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EXAMINE NEW GENERATION COOPERATIVES AND STRATEGIES TO MAXIMIZE

FARM AND RANCH INCOME

HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE

HOUSE OF REPRESENTATIVES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

OCTOBER 16, 2003

Serial No. 108–18

(

Printed for the use of the Committee on Agriculture

www.agriculture.house.gov

COMMITTEE ON AGRICULTURE

BOB GOODLATTE, Virginia, Chairman

JOHN A. BOEHNER, Ohio

Vice Chairman

RICHARD W. POMBO, California

NICK SMITH, Michigan

TERRY EVERETT, Alabama

FRANK D. LUCAS, Oklahoma

JERRY MORAN, Kansas

WILLIAM L. JENKINS, Tennessee

GIL GUTKNECHT, Minnesota

DOUG OSE, California

ROBIN HAYES, North Carolina

CHARLES W. ‘‘CHIP’’ PICKERING,

Mississippi

TIMOTHY V. JOHNSON, Illinois

TOM OSBORNE, Nebraska

MIKE PENCE, Indiana

DENNIS R. REHBERG, Montana

SAM GRAVES, Missouri

ADAM H. PUTNAM, Florida

WILLIAM J. JANKLOW, South Dakota

MAX BURNS, Georgia

JO BONNER, Alabama

MIKE ROGERS, Alabama

STEVE KING, Iowa

CHRIS CHOCOLA, Indiana

MARILYN N. MUSGRAVE, Colorado

DEVIN NUNES, California

RANDY NEUGEBAUER, Texas

CHARLES W. STENHOLM, Texas,

Ranking Minority Member

COLLIN C. PETERSON, Minnesota

CALVIN M. DOOLEY, California

TIM HOLDEN, Pennsylvania

BENNIE G. THOMPSON, Mississippi

MIKE MCINTYRE, North Carolina

BOB ETHERIDGE, North Carolina

BARON P. HILL, Indiana

JOE BACA, California

RICK LARSEN, Washington

MIKE ROSS, Arkansas

ANI ́BAL ACEVEDO-VILA ́ , Puerto Rico

ED CASE, Hawaii

RODNEY ALEXANDER, Louisiana

FRANK W. BALLANCE, JR., NORTH

CAROLINA

DENNIS A. CARDOZA, California

DAVID SCOTT, Georgia

JIM MARSHALL, Georgia

EARL POMEROY, North Dakota

LEONARD L. BOSWELL, Iowa

KEN LUCAS, Kentucky

MIKE THOMPSON, California

MARK UDALL, Colorado

RICK LARSEN, Washington

LINCOLN DAVIS, Tennessee

PROFESSIONAL STAFF

WILLIAM E. O’CONNER, JR., Staff Director

KEVIN KRAMP, Chief Counsel

STEPHEN HATERIUS, Minority Staff Director

ELYSE BAUER, Communications Director

(II)

(III)

C O N T E N T S

Page

Goodlatte, Hon. Bob, a Representative in Congress from the Commonwealth

of Virginia, opening statement ............................................................................ 1

Graves, Hon. Sam, a Representative in Congress from the State of Missouri,

prepared statement .............................................................................................. 4

Submitted letter of October 14, 2003 from miscellaneous cooperatives ....... 162

Smith, Hon. Nick, a Representative in Congress from the State of Michigan,

prepared statement .............................................................................................. 3

Stenholm, Hon. Charles W., a Representative in Congress from the State

of Texas, opening statement ................................................................................ 2

WITNESSES

Caspary, James E., president, First National Bank of Clifton, Clifton, IL,

on behalf of the Independent Community Bankers of America ....................... 57

Prepared statement .......................................................................................... 97

Dorr, Thomas C., Under Secretary, Rural Development, U.S. Department

of Agriculture ........................................................................................................ 4

Prepared statement .......................................................................................... 71

Answers to submitted questions ...................................................................... 178

Flory, Douglas L., board member, Farm Credit Association, McLean, VA ......... 6

Ginder, Roger, professor of agricultural economics, Iowa State University,

Ames, IA ............................................................................................................... 51

Prepared statement .......................................................................................... 108

Graves, David R., president and chief executive officer, National Council

of Farmer Cooperatives, Washington, DC .......................................................... 32

Prepared statement .......................................................................................... 75

Hanson, Mark J., attorney-at-law, Lindquist & Vennum, Minneapolis, MN ..... 53

Prepared statement .......................................................................................... 121

Hunt, Steven D., chief executive officer, U.S. Premium Beef, Ltd., Kansas

City, MO ............................................................................................................... 30

Prepared statement .......................................................................................... 81

Kisling, Keith, farmer, Burlington, OK ................................................................. 34

Prepared statement .......................................................................................... 84

Monson, Roger D., president and chief executive officer, Citizens Bank of

Finley, Finley, ND ................................................................................................ 49

Prepared statement .......................................................................................... 91

Peterson, Douglas P., president, Minnesota Farmers Union, St. Paul, Minnesota, on behalf of the National Farmers Union ............................................. 55

Prepared statement .......................................................................................... 77

Sims, Douglas D., chief executive officer, CoBank, Denver, CO .......................... 28

Prepared statement .......................................................................................... 67

Smith, John Henry, chairman of the board, Southern States Cooperative,

Rosedale, VA ......................................................................................................... 26

Prepared statement .......................................................................................... 79

SUBMITTED MATERIAL

Anderson, Bruce, producer, Glenburn, ND, statement ......................................... 87

Auer, Kenneth E., president and chief executive officer, the Farm Credit

Council, statement ............................................................................................... 166

Gerber, Michael, president and chief executive officer, Farm Credit of Western New York, statement .................................................................................... 172

Hazen, Paul, president and chief executive officer, National Cooperative Business Association, statement ................................................................................ 156

Page

IV

Lipinski, William J., president and chief executive officer, First Pioneer Farm

Credit, statement ................................................................................................. 174

Mendes, Michael J., president and chief executive officer, Diamond of California, statement ....................................................................................................... 167

Moreau, Dean, president and chief executive officer, Yankee Farm Credit,

statement .............................................................................................................. 176

Nowak, Robert J., president and chief executive officer, Farm Credit of Maine,

statement .............................................................................................................. 170

Reifsteck, John G., producer, Champaign County, IL, statement ....................... 86

Reyna, Michael M. chairman and chief executive officer, Farm Credit Administration, statement .............................................................................................. 88

Roe, Howard, treasurer, Tall Corn Ethanol, Coon Rapids, IA, statement .......... 160

Wright, Stephen, Pro-Fac Cooperative, statement ............................................... 85

(1)

EXAMINE NEW GENERATION COOPERATIVES

AND STRATEGIES TO MAXIMIZE FARM AND

RANCH INCOME

THURSDAY, OCTOBER 16, 2003

HOUSE OF REPRESENTATIVES,

COMMITTEE ON AGRICULTURE,

Washington, DC.

The committee met, pursuant to call, at 10:06 a.m., in room 1300

of the Longworth House Office Building, Hon. Bob Goodlatte (chairman of the committee) presiding.

Present: Representatives: Pombo, Smith of Michigan, Lucas,

Moran, Ose, Johnson, Osborne, Graves, Janklow, Burns, Rogers,

King, Musgrave, Nunes, Neugebauer, Stenholm, Peterson of Minnesota, Dooley, McIntyre, Etheridge, Baca, Alexander, Ballance,

Scott, Lucas, Udall and Larsen.

Staff present: Dave Ebersole, senior professional staff; Ryan Weston, Callista Gingrich, clerk; Kelli Ludlum, Teresa Thompson and

Russell Middleton.

OPENING STATEMENT OF HON. BOB GOODLATTE, A REPRESENTATIVE IN CONGRESS FROM THE COMMONWEALTH

OF VIRGINIA

The CHAIRMAN. This hearing of the House Committee on Agriculture to examine new generation cooperatives and strategies to

maximize farm and ranch income will come to order.

The Committee on Agriculture convenes today to hear testimony

on farmer cooperatives and the value they have brought to several

generations of rural Americans since the Grange movement began

to shape farm and ranch associations in the mid–19th century.

The primary focus of this morning’s hearing is to examine how

traditional cooperatives sustained themselves during the rapidly

changing and globalizing agricultural economy, and to learn more

about new structures of farmer associations that are focusing on

maximizing economic returns to the U.S. agriculture industry.

As all of us who represent farming and ranching communities

understand, and the Congress has understood since the New Deal,

agriculture is a cyclical industry, and profits often are fleeting. Access to adequate capital at crucial times is critical to the success

of agricultural economic enterprises.

Thus, the real subject of our hearing today may just as well be

how we can assist the financing of U.S. agriculture. Debt financing

has been the typical avenue with any profits generated by the operation being used for expansion. Today, agricultural producers are

2

looking for outside, passive investors who may have interest in the

community where the operation is located, but otherwise are looking for a reasonable return on that investment. That calls for new

business structures that may abandon the traditional cooperative

model. This morning, we hope to learn more about these organizations.

Finally, on credit, this committee has not done a thorough examination of the Farm Credit Act since the statute was amended substantially during the farm recession of the 1980’s. Of course, that

was a crisis situation, and although it was successful, I do not believe it was the kind of deliberative process that could be undertaken now that the system is adequately capitalized and relatively

prosperous.

I look forward to the testimony this morning and, at this time,

am pleased to recognize the gentleman from Texas, Mr. Stenholm,

for his opening comments.

OPENING STATEMENT OF CHARLES W. STENHOLM, A

REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS

Mr. STENHOLM. Thank you, Mr. Chairman, and thank you for

holding this hearing to begin the review of the Federal statutes

that govern agricultural cooperatives and, more specifically, consider how the marketplace has changed and impacted the ability

of farmers to join together successfully in cooperative self-help efforts to improve their incomes within the marketplace.

As a farmer-manager of an electric cooperative, a member of a

cotton cooperative and as a farmer with a partnership with my son

today, I know all too well the potential that cooperatives can offer

producers to add value and maximize our profits in the marketplace.

