCS for new legislation in the farm bill and by FCA to
expand eligibility of processing and marketing firms that are not farmer
owned and controlled, but rather investor-owned and controlled, would
*undermine competition, not enhance it.* This is due to the negative
impact that heavily subsidized FCS lenders would have on the ability of
private sector lenders to continue offering specialized lending and
expertise in the agricultural and rural marketplace.

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We also asked whether the array of agricultural related businesses in
rural markets have trouble obtaining credit. Respondents overwhelmingly
reported that agri-businesses do not have trouble obtaining credit.

**[Survey Findings]{.underline}**

3.  **There are numerous private sector lenders serving local markets**

4.  **Agribusiness and commercial firms have no trouble accessing
    credit**

It is also quite revealing to view the actual comments of bankers
responding to the question of whether allowing FCS expanded powers to
lend to agribusinesses and commercial businesses in rural areas would
enhance competition. Samples of their responses follow.

**Sample Banker Comments**

-   We already have 6 banks, two credit unions, Ford Motor Credit, GMAC
    financing, American Express Financial, State Farm Insurance/Bank.

-   There are already multiple sources of credit available to all of the
    commercial and agricultural accounts in this area.

-   Their tax preferred status would keep the current banks from
    competing

-   Too many banks are now competing for market share.

-   These firms are already being serviced by existing financial
    institutions.

-   Local tax paying banks cannot compete with subsidized lenders,
    consequently no competition.

-   It would effectively stifle competition since FCS does not play by
    the same rules. Eventually it would decrease competition with
    smaller banks selling out.

-   Our customers already have the choice of several banks as well as
    seed companies, feed companies, co-ops, etc.

-   In our community, lending is cutthroat. If FCS wants to compete,
    please remove their subsidy and let them pay taxes like our bank.

-   There are 40 bank and credit union locations within 25 miles.

-   Credit is available in our community for any viable borrowing
    entity. Competition from surrounding banks ensures fair pricing.

-   There is no shortage of lenders in our market, we are outside of the
    corn belt, but there are other types of producers in our area that
    are serviced by local banks, and there are plenty of banks in our
    market area. I don\'t see how a subsidized lender would help but to
    drive out competition by not competing on a level playing field.

-   We currently have more than a dozen financial firms vying for the
    same business - competition is already fierce and probably under
    priced to risk.

-   Competition is sky high in my area and Farm Credit does not help
    competition but merely monopolizes a community due to their unfair
    balance sheet financing.

-   It would not provide an \"enhancement\" since credit is readily
    available and at reasonable terms.

**Results of the 1996 Rural Manufacturing Survey**

USDA's Economic Research Service (ERS), in cooperation with Washington
State University, conducted the 1996 Rural Manufacturing Survey (RMS) to
address a number of questions relating to rural manufacturing
businesses. This report considered such issues as whether rural
manufacturers were adopting computerized automated production
technologies and new management practices, skill levels of rural
workers, adequate labor availability and, other key issues including
**[access to credit,]{.underline}** services, local infrastructure, and
schools. The report noted that "Globalization of industry means the
ability to compete in world markets is crucial to business success and
job creation." (Emphasis added)

Interviews were conducted with 2,844 manufacturing establishments in non
metropolitan areas of the United States and 1,065 establishments in
metropolitan areas. Respondents were representative of establishments
with 10 or more employees in all manufacturing industries. The report's
goal was to provide a unique source of information on rural businesses
that could serve as a vital tool for rural policymakers in USDA,
Congress, other Federal agencies, and State and local governments.

The survey reported this significant finding in terms of the
availability of credit for rural businesses:

> "Fifty-seven percent of nonmetro manufacturers reported a major
> expansion or modernization during 1992-1995, with nearly two-thirds of
> those companies using funds borrowed from a bank or savings and loan.
> **Capital seems to be [equally available]{.underline} for both metro
> and nonmetro manufacturers.**" (Emphasis added)

The report also stated in its conclusion: **"The similarity of the metro
and nonmetro responses suggests that capital is equally available to
metro and nonmetro manufacturing establishments**."

**Irrefutable that the FCS is a Heavily Subsidized Competitor**

That the FCS, as a government sponsored enterprise, is heavily
subsidized is not a point that can be easily dismissed. For instance,
when FCA, at FCS's bidding, proposed a 'National Charter' framework to
unleash all FCS lenders into any geographic market, the Treasury
Department, in a May 2, 2001 letter, raised several concerns to FCA. One
concern was whether it was necessary to introduce a heavily subsidized
GSE retail lender into markets that are well served by the private
sector. Treasury noted:

> "But the existence of such (private sector) competitors again suggests
> that the market failures that have existed in the past in providing
> agricultural credit may no longer exist. **We question whether
> enabling a GSE-subsidized competitor to better compete in this market
> advances a public purpose** ... **the System is a GSE, operating with
> a federal charter,** **a federal mission and federal subsidies**."
> (Emphasis added)

In an October, 2000 public statement the Treasury pointed out the FCS is
a heavily subsidized enterprise that enjoys competitive advantages over
the private sector.