The Plains Cotton Cooperative Association, PCCA, of which my

son and I are members, markets and adds value to our product by

transforming our raw cotton into denim fabric. This is a very successful endeavor that has helped our family farming operation remain viable. In fact, since 1976, PCCA’s denim mill alone has provided its members with over $300 million in added value for their

cotton. The PCCA is an excellent example of how things have

changed and also why there is a need to review and modernize

Federal cooperative law.

For example, the PCCA added this denim mill in the 1970’s at

a cost of roughly $25 million. However, building the same mill

today would cost between $100 and $150 million. Today, rural

economies are starved for capital. Because the PCCA is dependent

on its member producers for its capital, and with fewer producers

than 30 years ago, it is unlikely PCCA could construct the same

denim mill today.

We on this committee encourage and extol the benefits and virtues of value added on a daily basis, and vertical integration to

maximize producer profits in the marketplace. In the 2002 farm

bill, we included grants to assist farmers and ranchers in creating

greater value for agricultural commodities and we authorized the

establishment of agricultural demonstration centers for the purpose

of providing training and technical assistance to new or expanding

value added agriculture enterprises.

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In late September, Secretary Veneman announced $10 million in

grants to establish these centers in 10 States. While I am encouraged by our success in this area, there is much more work for this

committee and USDA to do to ensure that farmer and rancher cooperatives have the means to compete in an era of rapid consolidation and technical innovation.

The issue we must consider at this hearing is what the future

capital needs are for producer-owned downstream agricultural commodity processing. What are the changes in business and ownership structure, and who will provide the capital for these new

needs and under what new structures?

I look forward to the testimony of our witnesses as we help begin

laying the foundation for answering those very questions. I think

it is critical for those of us in agriculture who intend to survive in

agriculture, that we begin openly and honestly to look outside the

box, thinking in ways in which we can work together. It should not

be an adversarial approach between cooperatives and independent

banks. Rather, it must be a cooperative approach, because rural

America is dying on the vine, and unless we find ways to pump

more capital into rural communities, there can be very little hope

for our producers in the international marketplace as successfully

as we would like.

There are many examples out there in which people are thinking

outside the box. In my district, Rancher’s Lamb, a cooperative that

recognized when we lost the wool and mohair program that they

had to think outside the box and begin to do things in order to

allow lamb producers in America to be able to compete successfully.

There are a of interesting things going on, including looking at

ways to move cooperatively in the international marketplace, instead of an adversarial way. In the case of lamb, we need to look

at Australia, New Zealand and American lamb producers and see

if there can not be a way through cooperative effort to maximize

the profit for producers in all areas.

It is an interesting experience, but it is one that truly must be

continued. So, Mr. Chairman, I appreciate this hearing. I look at

this as another step in laying the foundation for the future of agriculture in this country. We have to take a look, as you said in your

opening remarks, at the laws that are there, see what needs to be

changed in order that we might give our producers a level playing

field in order to compete in the international marketplace.

Thank you, Mr. Chairman.

The CHAIRMAN. I thank the gentleman for his instructive observations, and I would advise the other members of the committee

that we will make any opening statements that they might have

a part of the record, and at this time, we would like to welcome

our first panel.

Other statements for the record will be accepted at this time.

[The prepared statements of Members follow:]

PREPARED STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM

THE STATE OF MICHIGAN

Thank you Mr. Chairman for holding this hearing to discuss issues faced by agricultural cooperatives.

Farmer-owned cooperatives constitute a vital component of our Nation’s agriculture industry, as evidenced by the approximately 3,000 farmer cooperatives scatVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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tered across the U.S. that market nearly 30 percent of our farm commodities. Over

the last century, farmers have entered into cooperative arrangements to pool resources in an effort to enhance farm income by opening new markets for products,

creating value-added opportunities, providing farm supplies, increasing farmer bargaining power, and decreasing input costs. Over this same time period, however, the

farm sector has changed dramatically as we now have substantially fewer but much

larger farming operations.

Paralleling the trend of increased consolidation of production agriculture has been

an evolution in the types of farmer cooperatives that are required to compete in today’s agriculture industry. As foreign competition on bulk commodities increases,

producer profit margins get thinner, and the farmers’ share of the consumers’ food

dollar continues to diminish, the focus, needs, and business structure of farmerowned cooperatives are changing. Cooperatives are moving more towards valueadded products and away from bulk commodity marketing. Such a shift creates a

demand for elevated capital investments and more non-producer investors. While

trying to meet these new demands and still retain farmer ownership and control,

cooperatives have to change their business structures to remain viable. As this evolution of cooperative structure occurs, it is imperative that farm credit policies maintain the flexibility required to meet the financing needs of the new generation of

cooperatives. Family farmers must be given every opportunity to form cooperatives

that take advantage of the benefits provided by value-added products in order to

compete with large, monopolistic food producing corporations.

As a long-time farmer and member of this committee, I look forward to finding

ways that we can continue to foster farmer innovation and better meet the needs

of our agricultural cooperatives.

PREPARED STATEMENT OF HON. SAM GRAVES, A REPRESENTATIVE IN CONGRESS FROM

THE STATE OF MISSOURI

I would like to thank Chairman Goodlatte for holding this hearing today and understanding the importance of farmer cooperatives. As a farmer myself, and a member of a farmer-owned cooperative, I hold this issue very close to my heart.

It is important most of all to know that farmers want to help themselves. When

a farmer asks Congress for assistance, it is because we have not provided them with

the tools they need to accomplish that goal. That is why Congressman Pomeroy and

I have agreed to co-chair the Congressional Farmer Cooperative Caucus. A Caucus

where the underlying goal is to ‘‘help farmers help themselves.’’

As member of this committee, anything we can do to strengthen the ability of

farmers to work together is a great accomplishment determining long-term solutions

challenges facing agriculture. As Members of Congress we need to think about what

we are doing to do to help farmers be more successful in retaining a profit from

their investment into the marketplace.

The farming community has changed greatly since our parents, and grandparents

farmed. In fact, we are becoming more and more removed from the farming practices all together. We cannot allow the market to pass us by.

Thank you again Mr. Chairman for this opportunity. I look forward to hearing the

testimony of your distinguished guest today.

The CHAIRMAN. We are especially please to have with us the

Honorable Thomas Dorr, Under Secretary for Rural Development

of the U.S. Department of Agriculture, the Honorable Michael

Reyna, Chairman and Chief Executive Officer of the Farm Credit

Administration, has been unable to be with us this morning, but

I am especially pleased that my own constituent and a member of

the Board of Farm Credit Administration, Mr. Doug Flory, is here

in his place.

Gentlemen, we are pleased to have both of you with us, and Mr.

Under Secretary, we will start with you.

STATEMENT OF THOMAS C. DORR, UNDER SECRETARY, RURAL

DEVELOPMENT, U.S. DEPARTMENT OF AGRICULTURE

Mr. DORR. Thank you, Mr. Chairman.

Mr. Chairman, members of the committee, on behalf of the President and Secretary Veneman, I appreciate the opportunity to come

5

before this committee to discuss with you ways in which the Federal Government might help farmers, ranchers and other rural

residents increase their incomes and improve their quality of life

through effective cooperative organizations.

I am honored that President Bush has given me the opportunity

to be at the helm of a consortium of dynamic and progressive investment programs within USDA. As a result, Rural Development

has two goals, first to increase economic opportunity and secondly,

to improve the quality of life for all rural Americans. With an $86 billion portfolio, USDA’s Rural Development is, by

today’s standards, a large bank. This year alone, with a budget authority of about $2.9 billion, we will invest nearly $16 billion in

rural investments to build housing, support business development

and strengthen our rural infrastructure of community water,

wastewater, electric, telecommunications, as well as all community

facilities.

Since arriving at Rural Development, I realized the critical need

to look at the effectiveness of the current cooperative model for assisting patron members. Farmers and ranchers still retain a high

level of confidence in cooperatives and this business model is still

one of the most trusted tools of business development in rural

America.

The traditional cooperative model and tax structure was developed with good intentions and has met our needs for many decades.

However, cooperatives like much of rural America face serious challenges. The companies they buy from and sell to are becoming larger, fewer in number and more sophisticated, which has all altered

the traditional marketplace.

Sweeping innovations in areas such as biotechnology, information services, transportation and global sourcing have made many

cooperative facilities and equipment obsolete, and also governance

structures and the resulting transparency appear to have helped to

make non-cooperative enterprises become more responsive to

change.

It is becoming more evident than ever that global economic challenges are here to stay, and that is why Rural Development has

placed a high priority on looking at the current cooperative model

for assisting farmers and ranchers in this increasingly competitive

environment.

We are challenged today to develop strategies for rural America

that are effective and programs that make sense. We in the public

sector simply have to do a better job, and cooperatives must be prepared to sail in uncharted waters, but with as much navigational

assistance as Rural Development can provide.

I believe we should consider modifying existing cooperative concepts and developing ones that are more responsive as well as

transparent. We need cooperatives that are attractive to investors

and tax rules that are more flexible and favorable, and let me add

that as someone who has spent over 30 years in farming, I understand that we probably can’t improve production efficiencies a great

deal, but I believe we can do better at investing and improving

yields on our assets.

My written testimony, which I have submitted for the record,

provides a more in-depth assessment of my views. We need to imVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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prove the ability of our farmers and ranchers to utilize a modified

cooperative structure that will improve their profitability and ultimately, the quality of life for their families.

Mr. Chairman and members of the committee, cooperatives are

an important part of rural America. Rural Development stands

ready to offer whatever leadership and support we can to improve

the business environment for cooperatives.

I am happy, and I will be happy to answer any questions you

may have at this or whatever time is appropriate.

Thank you.

[The prepared statement of Mr. Dorr appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Mr. Dorr. Mr. Flory, welcome.

STATEMENT OF DOUGLAS L. FLORY, BOARD MEMBER, FARM

CREDIT ASSOCIATION, McLEAN, VA

Mr. FLORY. Thank you.

Chairman Goodlatte and Ranking Member Stenholm, members

of the House Agriculture Committee, I am Doug Flory, Board Member of the Farm Credit Administration. Joining me today is my colleague on the FCA Board, Nancy Pellett.

Mr. Chairman, FCA Chairman and CEO Michael Reyna had

planned to present his statement today to the committee. However,

he has been subpoenaed as a witness in a criminal case and is unable to be here in person. Because Chairman Reyna is unable to

be here, he has asked me to deliver his statement on his behalf.

FCA delivered Chairman Reyna’s written testimony to you earlier in this week. On behalf of the Board of FCA, Chairman Reyna

wishes to thank you for the invitation to discuss the changing

structure of agricultural cooperatives and the challenges that cooperatives face as they seek to increase the income of their farmermembers, while at the same time, finding new ways to finance

their operations.

These challenges and how Congress chooses to address them are

of prime importance to agriculture and rural America. The Farm

Credit Administration is the independent Federal regulatory agency that is responsible for overseeing the mission and the safety and

soundness of two separate, but related, agricultural GSEs, including the Farm Credit System and Federal Agricultural Mortgage

Corporation, or better known as Farmer Mac.

We achieve our objective by conductive periodic financial safety

and soundness examinations and by adopting regulations that provide for necessary guidance of the two GSEs. The system is a nationwide cooperative network of borrower-owned financial institutions that lend to agriculture and rural America. Establish in 1916,

it is the oldest GSE in the United States and is the only GSE that

engages in lending at the retail level.

The mission of the System is to improve the income and wellbeing of American farmers and ranchers by furnishing sound, adequate and constructive credit, and closely related services to that

credit, and to their cooperatives and to the selected farm related

businesses necessary for efficient farm operations. It does this by

serving all eligible borrowers having a basis for credit, and as reVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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quired by Congress, by providing a program for financing young,

beginning and small farmers.

Cooperatives have played a crucial role in making agriculture

prosperous, productive and efficient. They increase the sales revenue of farmers and lower the cost that farmers pay for supplies and

business services. In addition to increasing revenues and lowering

costs, cooperatives are vital and an integral part of rural America.

Cooperatives strengthen the agriculture economy, improve living

conditions in rural areas in many different ways. For example,

earnings in the form of patronage are returned to farmers who contribute to the local community.

Cooperatives strengthen the economic base of that local community by adding to the tax base, creating new jobs, spurring retail

sales and services. Cooperatives also help provide consumers with

more choices and with new products. It is the unique structure of

cooperatives that strengthens the market power of farmers, so they

can earn more and live better.

For more than 80 years, Congress has sought to preserve and expand the benefits that cooperatives have offered. Specifically, Congress has devised a public policy that grants cooperatives certain

legal protections, tax benefits and other advantages that may not

be conferred on investor-owned agribusinesses. As a result, farmer

cooperatives have direct access to the GSE funding that their competitors or investor-owned agribusinesses may not always have.

It is important to note that farmer cooperatives play an important role in America’s agricultural economy, and the share of overall farm commodities marketed through cooperatives have been

fairly steady over the past five years, and although the number of

farmer cooperatives has declined 25 percent in the past decade, and

most of these, of course, as you know, are through consolidations,

the net business volume of cooperatives actually has increased.

While no empirical data is available to determine whether farmers have been reducing their use of the traditional cooperative farm

structure in recent years, our Agency did, however, conduct a very

limited survey, in which we contacted the 10 States with the greatest number of cooperatives to identify annual trends in new cooperative filings. Specifically, FCA staff found no consistent trend in

the number of new filings over the period 1993 to 2003. While half

of the States did displays a declining trend in the number of cooperative filings, two States displays an increasing trend and one

showed no change at all, and two States were unable to provide us

with that data.

Notwithstanding the numbers, trends and limited surveys, there

are concerns being raised by some individuals and groups that traditional cooperatives are not resilient enough to endure the economic changes facing agriculture today, and to help farmers overcome new challenges.

The cooperative movement developed at a time when farmers

comprised half of the American population, and farmer-owned,

value added enterprises were very rare. Today, farmers comprise

less than 2 percent of the American population. This means that

there are fewer farmers who can join and contribute financial resources to their cooperatives. It is not uncommon for farmers to

struggle to find sufficient capital to enable them to invest in their

8

own value added enterprises, and when farmers cannot raise sufficient capital on their own, they must turn to outside sources of equity.

To attract outside equity capital or increase their businesses with

non-members, some farmer groups are forming hybrid organizations or restructuring existing cooperatives. FCA staff has identified examples of value added cooperatives that had changed to LLC

form or had formed a joint venture LLC with other cooperatives or

subchapter C firms. In addition, some groups of farmers have chosen to form new value added enterprises as LLCs rather than a cooperative.

LLCs offer many advantages that cooperatives do not. Among

those advantages, for examples, LLCs attract outside investors by

giving them a say in management and a return in proportion to

their investment, and while a few well-established cooperatives

have been able to attract outside equity successfully, for a host of

reasons, most outside investors have little incentive to invest in agricultural cooperatives. This is especially true for startups.

Recognizing the limitations of the traditional cooperative structure, Wyoming and Minnesota have enacted new laws that allow

farmers and investors to join together to form new types of cooperatives. The two State laws are not identical and their treatment of

certain issues are different. These cooperatives can best be described as hybrids between traditional cooperatives and LLCs.

These laws are newly enacted and at this early stage, it is unknown how many traditional cooperatives plan to convert to the hybrid cooperatives, or how many entities will be formed under these

new State laws.

The FCA Board is aware that CoBank is developing a legislative

proposal that would give it more flexibility to finance cooperatives

that are adjusting their structure to respond to the changing marketplace. Depending upon the specific language ultimately adopted

by Congress, this proposal may help preserve the cooperative way

of doing business for farmers, ranchers and their cooperatives, and

it may also prove to strengthen farmers’ and ranchers’ income in

rural America.

While Congress is ultimately responsible for deciding the scope

of CoBank’s lending powers, FCA is prepared to implement and enforce any policy that Congress enacts. As always, FCA is ready to

offer you assistance in crafting any changes to the Farm Credit Act

and we look forward to working with this committee as it considers

issues that are important to agriculture in rural America.

Mr. Chairman, I thank you for the opportunity to present Chairman Reyna’s statement today, and we consider this a very important hearing. Nancy and I really appreciate being here, and I, like

Tom Dorr, would be willing to answer questions.

The CHAIRMAN. Thank you, Mr. Flory.

Mr. Dorr, some other witnesses that we are going to hear from

later today will call for the Rural Development program to refocus

on cooperatives and their continued prosperity. Do you have any

thoughts about those recommendations?

Mr. DORR. Yes, we do, Mr. Chairman. One of the four priorities

that we laid out when I was appointed Under Secretary about a

year and 4 months ago was to pursue an in-depth review of cooperVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
9

ative services at USDA’s Rural Development. I was considered that

a number of the issues that were enunciated here today by my colleague at the table, as well as from others, suggested that cooperatives were not in a position to respond to the changing economic

environment and, consequently, we are in the process of putting together an in-depth review of our cooperatives services group in

order to determine what our past work product has been, what our

resources are, and what our intentions are for the ensuing number

of years relative to both research and development in the cooperative area.

The CHAIRMAN. As co-ops change their business structures, some

may possibly lose Capper-Volstead protections. Others may lose

their relationships with CoBank. Do you see these changes ultimately threatening to farmers and ranchers? Does it potentially

harm the expansion and growth of individual co-ops?

Mr. DORR. Well, I think there is a legitimate concern about the

protection and what we do to enhance or degrade protection from

Capper-Volstead, so at this point, I think what we need to understand perhaps better than anything is what we will require, what

kind of innovations will be required to effectively capitalize the cooperatives, either in the traditional cooperative, the traditional patron co-op, or some of these new generation co-ops to enable them

to compete, and yet do it in a manner that allows them to capitalize on their asset base in a way that doesn’t get them crosswise

with Capper-Volstead or preclude them from doing other things

that they would like to.

The CHAIRMAN. Also, as a subset of the value added product development grant authorities contained in the farm bill, the Congress required the Secretary to establish agricultural innovation

center demonstration projects. Do you have any thoughts on how

that authority could be used to offer better assistance to cooperatives?

Mr. DORR. The way in which we understood what we call the Ag

Innovation Center Grant Program to work was to set up a series

by making these grants, a series of innovation centers around the

country, based on a set criteria that were developed in the notice

of funds availability as well as in the regulations that we are developing, to assist producers and producer groups who come in, to assist them in developing business models, pro formas, marketing

strategies and other things that would be required to enable them

to get into value added initiatives effectively and to be successful

at that, and I think these innovation centers are clearly a good approach to beginning this process. So, the first set of those were just

announced earlier in September. Obviously, it remains to be seen

how well they work, but we have considerable hope that they will

be successful in that regard.

The CHAIRMAN. Thank you. Mr. Flory, I apologize. My questions

are directed to Mr. Reyna, particularly to his statement, but in that

statement, he makes reference to a legal entity that is the parent

of an eligible cooperative may borrow from the ACB if, first, it

holds more than 50 percent of the voting control of the cooperative

and, second, use the loan proceeds to fund the activities of its cooperative subsidiary, and I wondered if you have any examples, either of you have any examples of such an entity that may be——

10

Mr. FLORY. Mr. Chairman, I can’t think of an example off the top

of my head, but I will be happy to go back to the Agency and we

will supply that to you in written form.

The CHAIRMAN. If you would ask Mr. Reyna if he——

Mr. FLORY. I will do that.

The CHAIRMAN. If he had anything specific in mind when he

made reference to that——

Mr. FLORY. Right.

The CHAIRMAN. And also, on page 15 of his statement, he says

that the CoBank proposal ‘‘may well be the change needed to save

the cooperative way of doing business.’’ Is a closed, investor-controlled organization still operating cooperatively?