> "**GSEs are private sector entities created by Congress and given a
> special set of benefits by Congress to accomplish a public purpose**.
> **Like other GSEs, the FCS is limited to a particular line of business
> -- providing credit and related services in agricultural communities
> -- and receive various government benefits that lower the System's
> operating costs and enable it to borrow at rates much lower than other
> financial institutions.**
>
> **"Some of these benefits include an exemption from registering
> securities with the SEC and exemptions from federal state, and local
> taxes** ... GSEs are an exception to our general approach of avoiding
> differential treatment among financial institutions. **The potential
> benefits that GSEs bring to a particular market must be balanced,
> therefore, against potential risks to the financial system and
> potential effects on market competition."** (Emphasis added)

The Treasury Department's letter also stated:

> "Because FCS associations lend much like private sector banks, it is
> tempting to think of them as just another competitor in the
> agricultural credit market. **But they are not just another
> competitor: they are a lender to which the government has given
> significant competitive advantages.**" (Emphasis added)

The Treasury Department noted at the time that expanding FCS's powers
through unlimited geographical constraints "**might well diminish
competition and innovation** in the medium- to long term **by driving
other competitors from the market.**" (Emphasis added)

Simply put, driving private sector competitors out of the rural
marketplace harms rural America. Furthermore, it is not credible for
FCS/FCA to claim that commercial banks as well as other types of private
sector competitors have comparable subsidies.

As the Treasury Department's comments emphasize, expanding the powers of
the FCS must be balanced with the potential harm to the financial system
and the potential effects on the competitive landscape of the rural
marketplace. FCA's proposal makes no effort to achieve this common sense
balance and therefore will be quite harmful to rural America in many
respects.

**A New "Groundhog" Day**

Mr. Chairman, it seems that with the FCS and their legislative
proposals, every new Congress is another 'Groundhog Day', in reference
to the popular movie. In practically every new Congress we were told by
FCS and the FCA that the FCS needs new powers. In 1995, for example,
during debate on the 1996 farm bill, FCS witnesses testified that they
'needed' new lending authorities. The rationale was similar then to what
is being expressed today. FCS stated that "new production techniques,
export markets, increasing foreign and domestic competition, and
environmental regulations are dictating the way American agriculture
does business." This sounds eerily familiar to the Horizons pitch of
2007.

In fact, many of the same proposals touted then are being dusted off
under the guise of the System having done a new, major, internal
assessment to address changing trends in rural America.

In 1995, on several occasions FCS witnesses stated, "We also believe
that FCS should be given the authority to directly lend to those rural
businesses related to agriculture." FCS witnesses also asked for
expanded mortgage lending authorities and the removal of borrower stock
and borrower rights requirements.

We have only received FCS's legislative proposal in just the past few
days. This proposal contains very similar, but apparently even more
dramatic initiatives than those mentioned above. The System, of course,
did not share their legislative proposals with the banking industry,
demonstrating that they knew the proposals are overreaching. What the
System is requesting could cause the demise of hundreds, perhaps
thousands, of community banks.

**Section II -- FCS Issues**

**FCS's Agenda: Becoming the New Commercial Bankers**

The FCS is a government sponsored enterprise. As the Treasury Department
noted, GSEs are granted special benefits by Congress to accomplish a
public purpose. The 'mission' of GSEs is limited by Congress in
recognition of the special competitive advantages that GSEs have over
private sector lenders. As the Congressional Research Service (CRS)
noted in their January 2007 report, "Each GSE is given certain benefits
such as implicit federal guarantees or tax exemptions, presumably to
overcome barriers faced by purely private markets. FCS is the only
direct lender among the GSEs; other GSEs such as Fannie Mae are
secondary markets." As CRS noted, "most investors feel the federal
government will not allow a GSE to fail."

By proposing expanded powers legislation, just as they have during
previous farm bill debates, the FCS is seeking to leverage its
significant competitive advantages as a GSE into direct lending to the
commercial business sector and to essentially perform the same role as
commercial banks.

**FCS Proposal on Commercial Business Lending** -- The FCS proposes to
lend to non-farmer owned and non-farmer controlled corporations
(persons) engaged in virtually any activity that benefits farmers. In
other words, any business that 'touches' farm products or engages in
activities that either directly or indirectly benefit farmers would
become eligible to borrow from the FCS. The only nominal constraint is
the requirement that the business be 'primarily engaged' in these
activities, an undefined term in FCS's proposal that FCS apparently
hopes would be left to their captive regulator to liberally interpret.

However, the FCA certainly has lost any credibility in terms of
enforcing mission compliance due to the agency's recent actions.

As one respondent to the banker survey stated:

> "**I am a former Farm Credit Administration examiner**, **now working
> with a community bank. As an examiner, I oftentimes was uncomfortable
> with the extent to which farm credit institutions strayed from their
> chartered purpose**. Now, as a community banker, I am disturbed with
> the System\'s push to gain further powers. **It is unfortunate that
> community banks, institutions that oftentimes are the bedrock of small
> community economies, are being assaulted by the Farm Credit System and
> enabled by the Farm Credit Administration**."

FCA's recent proposal to increase the eligibility of processing and
marketing firms illustrates the point. Current regulations provide that
a borrower is eligible for FCS financing for a processing or marketing
operation only if the borrower is eligible to borrow from the FCS under
statutory definitions *or is a legal entity in which eligible borrowers
own more than 50 percent of the voting stock or equity*. The proposal
would eliminate this specific requirement and replace it with a series
of subjective determinations that would look to the circumstances
regarding the control, the authority, or the dependent financial
condition of the legal entity that would make them eligible borrowers.
The proposal, however, does not provide guidance or specificity on the
process that will be used to make such determinations, and provides no
indication that there would be any public input, oversight or ability to
challenge a funding decision. The proposal eliminates the objective
regulatory limitation on the ability of a FCS entity to finance a
borrower and replaces it subjective and unenforceable criteria.

The FCS's latest legislative proposal would allow very subjective
interpretations of the statute. The FCS is proposing to eliminate much
of the system of deliberate constraints established by Congress to
prevent abuse of the FCS's GSE advantages which would: 1) significantly
damage private sector lenders in rural America; and 2) create a powerful
incentive for the FCS to lend to businesses only tangentially linked to
agricultural producers, and certainly not owned and controlled by bona
fide farmers, ranchers, and aquatic producers and harvesters. The first
result would significantly weaken a vibrant network of private sector
lenders that are essential to a competitive market for credit in rural
areas. The second result would distract the FCS from concentrating its
activities on those it is intended to serve. As a consequence, community
banking and private enterprise would be weakened, the implicit burden on
government and taxpayers would be expanded, and public benefits would
not be conferred where needed or intended. Moreover, there is no
evidence that the private sector is not serving these borrows; to the
contrary, community banks are active in these markets and serve their
customers very well.

FCS's latest legislative proposal appears to allow FCS to finance small
to medium size businesses on Main Street as well as large corporate
entities, including large, diversified manufacturers and retailers, even
publicly traded firms. While FCS suggests these firms be agribusinesses
-- a new class of borrowrers, FCS would be authorized to finance -- the
term 'primarily engaged' would be defined by the regulator in the
broadest manner possible. FCS's rationale for this proposal appears to
be that somehow having a subsidized lender driving private sector
competitors out of the marketplace will result in greater economic
activity and result in more jobs, thus benefitting rural communities.

FCS argues that it is trying to grow the economic pie in rural America
-- an amazing argument given that FCS has not consulted with the banking
industry on its proposals. However, statistics indicate that rural
![](media/image2.wmf)employment growth is comparable percentagewise to
employment growth in metro areas. Job growth in rural areas is a key
concern of community bankers and they work hard to bring jobs to their
communities.

Forcing many community banks out of rural areas, the inevitable result
of FCS's proposals, would harm the ability of rural areas to stimulate
job growth. Additionally, FCS is asking Congress to take a huge leap of
faith, that dousing rural America in subsidized credit when these
markets already have an abundance of lenders and credit available is the
answer to creating more jobs. This is a highly suspect assumption. The
1996 Rural Manufacturing Survey referenced above explained that credit
access is not the chief factor leading to new job creation: **"Many
rural development efforts are aimed at improving access to credit,**
transportation and tele-communications infrastructure, and technical
assistance. **In this survey, however, both rural and urban businesses
tend to report these as being relatively minor problems.**" (Emphasis
added)

**FCS Proposal on Mortgage Loans in Cities** -- There are many troubling
aspects of FCS's proposal to offer all types of mortgage products in
cities of 50,000 people. This is a dramatic increase not only in
population allowed but in types of borrowers allowed and size of loans
allowed. Income from such loans is tax exempt, which again allows FCS to
cherry-pick the prime credits from private sector lenders.

![](media/image2.wmf)Even the most casual observer realizes that the
mortgage markets are awash in credit for credit worthy borrowers. FCS is
certainly not going to target low-income borrowers under these
authorities. Furthermore, with these authorities, FCS would be able to
offer mortgages in areas surrounding nearly every major U.S. city,
including suburbs of Washington DC and New York City.