Mr. FLORY. Under the cooperative rules that we have today, no,

it would not be, I don’t believe. The issue on the table for all of us

to wrestle with is how they may be restructured in order to bring

equity to the table for those struggling co-ops and beginning co-ops,

and that is an issue that we all need to deal with, and we are looking at it. This committee, of course, has a great charge in looking

at that.

The CHAIRMAN. Thank you. The gentleman from Texas, Mr.

Stenholm.

Mr. STENHOLM. Thank you, Mr. Chairman. Secretary Dorr, in

your testimony, you make reference to the $1.1 trillion in value of

land with a debt of $110 billion, which is a very impressive equity.

What I wonder is what percent of that $1 trillion is owned by producers that are still actively in producing and would be interested

in investing in a value added, and what percent would be in landlords that may not have the same interests in a long-term capital

improvement? Do you have any information that would divide that

up?

Mr. DORR. No, I do not, but I expected that would be—I mean,

that’s a very good question. I think that is an underlying question

to this whole issue. Clearly, as producer numbers have declined,

land ownership control has shifted. The thing that I am cognizant

of, and I don’t have an answer for you and we will see if we can

get an answer on those percentages, and I am not sure if that data

is available, but the thing that I am inclined to point out is that

in many cases where there has been generational transfer of land,

there are frequently off-farm family landowners, who are very interested in investing, given the right opportunity, the right sorts of

structures, the right transparency, the right liquidity in value

added processes in rural areas, and I think that is a thing that we

need to keep in mind when we look at that number.

Mr. STENHOLM. I would ask both of you a question that the

chairman made reference to, and that is the CoBank proposal will

allow it to lend to new generation cooperatives. Do either of you see

anything in their proposal that would cause you concern from a

safety and soundness standpoint for farm credit?

Mr. DORR. I am not aware of anything that we have done within

the administration that would give us an indication one way or the

other, but I would be glad to have our chief economist’s office and

others necessary take a look at it and see what their opinion would

be.

11

Mr. FLORY. Mr. Stenholm, we have looked at it as it is structured

right now. We believe, as always, if it is written giving us proper

instructions, that we can do our good safety and soundness that we

do on all of our institutions, and the loans, and so we have no problem in dealing with that. Our staff and our systems are set up to

handle that.

Mr. STENHOLM. Secretary Dorr, before the USDA Reorganization

Act of 1994, of which I was a principal author, there was a separate agency called the Agricultural Cooperative Service, whose primary mission was to help encourage and promote cooperative selfhelp effort by farmers. Those responsibilities have since been combined into what is now called the Rural Business Cooperative Service. Simply, are cooperative services receiving the same attention

and resources as it did prior to 1994?

Mr. DORR. Having not been involved with the Agency and its previous structure, I really am not qualified to answer it in that regard. However, as I had indicated to Chairman Goodlatte early on

in his first question, I am very concerned about what is going on

in the cooperative area, particularly relative to co-ops’ abilities to

be competitive, to have access to capital and that sort of thing, and

that is the reason that we have undertaken an in-depth review and

we are in the process of trying to get that going now so we can get

a better handle on that issue.

Mr. STENHOLM. When will you be prepared to give the results of

your in-house study and survey?

Mr. DORR. We have just now got the initial draft of the proposed

way in which we would go about this. I am not really prepared to

say when, but surely some time within the next several months. It

should not be more than a year.

Mr. STENHOLM. Finally, in his testimony, David Graves, of the

NCFC will give later this morning, he makes what I think is a

good point. He points out that a new position has been established

at the Department of Commerce, an Assistant Secretary of Commerce for Manufacturing, to give greater priority to the challenges

facing the manufacturing sector. Would that be a good idea for

USDA to do for cooperatives?

Mr. DORR. Well, this gets back to your previous question, and it

is one that I have heard. We have been approached with this issue

in the past and, quite frankly, it is one that I think I prefer to assess the strength of that agency first to see where it is coming

from, what its internal asset structure is and where they expect or

anticipate we need to go relative to both research and the development of new cooperative sorts of structures. When we get that

done, I think we will have a fairly clear insight as to whether or

not this particular suggestion is one that we would support.

Mr. STENHOLM. Thank you. I think that outlines a very good procedure that this committee obviously will be very interested in

working with you on. Thank you.

Mr. DORR. Thank you very much.

The CHAIRMAN. I thank the gentleman. The gentleman from

California, Mr. Nunes.

Mr. NUNES. No questions from here.

The CHAIRMAN. The gentleman from Minnesota, Mr. Peterson.

12

Mr. PETERSON of Minnesota. Thank you, Mr. Chairman. Secretary Dorr, you mentioned the Minnesota and whatever other

State it was that passed these new laws.

Mr. DORR. Wyoming.

Mr. PETERSON of Minnesota. Wyoming.

Mr. DORR. That was mentioned by my colleague here.

Mr. PETERSON of Minnesota. I am sorry. But you are aware of

these——

Mr. DORR. Yes.

Mr. PETERSON of Minnesota. In your testimony here, you were

talking about building on these new generation cooperatives. I

don’t know why they are called new generation. They have been

around for some time, as far as I know, but I am a little bit concerned, and I think some people in Minnesota are concerned about

the law that was passed there, in terms of—that we may end up

having these equity owners take over these cooperatives, which has

happened in my State already. One of the biggest cooperatives took

on a private investor and then was taken over. You are talking

about building on this and trying to develop new strategies and

structures to overcome obstacles. Can you tell me, have you got any

specifics worked out at this point, or are you just kind of talking

generalities?

Mr. DORR. I don’t think that at this point, we have specifics that

we are prepared to discuss. I think, clearly, the issue relative to coops and these producer value added on organizations is one that

you have already alluded to, and that is their ability to raise an

adequate amount of equity and to run it within the framework of

a successful and a sound business plan in order to be successful

without reverting to preferred equity issuances that ultimately, if

the situation devolves into difficulty, that it results in the non-producer ending up owning the organization. I think that is clearly the

significant issue that we have to deal with, and we have to figure

out how to capitalize on the available capital in rural America in

a way that producers can participate in these value added operations without risk of always reverting to some loss of equity or,

perhaps, all of the loss of equity in these value added ventures, and

that is the challenge that we face.

Mr. PETERSON of Minnesota. Well, I understand that, and appreciate your comments. I don’t know, maybe we can look at some tax

law changes or some other things that would try to encourage this,

but I think in my judgment, the problem is that in a lot of these

areas that these co-ops are getting into, or considering, you have

a marketplace that is controlled by three or four entities basically,

and they can—if you get into these commodity type operations,

these big guys can squash you like a bug, and I think part of the

reason that farmers are unwilling to get involved in some of these

new co-ops is that they are concerned about that, because it has

happened. We put up a corn processing plant, the sugar guys in my

area, and ended up having to sell out to Cargill. It didn’t go over

too well, so I think part of the problem with this whole thing is

that we have got a marketplace that is so controlled by these big

guys in some of these areas that people are concerned that they

can compete, given the situation now.

13

Now, maybe we could change some tax laws and do some other

things that would offset some of that, but you still have a situation

where they can—when they control that much of the market, they

can run down those prices and put you out of business, and then

force you to sell out. I mean, that is, I think, a lot of the concern

people have in some of these areas, and so in our part of the world,

what we are tending to look at is more of niche markets, where the

big guys aren’t operating, and there is maybe some ability to make

some money without having to go head to head with these big guys

that control so much of the market, so I don’t know what the answer is, but I think that is part of the reason we are not getting

this investment, and I think we have to be careful about how we

go about this, because we might lure people into situations where

they are not going to end up making any money, and I think that

is what my guys are concerned about, so I would, when you do get

some specifics, I would be interested in seeing what you are looking

at, and——

Mr. DORR. We will be delighted to share them with you.

Mr. PETERSON of Minnesota. I think that it is an important area,

but I just—I think this whole market concentration issue is a big

problem in this area.

Mr. DORR. I think, just as an aside, I think the point that you

are making is also why it is very important to make sure that we

clearly understand whatever we do and how it affects the CapperVolstead provisions of the cooperative structure, and so I think

your statement clearly points us in that direction.

Mr. PETERSON of Minnesota. Thank you.

The CHAIRMAN. I thank the gentleman. The gentleman from

Texas, Mr. Neugebauer.

Mr. NEUGEBAUER. Thank you, Mr. Chairman. Certainly, in rural

America, one of the big concerns is capital attraction, and generally, in rural America, we are capital deficient, and I know that

there is some concern about the CoBank proposal, and that that

would put CoBank in competition with the lenders within those

communities. Are there some opportunities out there where we can

begin to look at some proposals like—from my banking days, I used

to do a lot of SBA lending, where we were leveraging the SBA

guarantee with private lenders loaning the additional moneys, are

there some opportunities here with some modifications, where we

can protect the integrity of the system that is there today, but also

hopefully increase the ability for the cooperatives and for the rural

communities to attract that new capital?

Mr. DORR. Are you addressing that to me?

Mr. NEUGEBAUER. Both of you.

Mr. DORR. I am sure there are. I guess I will use an example

that I have used before, and I think—I will try to make it very

brief. Shortly after I was nominated and came to Washington, DC,

I received a call from a group in Iowa who were interesting in involving themselves in a factory that was going to be built by the

Winnebago company, $15 million project, 350 jobs, they wanted to

know what Rural Development could do.

My point to them when we got all done was that if it was a good

project, if it would legitimately turn an 18 to a 20 percent return

on invested equity, like most business plans should require, they

14

really didn’t need any equity from us, because it—40 percent equity

on a $15 million project, over $6 million, they had 350,000 tillable

acres in their county, if they were, for example, interested in borrowing $200 an acre on whatever number of acres that required at

the time, and it returned 18 percent, and if they borrowed the

money from the Farm Credit Bank at 6 percent, they got 12 percent return, that is $24 an acre. That is truly value added. That

is the kind of value added I think rural America should take some

time to look at.

It keeps farmers involved in producing on their farms. It gives

them off-farm employment. It gives their youngsters executive type

positions to stay in the community. It creates a lot of opportunities.

The risk in that, and I realize this, is the fact that we aren’t traditionally reinvesting that money directly into production agriculture,

but we are growing rural communities in a very creative way that

involves both the Farm Credit System and, quite frankly, the private banking sector, so those kinds of opportunities that I would

hope we could be more creative about looking at to leverage assets

in very responsible ways, and I think they have—that has opportunity.

Mr. NEUGEBAUER. I agree.

Mr. FLORY. Congressman, a super question. That is right on top

of what we are dealing with here today. And I firmly believe, you

bring SBA guarantees, and I think that every lending opportunity

and guarantee opportunity needs to be brought to the table, whether it be SBA, FSA, State programs and whatever. As an aside,

CoBank does have the ability to participate with community and

commercial bankers on these types of transactions, which helps leverage the opportunity out there in rural America.

Mr. NEUGEBAUER. Well, and I agree, and I think what we need

to do is make sure that whatever changes, if we make changes in

here, do not jeopardize that relationship, because I do know that

community banks are working very closely with communities and

bringing some diversification to those economies and not necessarily being totally dependent on agricultural, the production aspect of it. I know that in our district right now, we are working

on a project for an ethanol plant, and getting the capital alignment

and the right formation and the structure to get that plant underway in our area is taking quite a bit of time and difficulty, but if

we can get the right tools and bring incentive, if we ever take the

incentive away for private interests into these projects, there is

probably projects we shouldn’t be involved in. I think we have to

have a balance here. I thank the gentlemen, and I yield back, Mr.

Chairman.

The CHAIRMAN. I thank the gentleman. The gentleman from

North Carolina, Mr. McIntyre.

Mr. MCINTYRE. Thank you, Mr. Chairman, and thank you to our

distinguished panelists. I just wanted to commend you all for the

special work that you do, and the difference that it makes in rural

America, and particularly rural North Carolina. Under Secretary

Dorr, the premiere Federal agency in the public eye is USDA Rural

Development back home, and with an area that has been hit by

many hard times recently, with tough job situations and job loss

situation facing textiles and also, some efforts we are making in reVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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gard to tobacco, we are very grateful for what your agency does,

from the rescue squads and the fire departments to the community

buildings, we just had a recent town hall open, we have got two

more, including one in my home town of Lumberton and one right

down the road in Pembroke, North Carolina, coming up next

month, water and sewer lines, business incubators, USDA Rural

Development is seen as the opportunity for jobs and the opportunity for a brighter tomorrow, quite literally, when times have

been bleak and tough in the economy.

Your State Director, John Cooper, as I have mentioned to you

privately, I want to say publicly, does an excellent job, and not only

is he a pleasure to work with, but also, we are grateful for the

work of him and his staff. Jerry Batten, who I know and work with

personally in southeastern North Carolina, is an excellent Regional

Administrator as well and Irma McPherson and Ronnie Pope.

Erma are Ronnie are on the front lines every day with local business, local communities and local agencies, and when you have

folks like Jerry Batten or Ronnie Pope and Erma McPherson, your

agency has a lot to be proud of, so in addition to Mr. Cooper, I commend those folks from our regional level who do you well every

day. USDA Rural Development has been heard of, but now it is

well known, and I cannot think of a better way that this committee

can help serve people in rural America than working with your

agency, in terms of seeing immediate impact and immediate economic benefit, and for that, I thank you very much, and I yield

back the remainder of my time, Mr. Chairman.

The CHAIRMAN. Thank you. I thank the gentleman. The gentleman from Michigan, Mr. Smith.

Mr. SMITH of Michigan. Mr. Chairman, and thank you for holding this hearing. I think that agricultural farm co-ops probably

have the potential to be a great service to American producers if

the co-ops and if Congress is smart enough to encourage that potential. We are going to be faced in the next several years, certainly by the time we rewrite the next farm bill, with lowering subsidies for agricultural production. The value added potential of

passing on some of that profit to farmers rests with co-ops. If we

are able to give co-ops, Mr. Chairman, the kind of advantages that

they need to develop. With CoBank, I think we also need to guarantee a certain percentage. Maybe we guarantee 20 percent of the

loans that go into the co-ops.

Capper-Volstead was designed to give farm co-ops, an advantage.

That is now outmoded. We need to look at ways, it seems to me,

to give co-ops a greater advantage. Tax advantages, free USDA

services to help develop those co-ops, we are looking at a potential

of helping farmers through value added, and that potential is only

going to come with good management of co-ops. It is my experience

that too often, the co-op boards have been pretty tight-fisted in

terms of paying the kind of quality management that is going to

make that co-op survive against a tremendous pressure from huge

growing monopolistic type of private enterprise structures that

have been moving in on co-ops. So I am interested to hear your

comments, but also interested to hear the testimony of the other

witnesses today that maybe can allude to this.

16

I think we need to go over—as we start reducing subsidy payments to farmers, one way to counter that is to make the kind of

legislative changes that is going to give farm co-ops an advantage,

and so, there is some concern that CoBank will take over the lending possibility, but I think we need to open up and change the laws

for CoBank to be more helpful, but at the same time, the private

financial institutions need to have the kind of support of some government guarantee for part of those loans going into CoBank, so

I am just a strong advocate of pushing co-ops, because I think it

has the potential of being our salvation as we look towards reducing subsidies in the next farm bill. Mr. Chairman, I just don’t have

a question, unless there is a response from the Secretary or Mr.

Flory.

The CHAIRMAN. I thank the gentleman. The gentleman from

North Carolina, Mr. Etheridge.

Mr. ETHERIDGE. Thank you, Mr. Chairman, and thank you for

holding this hearing, and let me, Mr. Under Secretary Dorr, associate myself with my colleague, Mr. McIntyre, who has just spoke

and lauded your agency and Mr. Cooper and others in North Carolina. And I think that is probably repeating in a lot of areas across

the country, but I would add that as we look at rural America

today, there is a reason why we have those subsidies for agriculture, because agriculture is hurting badly and rural communities are really having a difficult time, and that is why you see,

across this country, more and more farmers moving off the farm.

North Carolina is a great example. We have had far more small

farms than most States, and there is a reason for that, tobacco, a

lot of other issues, well-diversified, but as a result of the changes

in economics and the stress and pressures, we are seeing more and

more farmers come under stress, pressure, moving off, that is having an impact not just on the farm operations themselves, but rural

communities in general. So, let me thank you for the dollars that

have flowed our way, and the dollars appropriated by this Congress, and I encourage my colleagues to remember that as rural

America prospers, so does the whole country. We may have a very

small percentage of our people engaged in agriculture, but I know

in North Carolina, and it is true in most States, the largest industry in America is still agriculture, so there is a lot of people, it not

only feeds our people, but feeds the people of the world, and we

should not forget that as the numbers decrease, they have been

very efficient, and we are going to have to continue to be very careful about the policies we structure, so that we don’t do damage to

an industry that has allowed us, I think, to gain a strong foothold

and be a bulwark of democracy around the world, because we can

still feed ourselves.

Thank you, Mr. Chairman, and I yield back. I don’t have any

questions, I just want to thank you.

The CHAIRMAN. I thank the gentleman. The gentleman from

Iowa, Mr. King.

Mr. KING. Thank you, Mr. Chairman, and I would like to thank

the panel for their testimony. The very future of our economy in

the region I represent depends in a great deal, part on how well

we put together a plan and a policy that is going to enhance the

economic growth in our regions, and as I watch it change and shift

17

over my adult lifetime, I just have to subscribe to the philosophy

that we have a tremendous amount of new wealth that comes out

of the land every year, and the key is how do we best arrange our

business structures so that we can now build the most layers of

capital as close to the cornstalk or bean stem or cotton plant, gentlemen, behind me, as possible.

With that in mind, and Mr. Dorr, you discussed to some limited

degree the effect of technology on developing the value added industries, and I think one of the things that is missing from all of

our minds is a very clear picture, or even a significantly vague picture, or what the future of agriculture can look like, and I know

it will be different in different regions, and it will depend a lot

upon the individual entrepreneurs and their ideas, but could you

paint some kind of a picture on what a family farm operation

might look like in, say, the year 2020 or 2030?

Mr. DORR. Well, I don’t know that I am very good at painting pictures. I have tried it in the past, and sometimes, it creates problems for me. So, perhaps I had best leave painting to others, but

I would attempt to answer what you are saying in this vein. First

of all, the gentleman from North Carolina, in their reference to

their State Director, Mr. Cooper, out there, is quite frankly, Mr.

Cooper is representative of the CEOs that we have in rural development across this country. They are a very top notch group of people that are running an investment bank, and I think it is important to point out that Rural Development funds are actually being

used for investment purposes. They are a very unique leverage device. We have $2.9 billion in budget authority. We will put out

about $16 billion this year, mostly in loans and loan guarantees,

not a lot of grants. This money is being leveraged into other business opportunities as well as into those in value added and production agriculture.

The unique part about all of this is one of the big components

that we are investing in now is technology and developing a

broadband technological infrastructure backbone in rural America

that will enable us to compete. I think our understanding or our

expectations of the technology footprint that is clearly being placed

all across rural America is underestimated in its capacity to attract

jobs, to attract investment opportunities, to attract people who are

interested in investing in those areas.

And then, in conclusion to this comment, relative specifically to

your question, as we reflect on where the new jobs are growing in

this country, they are coming from small businesses. They are a result of small businesses having the ability to tap knowledge, to tap

information that heretofore large corporations were the only ones

capable of doing that. And in that vein, Mark Drabenstott, the Vice

President of the Federal Reserve Bank of Chicago, clearly and

deeply involved in rural development, points out that clusters of

highly technical co-ops, small operators working together, can

clearly be as capable and as competitive as anyone in the world if

they want to be, and finally, one very brief example.