FCS has stated its desire previously in allowing individual FCS
institutions to determine their own loan limits in order to allow FCS to
finance very large mortgage loans. An example given in the
'confidential' FCS Horizons report regarded financing homes in bedroom
communities where houses were selling for \$600,000. **Other GSEs have
conforming loan limits and requirements to apportion a percentage of
their income into affordable housing funds for low-income individuals.**

The FCS also indicated a desire in this report to finance developers,
multi-family housing projects and offer home equity loans. This would
mark a dramatic shift by FCS away from serving farmers and towards
serving non-farmers for non-farm lending purposes. **Home equity loans
can be used for any purpose including any non-housing related and
non-farm purpose.** This will allow FCS over time to dramatically shift
their attention away from serving farmers.

USDA statistics offer very revealing information regarding housing,
comparing metro to nonmetro areas in terms of housing stress and home
ownership. **Housing stress is greater across all categories in metro
areas** **than it is for nonmetro areas.** Sectors reviewed include
renters, owners, the elderly, Hispanic and Black.

**USDA statistics also show a higher degree of homeownership for
nonmetro areas** **than for metro areas.** All categories were looked at
including Black, Hispanic, and the Elderly. This information raises
numerous questions, including a very basic one: what is the need to
allow FCS to expand into mortgages beyond towns of 2,500? As stated
earlier, over 2,500 banks are located in towns of this size and this
population level is representative of the size of many rural
communities.

![](media/image2.wmf)Congress intended FCS to focus on rural, remote
areas and even gave them a tax exemption for doing so. Has FCS ever
reported the extent to which it serves these rural, remote areas? We
have previously asked the FCA to report such data but have not gotten a
satisfactory response. Congress should not reward FCS with the authority
to serve a significantly expanded market when the market is already
awash in credit. Many would wonder why a tax subsidy should be afforded
to a GSE to lend to high net worth consumers. This scenario completely
distorts public policy precedents of targeting subsidies towards
low-income households / borrowers. We also emphasize that FCS housing
proposals do not target high stress borrowers, minorities, the elderly
or low-income borrowers.

**FCS Proposal to Remove Borrower Stock Requirements** -- FCS proposes
to allow individual institutions to determine whether they require
borrowers to purchase stock. Requiring borrowers to own stock is a
fundamental tenet of cooperatives. FCS has in the past sought to justify
their special benefits on the basis of their cooperative nature. This
proposal undermines FCS's cooperative nature and has numerous troubling
ramifications.

One outcome would be FCS urging their regulator to also remove borrower
rights requirements, which were established by Congress in the mid 1980s
as a result of FCS's heavy handed treatment and liquidation of thousands
of farmer borrowers.

Another outcome would allow businesses and individuals to borrow from
FCS without any stock ownership and without any commitment to the FCS as
a 'cooperative'. If FCS wants to lend to almost any borrower that
commercial banks lend to and do away with its cooperative principals
over time, then FCS should simply allow its institutions to convert
their charters to banks.

One would also expect non-farm businesses and other 'eligible borrowers'
to be able to purchase any product over the internet without being a
farmer-owner of the FCS. This would allow FCS to engage in broad
commercial and consumer lending. It would also result in complaints of
discriminatory treatment as some borrowers will be required to purchase
stock and others will not.

This would create different classes of "owners" with one class allowed
voting stock and a second class of borrowers without voting privileges
and without the benefits of belonging to a cooperative. Borrowers' stock
requirements are already minimal with borrowers required to purchase
stock equal to *the lesser of* two percent of the loan amount or \$1000.

**FCS Experiencing 'Unprecedented Growth'**

As mentioned, Mr. Chairman, we seem to go through a semi-annual rite in
every new Congress of being presented expanded powers proposals by FCS
and their regulator. These proposals are typically not based on any
credit need in rural America but rather a desire by FCS managers to grow
their empire. And the empire has grown quite dramatically over the last
decade.

For example, FCS loan volume has tripled since 1994, from \$55 billion
to over \$155 billion. FCA stated recently that the FCS is experiencing
'unprecedented growth' in assets of over 14% as of the end of the third
quarter, 2006. FCS net income in 2006 will approach \$2.5 billion.
Furthermore, FCA recently stated, **"Loan volume grew by over 12 percent
(in 2006). This represents the System's highest growth rate since
1981."**

**FCS has achieved this dramatic growth under current authorities**.
**If this rate of growth continues, FCS will double their assets within
five years; quadruple their assets within ten years and grow their
assets by ten times within a decade and a half.**

When presented with such facts, FCS representatives try to suggest that
'commercial bankers are experiencing record profits.' FCS doesn't,
however, portray an accurate picture. What FCS doesn't explain is that
the growth of FCS institutions far exceeds the growth of community banks
in rural areas. For comparison, the average return on assets (ROA) of
FCS institutions in 2005 was 1.6%. For commercial banks, the ROA was
much smaller as of year-end 2006, with banks of under \$1 billion
reporting a 1.14 percent ROA.

There is an even greater disparity for smaller community banks. As FDIC
Chairman Sheila Bair pointed out earlier this month: "There are
challenges. For example, the return on assets for the smallest
institutions -- those with total assets under \$100 million -- was only
0.93 percent. These banks typically have higher overhead expenses and
fewer means of generating non-interest income than their larger
competitors. Also, a persistent flat-to-inverted yield curve and stiff
competition on both sides of the balance sheet have created a difficult
operating environment. **As a result, net interest margins have narrowed
to an 18-year low** (emphasis added)**.** While this erosion has
occurred across the spectrum of institutions, shrinking margins tend to
disproportionately affect you. This is because community banks typically
derive most operating revenue from net interest income."

FCS has utilized its GSE tax and funding advantages to grow much more
rapidly than the private sector with the highest growth rate since 1981,
a time just prior to the FCS collapse and subsequent bailout by the
federal government. FCA stated in its Feb. 9 Memorandum to FCS lenders:
"System loan volume has continued to grow very rapidly from many
sources." FCS lenders are experiencing this unprecedented growth under
current authorities. No new powers are needed for the System.

**FCS Lenders Target Customers Least in Need of Subsidized Financing**

As was noted in a recent letter to the committee, **Non-farm lending is
the new "Horizons" that FCS is seeking. Horizons will not cause new
loans to be made.** The new authorities will be used by FCS lenders to
shift loans off the books of local, tax-paying community banks and onto
the books of larger, more regionally based, tax-exempt, FCS
institutions. This will cause a significant tax loss to state and local
governments, making it more difficult for rural communities to maintain
an adequate level of services, schools, roads and other necessary
infrastructure.

The former FCA chairman admitted this potential threat during a public
hearing in June, 2003, stating: "**GSEs produce a variety of indirect
and direct public benefits and costs in the marketplace ... Public
costs, for example, result from a GSE's reduced or limited tax
liability** ...". (Emphasis added)

The typical experience of bankers is that FCS lenders consistently
choose to serve mainly the prime credits in the marketplace. While FCS
and FCA like to claim that the FCS has done a better job recently in
serving young, beginning, and small farmers, this simply is not the real
world experience of community bankers serving the agricultural markets.
Survey responses of bankers were quite revealing in this regard. Sample
comments included the following:

-   **In no case has FCS EVER refinanced a farmer from our bank that was
    in trouble from years of drought or falling commodity prices. They
    always use their unfair advantage to take the best customers.**
    (Emphasis added)

-   As a past employee of the FCS I am very aware of its history and
    original charter. Since the consolidation of 1986 the FCS has
    greatly changed how it does business and who it wants to do business
    with. Its matrix lending has limited their customer base to a select
    group of the very best farmers.

-   The competition in our market is already fierce. When FCS competes
    in our market, they only target the very best customers and then
    they take advantage of their government sponsored funding sources
    and lower operating expenses to buy the customers' business.

-   They are able to skim the best customers away from commercial banks
    based on interest rate differential.

-   **Typically, Farm Credit cherry-picks the market leaving the banking
    community to address the needs of marginal or struggling
    enterprises. The hallmark of Farm Credit is only those who don\'t
    need their help qualify.** (Emphasis added)

-   They are in our area and only talk to the large farmers of our bank

-   **The FCA has a history in our community of coming in and
    \"cherry-picking\" our best customers. This is definitely
    detrimental to all of the banks in the area.** (Emphasis added)

-   It continues to appear that FCS is simply interested in the \"cream
    of the crop\" in our area and is very aggressive in rates and terms.
    I can only imagine that this will continue if they are granted
    expanded powers to serve non-farm operations and consumer needs.

-   FCS\'s mission seems to be attempting to \"cherry-pick\" our best
    customers by low-ball pricing due to their GSE status.

-   We are able to provide agricultural financing in our area. FCS only
    loans to the strongest and larger operations in our area. We have
    lost a number of loans to FCS because of their ability to offer
    lower interest rates to strong borrowers.

-   Farm Credit has a tendency to finance only the lower risk operations
    in the marketplace. **Most of the borrowers that they take on could
    obtain financing any number of places.** (Emphasis added)

-   FCS has been able to cherry pick the best customers that the banks
    would like to have but our costs of funds are higher then what FCS
    has.

-   We see local FCS offices cherry picking our largest and most
    financially secure farmers, and giving them interest rates much
    lower than prime rates offered by large banks, giving them an unfair
    business advantage against us.

-   The FCS has become a system that \"cherry picks\" the best customers
    using interest rates to do so.

-   The FCS does not do beginning farmer and small farm loans unless
    their parents are good customers of theirs and willing to guarantee
    the loan.