Over 2 months ago, I took a brief trip to northern Virginia, I

stopped at a farm produce stand on the way back, it was run by

a young lad who was 40, who had sold his dotcom company 2 years

ago that he had operated for 15 years and lamented that the busiVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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ness was being competed out of the country to India, to Ireland and

other places. I asked him, I said why is that? He said, well, we

have got 3-hour commutes, we have $800,000 homes that are way

too expensive, I can’t compete. I said what happens if you go to a

15-minute commute, a $150,000 home and you can do it all in rural

America and you don’t have to deal with a legal, currency, or other

trade issues sorts of situations and you can do it right here, and

he said yeah, that is great.

I think that is the opportunity we have with technology, with

small businesses, in maintaining vital, effective, rural-based businesses in this community and this country, whether they are predicated on agriculture or some other aspect of business in those rural

areas.

Mr. KING. And then, the other trick question would be, we do

have a lot of capital in the regions that I am familiar with as well,

and as you described that capital, there is that sense that the safe

investment of it is in the land and maybe other investments that—

outside the region that doesn’t get rolled back into agriculture and

I talked about leveraging the land, but I think it is key also that

this vision, this picture, for the future of agriculture be painted

clearly so that we can attract that capital.

Do you have any further insight into the key on how we get that

capital unlocked? How do we market that to the people that happen to hold it in their hands today?

Mr. DORR. I think as Congressman Stenholm said early on, it is

a unique opportunity with a difficult question that is going to take

a lot of cooperation. I don’t think there is a right or wrong. I don’t

think we have clearly defined both the issues and the opportunities. We know it is there, but I think it has—there is a scope of

potential opportunities and solutions that will take some time to

work out.

Mr. KING. Thank you, Mr. Dorr. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you. The gentleman from North Carolina,

Mr. Ballance.

Mr. BALLANCE. Mr. Chairman, I don’t have any questions.

The CHAIRMAN. Not making much progress here. The gentleman

from Oklahoma, Mr. Lucas.

Mr. LUCAS of Oklahoma. Thank you, Mr. Chairman, and first, I

would like to offer an observation to the Secretary, and then discuss a few other concepts.

Now, Mr. Secretary, one of the key things, and I can’t help but

think about Mr. Smith of Michigan’s comments about the challenges we face in the coming budget years, and the ranking member has always been very honest with us about the budgetary challenges we face, to implore you and the rest of the Department and

your fellow Under Secretaries and Secretaries that as we work

through each year’s appropriations process, not only to diligently

work to see that the rules are put into place, that these resources

and what ever programs are authorized that you shepherd over are

properly, fully and efficiently spent every time, because in the coming season, if we don’t have the support of yourself and your colleagues in the Department to protect the resources that this committee was extremely successful in setting aside in the 2002 farm

bill, we will be nickeled and dimed to death, and just as this comVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
19

mittee found in 2002, there was a need for all of those rather impressive increases in a variety of programs funded, economic development or otherwise, through the farm bill.

So, it is a responsibility on our shoulders and yours too, Mr. Secretary, to use those resources, to fully use them and to defend ourselves from other committees within this body and other bodies

within this institution as a Congress, so first, the free lecture from

the mountain.

No. 2, I also have the privilege of serving on the Financial Services Committee, and that cuts to the chase, I think, in what we are

talking about here. How do we make sure that the capital needs

are adequately addressed in agriculture and in rural America. How

do we make sure those resources, Mr. Flory, are there so that our

fellow citizens can live up to their potential, whether it is traditional agriculture, traditional agricultural production or value

added?

And over on the other side on that other committee, I have observed that the financial world is changing and changing rather

rapidly. There seems to be a definite blurring of lines with the passage of financial modernization, Gramm-Leach-Bliley, and we in

rural America and production agriculture can’t ignore that either,

but that takes me to my point here. With comments about Wyoming and Minnesota changing their laws, potentially altering the

definition of co-ops, first to you, Secretary Dorr, is the Department

monitoring these changes closely? Are you working diligently to

make sure that whatever changes are implemented by the States

will be reflected, or in the programs you administer, or should I say

perhaps that the Department will be mindful of those changes occurring?

Mr. DORR. The Department is mindful of those changes. Whether

or not we are monitoring them as thoroughly and effectively as we

should be is what we are attempting to do in the study that we

are—discussed earlier that we are embarking on.

Mr. LUCAS of Oklahoma. Because I can’t think of anything more

important than those precious taxpayer resources that you are

shepherds of, that we work so diligently to help provide to you that

are available to help, encourage that economic development, that

they be spent in a way that, as I mentioned just a moment ago,

makes it easier to go back to the well to show those accomplishments, but there again, the financial landscape is changing rather

dramatically.

Mr. Flory, in your opinion, being involved in this process for

some time, at what point as we adopt, or the States have adopted,

or as some would advocate in Congress, that we adopt a changing

definition of a co-op, at what point do you think it is not a co-op

any more? And I am asking you for kind of a hypothetical answer,

and that is not fair, but you are in front of a committee, I am

afraid.

Mr. FLORY. And you are asking my personal opinion?

Mr. LUCAS of Oklahoma. Your personal opinion, yes.

Mr. FLORY. I think it all runs to whether or not farmers have

control, and whether that is 50 or 51 percent, or some other percentage, is a debate that this committee and others will have to

talk about, but I think in rural America, farmers must be in control

20

in some fashion, and as we structure the new generation of, or

whatever generation we want to call them, that we need to be

mindful of that.

At the same time, I believe that we have got to do things that

have been mentioned here today and other things that may be surfaced in order to bring equity capital into those co-ops and have tax

laws and other structures so that both the investor and the farmer

benefit.

Mr. LUCAS of Oklahoma. My time has expired, Mr. Chairman. I

am sure we have several more panels and this is going to be one

of many committee hearings on an exciting topic. Thank you.

The CHAIRMAN. I thank the gentleman, who is the chairman of

the pertinent subcommittee with regard to this issue, and thank

him for his work in this area. The gentleman from Georgia, Mr.

Scott.

Mr. SCOTT. Thank you very much, Mr. Chairman.

My question is for you, Under Secretary Dorr. Co-ops are a

strong source of economic well-being in our rural communities. In

many cases, the FCS lenders such as AgSouth, which operates in

my home State of Georgia, are one of the few sources, if not the

only source, of funding for the much-needed new economic development initiatives undertaken by co-ops. Can you comment on ways

the USDA can partner with co-ops to make the most of every opportunity for economic development in rural areas?

Mr. DORR. As you have already, are I am sure already aware, we

have, within the Rural Development operation, a number of investments and loan and loan guarantee and grant programs. Probably,

the most significant that have evolved in terms of working with coops and/or other small business development opportunities in these

rural areas would, in terms of unique new things over the last few

years, would be the value added development cooperative effort.

That is one that is clearly focused on helping small producers and

rural businesses or in farm and ranch groups to develop business

plans and to provide them with some resources to analyze possible

opportunities for adding value to their particular operations.

In addition to that, we have a number of other programs that

have a little longer longevity. The Intermediary Relending Program

is a program in which we put out funds to these rural areas at a

very low interest rate, and sometimes a zero interest rate, that are

relent by the RECs and others for purposes of building new business opportunities in the area. We have the Rural Business Opportunity grants and the Rural Business Enterprise grant programs.

All of these are programs that are monitored in ways that we hope

give us an insight in what not to do and what to continue doing

in the future, relative to creating these economic opportunities.

I think I would also be remiss if I didn’t point out that our top

priority within Rural Development is to develop performance-based

indicators to make sure that we do, as Congressman Lucas was alluding to earlier, marshal these resources in a highly effective and

efficient manner, and we hope that through that development, we

will have a better idea of what works and what doesn’t work. And

so, these are just a few of the programs, but we think they have

a fairly broad effect in a lot of areas.

Mr. SCOTT. Thank you.

21

The CHAIRMAN. Has the gentleman completed his questioning?

Mr. SCOTT. Yes, I have, sir.

The CHAIRMAN. I thank the gentleman. The gentleman from Nebraska, Mr. Osborne.

Mr. OSBORNE. Thank you very much, Mr. Chairman, and I thank

both of you for being here today. One of the most common complaints and concerns that I hear as I travel around rural America

and particularly Nebraska, is the concerns of the bankers regarding some of the tax advantages given to farm credit, and my understanding is that FSA is the lender of last resort, but we hear a lot

of complaints about red tape and how difficult it is to wade through

the loan process. And it is my understanding that farm credit, because of the tax advantages, normally would be assumed to take

a little more high risk loans, particularly those for young and beginning farmers, so recently, the bankers decided that instead of

trying to remove the advantages that farm credit had, they would

introduce legislation that would provide some of the same tax advantages for the bankers. And when we had that scored, we found it was about $70 billion

over 10 years, $7 billion a year, which leads me to believe that the

tax advantage that farm credit enjoys is fairly substantial. I was

just wondering what oversight you are providing or what you feel

farm credit is doing to address some of the special needs people,

particularly the young and beginning farmers, because the accusation, of course, always is that they are cherry-picking, that they are

getting some of the soundest loans, because of their rates, and they

are not really fulfilling their mission, and so in view of the fact

that I get asked this question all the time, I would be interested

in your response.

Mr. FLORY. You are addressing that to me, Congressman?

Mr. OSBORNE. I am addressing it to either one of you that would

like to take a shot at it.

Mr. DORR. I think I could address it very quickly, in that the

FSA farm operating loans and farm real estate loans are actually

administered by the FSA and not Rural Development, so we don’t

have any direct involvement in that.

Mr. FLORY. I appreciate your statement, Congressman Osborne.

To address the young and beginning farmer, we have a regulatory

agenda that we are working on right now to look at how the system

is providing funds and services to young and beginning farmers.

That is an issue that we are interested in on a regulatory basis,

and want to also mention that part of our stance, as I mentioned

in my statement, is that the system furnish sound and adequate

credit, that was the mission as it was originally set up. And you

are correct that FSA is a lender of last resort, and the nice thing

is that the system partners so many times to help rural American

farmers and ranchers.