-   **The local Farm Credit office advertised for a credit officer. The
    criteria included calling on operations that were over \$500,000 in
    gross sales. What happened to the original mission?**

FCA should enforce the predatory pricing prohibitions in current statute
and prevent the System from operating as a GSE whose apparent public
mission has become one of cherry picking the best loans in the markets
in which they compete. The comments above provide ample, real evidence
that the FCA is allowing the FCS to get away with focusing on cherry
picking the best loans. This situation would only be exacerbated under
FCA's proposals, which make no attempt to target any verified
underserved market or low-income borrowing categories.

The FCS likes to say that their proposals just offer 'more competition'.
But as the above surveys reveal, there are thousands of lenders
competing for business in rural America every day. As the Treasury
Department stated: "The potential benefits that GSEs bring to a
particular market must be balanced, therefore, against potential risks
to the financial system and potential effects on market competition."
Remember the law of unintended consequences. American farmers aren't
afraid of competing in foreign markets, but they want a level playing
field. So do we.

**Section III -- FCA Issues / Recommendations**

**Has FCA Delegated Agency Supervision Over Mission Compliance?**

Bankers have often complained about FCS's lack of mission compliance.
That FCS lenders have often skirted their charter in an illegal manner
is public knowledge. In fact, former FCA Chairman Michael Reyna made the
following statement during a June, 2003 public hearing:

> "**While it is unclear whether it is a case of system institutions
> "asking for forgiveness, rather than asking for permission," today's
> hearing is also being held because of questions and concerns among our
> examiners who are increasingly finding violations of these same
> regulations**.
>
> **"For example, our examiners are finding some System institutions
> financing non-agricultural commercial enterprises that exceed the
> borrower's agricultural operations in terms of assets or income.
> Similarly, some institutions have been found financing the acquisition
> of agricultural real estate by developers**; and, still others have
> been found to be financing the construction of houses for persons who
> own agricultural land but have minimal or no farming income.
>
> Are these instances examples of a GSE attempting to fulfill its
> mission and congressionally mandated charter? **Or are they instances
> of "mission creep" and attempts by some to use a GSE \-- a public tool
> \-- chartered by Congress to serve agriculture, for very different
> purposes; purposes that legitimately could and should be served by
> private sector lenders?"** (Emphasis added)

FCA's recent liberal, creative and questionable interpretations of
statute are quite alarming since it appears that mission compliance is
now being determined by FCS institutions. This appears to be the gist of
comments recently made by FCA. For example, FCA's Chairman, recently
stated:

> "First, you have been hearing about the changes in the way we examine
> and have begun to experience this ... we are now doing it differently
> ... We are relying on your good governance and your internal systems
> of controls more and more ... we are committed to continue making
> sound policy decisions that address System mission accomplishment ...
> we have worked to provide appropriate flexibility while holding System
> institutions responsible for making the right decisions in financing
> borrowers within the System's charter."

In fact, a Feb. 9, 2007 FCA memo to FCS institutions, FCA seemed to
express concerns about FCS's neglecting the issue of mission compliance,
stating:

> **"Meeting those needs does not include non-mission related real
> estate development or speculative purposes.** **Such lending practices
> are not consistent with FCA regulations and may significantly increase
> risk to the overall favorable reputation enjoyed by the System at
> large**. **System lenders must ensure that they maintain** sound
> credit and **a sound reputation** by focusing on agricultural and
> rural lending permitted by FCA regulations § 613.3000 and § 613.3005,
> as was recently clarified by guidance found in Examination Bulletin
> 2006-2. **If your institution is growing at a significant rat**e, you
> should be sure that growth is consistent with the FCS mission."

Why has FCA apparently abdicated its oversight over mission compliance
to individual FCS institutions? In regards to the last sentence of this
statement, we raise the question as to why the admonition to better
monitor mission compliance relates only to those FCS institutions
'growing at significant rate'. Has FCA given those who may interpret
their growth as not significant wider latitude to avoid mission
compliance? Raising these issues of mission compliance indicate internal
FCA awareness of abuses. If illegal practices were occurring in the
commercial banking industry, bank regulators would make them public.
**FCA needs to publicize illegal activities of FCS associations. We need
greater transparency from FCA.**

**Ineligible Lending & Deposit Taking**

In addition to lax attention to mission compliance, FCA has developed
several novel approaches that allow FCS lenders to skirt the law and
engage in ineligible lending activities. This is appalling behavior for
a federal agency supposedly accountable to the public.

**Exemption Letters** -- A November 26, 2006 article in the *Des Moines
Register* noted that the former FCA chairman "ended the (FCA) board's
practice of issuing letters to institutions who wanted cover for lending
practices that might be questioned later." Federal banking regulators
have not had similar allowances for banks.