Mr. OSBORNE. Thank you. I might just also mention that as we

look at young and beginning farmer loans, it is very feasible to

have a young farmer who maybe is operating with his father and

going to operate some land separately, who is in a pretty good financial position, as opposed to someone who is coming into the

business, and is having to raise the capital to buy the land and do

the whole thing. We would hope that there might be some separaVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
22

tion of—when you begin to look at the data, when you begin to look

at well, are you really serving young and beginning farmers, because it seems to me that some of those young and beginning farmers are given a leg up to begin with, and then some aren’t. So we

hope that as we look at this thing, that we do see the mission fulfilled of farm credit, because one of the biggest problems I see in

rural America today is the lack of young farmers, and the fact that

it is so capital-intensive that people simply can’t get into the business unless they inherit the land from their parents, so bearing

that in mind, I know you have a difficult job, but I just wanted to

pass on my concerns and some of the things I was hearing.

I yield back, Mr. Chairman.

The CHAIRMAN. I thank the gentleman. The gentleman from

California, Mr. Dooley.

Mr. DOOLEY. Thank you, Mr. Chairman, and thank you both for

attending. Secretary Dorr, there has been a lot of interest in terms

of modifying some of the tax laws, that actually work counter to

the ability of co-ops to expand the scope of their business to get involved in some value added enterprises. One of the specific tax

issues is the dividend allocation rule, also commonly known as the

triple tax problem that co-ops face, where they have income that

is generated from non-patronage enterprises or commodities is subject, really, to the corporate tax rate. If it is allocated as dividends,

it is subject to another tax there, and then it is subject to a personal income tax. I am just—there has been legislation introduced

in the Senate by Bacus and Grassley and also in the House side

by Herger.

Has the administration taken a position on this legislation,

which has been scored only at a cost of $14 million?

Mr. DORR. To the best of my knowledge, I am not aware of a position on it at this point, but I would be delighted to check and get

back to the committee with that.

Mr. DOOLEY. Well, I would encourage, the administration, and

particularly USDA, I mean, when we have a bill that has been only

scored at $14 million which works, which is so, I think, instrumental to the ability of co-ops to be organized, to really capture additional markets in value added, and you talked about the LLC

issues and how some co-ops are doing that, if the administration

would put their weight behind this and really ask the chairman of

the Finance Committee as well as Chairman Thomas at Ways and

Means to include this $14 million item on any tax vehicle that

moves through the end of the session, I think we would be doing

a great service to the cooperatives throughout this country, and I

really would appreciate hearing whether or not that is something

that you folks could do in the next couple weeks before we adjourn.

Mr. DORR. Yes, I am aware of the dividend allocation rule, and

I will follow up on that for you.

Mr. DOOLEY. Thank you. And the other thing, and this is just a

general comment, is we talk about rural development, we talk

about value added, but when we, and it is something that we are

guilty of in Congress, or a lot of our colleagues is well, this administration, I would see, and even past administrations, is that when

we present budgets for USDA, they really don’t reflect a true commitment to supporting this agenda as being a priority. And I would

23

just point out our last farm bill, where we beefed up spending by,

I can’t remember now, but $10 billion, but we are allocating $19

billion out, 70 percent of that is going to the basic commodities in

terms of payments that represent only 20 percent of gross agriculture receipts in this country, and yet we are spending very little

in terms of making investments in the programs that you are talking about that actually can provide for a long-term, sustained income stream that can benefit rural America. There really is a vacuum here that has not been filled by this administration or previous

administrations, to really back this up as a priority. And we had

Mr. Osborne’s comments about the difficulty of farmers getting involved in the business, but part of the reason of that is that so

much of this $19 billion we are putting out is being capitalized into

land values, which is creating a barrier to entry, and if we would

just—we don’t need a whole lot of that money that we are putting

out in direct payments, but I am willing to work with anyone that

would be willing to invest some political capital to say that we need

to take a small portion of that money and allocate it into programs

that capture or provide value added opportunities that can benefit

even a larger sector of agriculture, and I think there is a real need

for us to really try to shift this debate a little bit, and really develop a vision for agriculture in this country that is looking forward

and is not relying on the past and the historical allocation of funding.

Mr. DORR. I concur, and the thing that I would like to make this

point, that this administration has regularly, relative to the Rural

Development programs, addressed the fact that we are leveraging

a very small number of resources into nearly $16 billion worth of

programs that directly impact all of the what we term roughly 65

million rural Americans out there, and we are doing that in the

context of not necessarily viewing ourselves as lenders of last resort, but those who provide and facilitate the entrepreneurs and

the business developers in rural America the opportunity to grow,

to create job opportunities and quite frankly, we are very focused

on that, and I appreciate your concurrence in that.

The CHAIRMAN. I thank the gentleman. The gentleman from

South Dakota, Mr. Janklow.

Mr. JANKLOW. Thank you very much, Mr. Chairman. Let me

start off by painting a picture of the world that I live in, and I don’t

say this in a derogatory way at all.

Sixty, 70 years ago, we had 6 million farms. Today, we have 2

million or less. By Federal law, a farmer is someone who has

$1,000 a year or more of sales of food or fiber, so that includes a

lot of people that aren’t what we call traditional farmers. The State

of North Dakota, or my State, South Dakota had 70,000 farmers.

Today, they both have less than 30,000. I live in a State that is

made up of 88 million acres, has 310 towns and cities, and the 15th

largest has less than 5,000 people. The fate of agriculture is the

fate of rural America.

Both political parties, the Republicans and the Democrats, mine

and the other one, for decades have funded tens if not hundreds of

billions of dollars into programs in rural America, and yet we come

here today facing a situation where because of the economics in

rural America in most all States with large rural populations, they

24

are having trouble funding schools, they are having trouble dealing

with their highways and byways and bridges, they are having trouble dealing with their medical services for their people, they are

having trouble dealing with the economics of the situation, and we

all talk about how are we going to get people to move or stay in

rural America. The reality is we are not going to, and we need to

face up and be honest with it.

Our problem isn’t a co-op problem. It is not the legal structure

of the business entities. Agriculture America, by and large, deals

with commodities, and the vast amount of success in co-ops, and

I am aware of things like U.S. Premium Beef, but we all point to

that because it is such a unique thing in terms of being successful,

given what a lot of other attempts that have been made.

Both administrations have been terribly guilty of politically allocating money, and not administrations, but parties, I should say,

in allocating money politically as opposed to fiscally sensibly when

it comes to investing in rural America and in specific areas. And

when you give out money politically, you are always going to have

those kinds of problems. When you are dealing with public money,

it will always be allocated on some type of political basis.

But given the fact that we are dealing with commodities, and

given the fact that the major companies, and I don’t say this in a

critical way, the Cargills, the Tysons, the Bungees, the Pillsburys,

the ConAgras are all entrenched and have their marketing chains,

have their business expertise. For you and I to start a co-op tomorrow with a group of others, you need management, you need labor,

you need capital. We would have a difficult time bringing the

skilled management to the table that we need that has got an institutional memory. In putting this together, were we to try to put

something together like rural people do, the Cargills of this world

have, you start out and you work your way up into those companies, and so my real question is, is there, putting aside the rhetoric

that I use, is there a real future for rural America in the general

sense? Or are we really dealing with the reality that we will face

a continuing decline as we struggle to find a way to help certain

specific areas, not unlike we are doing with foreign countries. Do

you understand what I am saying, Mr. Dorr? And I am not picking

on you. I think you are a terribly bright guy, and I think you folks

and this administration, the last one, everybody struggles to help

rural America, but it keeps going downhill.

Mr. DORR. You have clearly identified the scope of the issue, and

I think perhaps the simplest way to reflect on it, there are regions

of rural America that are going to do very, very well. Commodity

production agriculture is a very difficult business, and how we sort

through that and how we deal with it will tax all of us. I don’t

know that any of us have the magic bullet. I reflect on places like

your State, there are regions within your State that are delightful,

that are growing. They are very successful. They are not necessarily always tied to production agriculture. In Rural Development, we are focusing on those opportunities and to the extent that

we are involved in value added initiatives and we see opportunities, we try to enhance those whenever possible. Thank you.

Mr. JANKLOW. Thank you, Mr. Chairman.

25

The CHAIRMAN. I thank the gentleman. The gentleman from

California, Mr. Pombo.

Mr. POMBO. Thank you, Mr. Chairman. Mr. Dorr, on September

29, you signed a directive, No. 3894, that establishes a methodology

for implementation of the 2000 Census for income information for

grant program eligibility purposes. Under this directive, grant eligibility is based on the applicant being below the statewide nonmetropolitan median household income for the State. Because only

3 percent of Californians live in non-metropolitan areas, this directive will have a severe negative impact on California’s rural communities, access to fund eligibility for grant programs. As an example, the city of Byron, which is in my district, has a median household income of $35,938. Because their income exceeds the $35,680

non-metropolitan median household income in California, they are

not eligible under this directive. My questions are, will there be exceptions for cities like Byron, which is in need of Federal assistance? I mean they are, I guess, $200, 200 and some dollars over

your income level.

Mr. DORR. Well, my limited experience in Washington and USDA

relative to these sorts of definitions, there are always cutoff points,

whether they are population-defined or income-defined issues, and

once the regulations are in place that guide these programs, that

is what we have to operate by, sometimes there are exceptions that

are made, but those are usually outside of our purview, and when

they are made, we accommodate them accordingly.

Mr. POMBO. I notice that New Jersey is exempted from this cutoff point. I suppose the whole State is exempted. Is it possible for

California to be exempted as well?

Mr. DORR. That is a more technical and detailed request than I

am capable of answering at this point. We would be delighted to

try to get some information and get back to you on that.

Mr. POMBO. Well, I would appreciate it and, in fact, I will submit

to you a number of questions in writing that, if you could answer

them for me. It appears that under this formula, a number of

States that are heavily populated but still do have rural communities are negatively impacted by this formula that you have come

up with here, that the Department has come up with, and the impact on districts like mine and Mr. Dooley’s and others in California, even though the coastal areas of our State are heavily populated, most of the rest of our State is very rural, and the impact

that that has on our State impacts all of our communities, so I

would appreciate it if you could give me an answer, and I would

really like to work with you on that, because it does have an impact on districts like mine.