**Investment Bond Program** -- Bankers are also perplexed and amazed at
the FCA's development and implementation of a series of broad-based
pilot programs under the name "Investments in Rural America". Under this
program FCA is allowing FCS lenders to engage in loans that would
otherwise be illegal if the loans are labeled as "investments" on the
institutions' books. An October 2006 article by ArborOne
(ArborOneACA.COM) explained that the FCS institution had made its
first-ever health facility 'loan'.

The article noted that the financing was a loan both in the article's
headline and the text. Their justification was that: 1) ArborOne had an
expanding role within the rural community; 2) there is now a broader
interpretation of FCS institutions' role helping rural communities
prosper and grow; and 3) FCS is "now able to serve more people in more
ways by opening new doors and stretching our boundaries."

Community banks in this market reported they were quite willing to
extend financing for this loan. This is a perfect example of how FCS and
FCA's expansion efforts are undermining private sector capital.

It is particularly perplexing that FCA has covered this program in a
shroud of secrecy. FCA did not issue a proposed regulation on the
"Investments in Rural America Program" The full committee has in the
past reprimanded FCA for not complying with the Administrative
Procedures Act when the agency tried to impose the National Charters
proposal without a public comment process. When the National Charters
program did see the light of day through a public comment process,
intense criticism from a variety of sources both within and from outside
the System and from the Treasury Department led to FCA's withdrawal of
the proposal.

It appears that history is repeating itself with FCA's Investment Bond
program and the astonishing lack of public information available. For
example, FCA failed to provide any details on the program to a FOIA
request. In fact, the agency responded with a ten page document that
blacked out most or all of the materials relating to the following
categories: Issues/Decisions, Background, Recommendation, and Financial
Profile data. The agency stated that it had also redacted 128 pages of
additional material. The FCA's FOIA response in essence provided no
useful information on the program and no understanding of its purpose or
need. Such responses from FCA seem typical of the agency and reflect an
appalling lack of transparency and secret dealings for a federal agency.

The CRS, in a March, 2007 briefing paper, provided this description:

> "Selected FCS institutions also have begun investing in "agricultural
> and rural community bonds" as a pilot project, with the approval of
> FCA. The bonds, issued by private or public enterprises, are assets to
> the FCS institution with structured payment terms. **The bonds
> effectively result in loans to businesses and communities, some of
> which may not otherwise qualify for FCS loans. For the FCS
> institution, the bonds are treated as an investment and thus not
> subject to loan eligibility regulations."** (Emphasis added)

This program has no real basis in statute or legislative history. It was
never discussed nor contemplated by Congress. It makes a mockery of
congressional efforts to place appropriate constraints upon the FCS, as
a subsidized, special purpose GSE lender. **We strongly urge the
Subcommittee to request FCA halt the program and provide all background
information on this program for public review. FCA needs to prohibit
non-mission related activities of FCS institutions. FCA should also be
required to testify annually to Congress, providing an evaluation of the
performance of the FCS in carrying out its mission and provide assurance
that no ineligible lending activities are occurring. We need more
transparency from the FCA.**

**Deposit Taking** -- In yet another example of allowing abusive
practices, bankers complain the agency is allowing FCS institutions to
essentially engage in deposit taking, check writing and cash management
services. These practices take money out of local communities that
community banks would otherwise use to finance loans in these same
communities. FCS lenders have even promoted the idea that cooperatives
and customers should not leave their money in local institutions but
allow larger FCS lenders to engage in various cash management
arrangements through a large commercial bank. This practice harms rural
communities and siphons local deposits from the very rural communities
that FCS says it wants to help with expanded powers.

Bankers have also been told by local customers that FCS institutions are
offering checking accounts in addition to lines of credit needed to
repay loans, clearly inconsistent with statute and legislative history.
Implementing deposit taking mechanisms is a totally inappropriate
practice for FCA to allow and is harmful to rural communities. These
programs are simply a method by FCS to prevent borrowers from using
products and services offered by community banks.

**Non-Farm Lending & Financially Related Services**

FCA plans to propose this year broad new scope and eligibility
provisions allowing FCS to finance the non-farm credit needs of farmers.
If FCS's legislative proposals were adopted, this would dramatically
expand the categories of borrowers eligible for non-farm financing with
the term 'bona-fide farmers and ranchers' apparently applying to
virtually anyone. FCA attempted the same regulatory expansion in the
mid-1990s. At that time, FCA proposed allowing 'farmers' to receive
non-farm financing from FCS equal to the value of their farming assets.
Agricultural assets are valued at well over a trillion dollars. FCA also
proposed removing any requirement that 'farmers' actually have any
agricultural credit needs financed as part of an overall financial
package. Such proposals are simply outrageous. FCS was established to
serve farmers and ranchers. Allowing FCS to finance all non-farm needs
of anyone labeled a farmer, even though they have no agricultural credit
needs, is ridiculous.

FCA also intends to propose allowing FCS entities to engage in a broad
range of financially related activities. Again, the focus by the FCS and
the FCA is to become commercial bank like. Former FCA Chairman Reyna
succinctly pointed out during the 2003 public hearing:

> "**Government-sponsored enterprises, like the Farm Credit System, are
> established to serve a specific public purpose**, **rather than a
> general public purpose.** For example, Fannie Mae and Freddie Mac were
> established to facilitate the flow of funds to housing; whereas, the
> System was established to do the same for agriculture. **Commercial
> and community banks, in contrast, are chartered to serve a more
> general public purpose.**" (Emphasis added)

**USDA Guaranteed Loan Programs**

Mr. Chairman, the USDA's guaranteed farm loan programs continue to be
important to many customers of community banks. We urge adequate funding
levels be maintained in the new farm bill. There are several issues
relating to the administration of the farm loan programs which bankers
will want to address with the subcommittee in the near future. The
elimination of borrower term limits and USDA's regulations regarding the
setting of interest rates are two issues of concern.

**Conclusion \-- Reforms Need**

Mr. Chairman it is quite clear that rural America is awash in credit. It
is also clear that the FCA is not supervising sufficiently to prevent
the FCS to engage in illegal lending and abusive and harmful lending
practices. **The former chairman of the FCA stated in the Des Moines
Register article that the FCA board should be expanded to include
additional members with regulatory backgrounds. We wholeheartedly
agree.** **There is clearly a need for greater public transparency,
accountability and reform.**

Banker representatives will soon be presenting the committee with a
number of very positive reform minded ideas. We will also propose ways
for community banks and FCS lenders to work together in a mutually
beneficial manner, rather than the 'winner-take-all' proposals put forth
by the FCS. We realize that typically the FCS has refused such
suggestions because they desire a totally unlevel playing field tilted
in their favor. The FCS was granted privileged GSE status in an effort
to bring capital from Wall Street to serve agriculture. Rather than
shifting dramatically away from serving real farmers, FCS appears intent
on pursuing the demise of many community banks by unwarranted
legislative and regulatory proposals. The FCS should seek a more
constructive path and work cooperatively with community banks to finance
the agricultural sector and FCS should be a key source of funding for
commercial banks.

We are aware that FCA reports there was a total of \$14 billion in
'participations and syndications' conducted in 2006. However, FCA has
not broken down this dollar figure by how much was actually done in
participations with community banks. FCA has not indicated what
categories of financial activities it includes in the categories.
Syndications are typically very large financial transactions.
**Furthermore, if FCS and the FCA achieve their legislative and
regulatory agenda, there will be no incentive for FCS lenders to engage
in loan participations with community banks.**

**Mr. Chairman, eighty percent of the 8,500 community banks are in rural
areas. There is ample credit available and fierce competition for
loans.** While FCS proposals to expand their powers are a regular
occurrence in Washington, the double whammy of legislative and
regulatory changes the FCS is pointing at the community banking industry
is both dangerous and overreaching. **Congress should not pursue any
legislative agenda that displaces rural community banks from the rural
marketplace. FCS should be required to pursue a much more constructive
agenda going forward and we look forward to discussing ways to achieve
this outcome with the committee.**

Thank you.

[^1]: The Independent Community Bankers of America represents the
    largest constituency of community banks of all sizes and charter
    types in the nation, and is dedicated exclusively to representing
    the interests of the community banking industry. With nearly 5,000
    members, representing more than 18,000 locations nationwide and
    employing over 268,000 Americans, ICBA members hold more than \$908
    billion in assets, \$726 billion in deposits, and more than \$619
    billion in loans to consumers, small businesses and the agricultural
    community. For more information, visit ICBA\'s website at
    www.icba.org.

[^2]: America\'s Community Bankers is an independent national trade
    association that represents the nation\'s community banks of all
    charter types and sizes. ACB members pursue progressive,
    entrepreneurial and service-oriented strategies in providing
    financial services to benefit their customers and communities.  For
    more information about ACB, visit
    [[www.americascommunitybankers.org]{.underline}](http://www.americascommunitybankers.org/).

[^3]: PACB represents, exclusively, the interests of almost 200
    community banks across the state of Pennsylvania. Despite the
    differing structural makeup of our member institutions [(commercial
    banks, savings banks &
    thrifts),](http://www.pacb.org/banks_and_banking/index.html#name023)
    they all share a strong commitment and philosophy \-- meeting the
    financial needs of their community and citizens through hometown,
    quality service. PACB and its members believe that \"community\"
    banks are better able to serve their local area than financial
    entities whose policies are not set locally and thus may not meet
    local needs. What sets community banks apart is their commitment to
    keeping the people of their communities first in the list of
    considerations for every financial decision they make.