Mr. DORR. I appreciate your concerns and we will definitely take

a look at that.

Mr. POMBO. Well, thank you very much, Mr. Chairman, and I

yield back.

The CHAIRMAN. I thank the gentleman. I understand the gentleman from Kansas does not have any questions, I think.

Mr. MORAN. I do not, Mr. Chairman.

The CHAIRMAN. Well, thank you very much, and we will thank

our two witnesses for spending an hour and a half with us to go

into this subject in considerable depth. It is one that we are going

26

to spend a lot more time on, and we have a lot to understand in

terms of what needs to be done to make investment of capital in

agriculture in rural parts of our country more attractive, so I thank

you again for your contribution and we will, at this time, dismiss

you and go to the next panel. I thank you again very much.

Mr. DORR. Thank you, Mr. Chairman, thank you to the committee.

The CHAIRMAN. Thank you, Mr. Dorr. The next panel to the

table. Mr. John Smith, chairman of the board of Southern State

Cooperative of Rosedale, VA; Mr. Douglas Sims, chief executive officer of CoBank of Denver, CO; Mr. Steven Hunt, chief executive

officer of U.S. Premium Beef, Ltd., of Kansas City, MO; Dr. David

Graves, president and chief executive officer of the National Council of Farmer Cooperatives of Washington, DC; and Mr. Keith

Kisling, who is a farmer from Burlington, OK.

Gentlemen, we welcome all of you to the table. We remind you

that your complete statements will be made a part of the record

and ask that you limit your testimony to 5 minutes, and Mr.

Smith, we will begin with you.

STATEMENT OF JOHN HENRY SMITH, CHAIRMAN OF THE

BOARD, SOUTHERN STATES COOPERATIVE OF ROSEDALE, VA

Mr. SMITH. Thank you. Chairman Goodlatte, Congressman Stenholm, other members of the committee and guests, my sincere

thanks for the opportunity to testify today on a subject important

to me and my fellow producer-members of Southern States Cooperative, as well as members of other farmer cooperatives throughout

the nation.

My name is John Henry Smith, and I am a cattleman and tobacco producer from Russell County in southwest Virginia. Since

you have my written statement, I will briefly summarize my main

points in the interests of time. I have been a member of Southern

States Cooperative since 1958, and use many of its products and

services in my farming operation. Since 1991, I have had the honor

of serving on the Southern States Board of Directors, and I was recently reelected by the producer delegates on the Board to a fifth

3-year term, and I have served as chairman of the board the past

3 years.

Our cooperative serves more than 300,000 farmer-members and

other customers from Maryland to Florida. It includes some 237

farm supply store locations owned and managed by Southern

States and some three dozen other facilities, such as feed mills, distribution centers, fertilizer facilities, et cetera. In total, these operations provide more than 3,200 full-time jobs and more than 600

seasonal and part-time jobs, with most located in rural communities.

Being farmer-owned, Southern States is focused on providing its

farmer-members with a dependable supply of farm inputs and

other services that will help contribute to their economic well-being

and success.

One of the other ways we are trying to help farmers is through

the Southern States Cooperative Foundation. We have worked with

more than a dozen producer groups in developing new cooperatives

in a variety of value added enterprises. Mr. Chairman, we have

27

been able to do a great deal through USDA’s Rural Cooperative Development Grant Program, and we certainly support continued

funding for it.

The past 12- to 18-month period has been one of considerable

challenge for Southern States. Due to a combination of drought and

other adverse weather conditions, a difficult farm economy and

some diversification and growth steps that did not generate the returns that Southern States had expected, our cooperative has been

confronted with major financial challenges. I am happy to report

that steps this cooperative has taken during the past year have

gotten us back on what I believe is the right track.

The point in all this is to note the reactions of our members during difficult times. More times than I can count, this member-producers have told us how much they need Southern States and how

much the well-being of their farming operation depends on Southern States.

It has been 81 years since the Capper-Volstead Act was enacted

by the U.S. Congress and much has changed during those eight

decades, but as the comments from my Southern States producer

colleagues attest, farmers today still need and rely on their cooperatives as much as they ever did, all of which explains why we

were pleased to see the formation of the Congressional Farmer Cooperative Caucus.

We appreciate the leadership of Congressmen Graves and Pomeroy in serving as House co-Chairs of this group. There is no doubt

in my mind the 2002 farm bill, along with disaster assistance and

other steps Congress has taken to boost farm income have played

a key role in improving the farm economy that has also helped

farmer cooperatives. We sincerely appreciate that.

As noted earlier, today’s marketplace and the challenges it poses

to farmers are different in many respects from what prevailed

when Capper-Volstead went into effect, but they are no less

daunting. Not only does today’s U.S. farmer produce for a national

marketplace, he must also compete with producers around the

globe. I personally do not know of any farmer who is large enough

to tackle any of these and other similar challenges on his own. Today’s farmers still need a reliable place to turn, and co-ops provide

that.

What are the actions Congress can and should take to improve

the ability of co-ops to serve their producer members? While there

are many possible actions, I limit my recommendations to those applying to farm supply and service cooperatives, because that is the

area I am most familiar with from my involvement with Southern

States.

First, Southern States believes the existing programs and tools

within the U.S. Department of Agriculture can be strengthened.

Among other things, we strongly support the establishment of a

separate farmer cooperative agency within the USDA. Having a

separate farmer cooperative agency would provide for greater accountability and promote greater support for farmers and their cooperatives.

Second, we urge Congress to approve legislation, House Resolution 1671 as introduced by Congressmen Herger, Graves and Pomeroy, to clarify what is known as the dividend allocation rule. This

28

would be an important step in helping farmer cooperatives attract

equity capital.

Third, to make sure that farmer cooperatives have continued access to a competitive source of credit, we support updating the Federal Farm Credit Act, especially in view of changing State laws.

Updating the law would allow farmers to continue to have choices

when it comes to organizing and financing their cooperative businesses.

My fourth point probably is a sub-point of my first comments

about strengthening existing tools within USDA. However, it’s an

issue important enough to us that we wanted to make note of it

separately. New provisions in the Business and Industry Guaranteed Loan Program in the 2002 farm bill provided loan guarantees

up to 90 percent on the maximums of loans to cooperatives of up

to $40 million. However, having Federal guarantees behind loans

of up to $100 million, as originally proposed by this committee in

the 2002 farm bill would come much closer to meeting the needs

of today’s larger, capital-intensive co-ops.

Fifty years ago, Southern States observed its 30th anniversary

by producing a movie entitled ‘‘We’’. The main point of that movie

was that cooperatives are farmers themselves working together to

accomplish what none of them could do by themselves. In short, a

more appropriate way to view our organizations is with an equal

sign between the words we, farmers and cooperatives. That was

true in 1923 when Southern States was founded and it remains

true today.

Mr. Chairman, in closing, let me reinforce the invitation in my

written statement to this committee and its staff to visit any of our

nearby operations that would be helpful.

Thank you again for the opportunity to share these thoughts.

[The prepared statement of Mr. Smith appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Mr. Smith, and now, the committee

turns to Mr. Sims, chief executive officer of CoBank in Denver, Colorado.

STATEMENT OF DOUGLAS D. SIMS, CHIEF EXECUTIVE

OFFICER, COBANK, DENVER, CO

Mr. SIMS. Thank you, Mr. Chairman, and thank you to this committee for holding this hearing. My name is Doug Sims. I am the

chief executive officer of CoBank, a major lender to agricultural cooperatives. I appreciate the opportunity to present testimony on

business structures being used by new generation cooperatives and

associations of producers. I am going to summarize my comments

and ask that my complete testimony and supporting materials be

included in the record, and we thank you.

CoBank provides financial services to about 2,600 customers

throughout the United States. These customers are also CoBank’s

member-owners and include farmer-owned cooperatives, rural telecommunication companies and rural electric cooperatives.

We also provide financing to support the export of agricultural

products. Farmer-owned cooperatives have and continue to play a

vital role to support the American farmer, as you have heard here

29

today. We estimate that CoBank provides about 80 percent of all

credit extended to farmer-owned cooperatives.

My comments today will focus on finance-related matters, but

CoBank, as a member of the National Council of Farmer Cooperatives, strongly supports the recommendations of NCFC pertaining

to cooperative issues. The mission of serving the financial needs of

farmer-owned cooperatives was assigned to us by this committee

and Congress as set forth in the Farm Credit Act of 1971, as

amended. I am here today because outdated provisions of that Act

will increasingly make it difficult for CoBank to serve new generation farmer-owned cooperatives and associations.

As we view the farmer cooperative marketplace today and our

role as a cooperative lender, I would just summarize a few key

points. One, farmers and their cooperatives are changing, and as

the marketplace and competition changes, many are aggressively

seeking ways to enhance returns to farmers and address new challenges and opportunities.

Two, increasingly, farmer-owned cooperatives are seeking new

approaches to return more income to their farmer-members

through value added enterprises. Farmers often do not have the financial capacity to provide all of the equity capital required for

many value added enterprises.

Third, to adjust to the marketplace, cooperatives are adopting

new business models which allow more flexibility in raising equity

capital from non-producer sources, minimizing tax liabilities and

providing more operational flexibility for the cooperative. These

new structures will often make the cooperative ineligible for

CoBank financing.

Number four, as cooperatives and associations adjust to better

serve their farmers, CoBank should be able to serve these farmer

businesses. State laws are changing as you have heard today to reflect the needs of cooperatives in today’s economic environment,

and Federal laws will need to be modernized. Under the current

situation, a farmer cooperative could be organized under the Minnesota cooperative law, have farmer control of the Board, and not

be eligible for financing from CoBank, the bank that you have established and Congress has approved to serve farmer cooperatives.

Without action by Congress to update the cooperative eligibility

provisions in the Farm Credit Act, CoBank will be unable to fulfill

our congressional mandated mission of providing credit to associations of producers operating on a cooperative basis.

The competitive needs of farmer-owned cooperatives are placing

them in a difficult position. By choosing the most advantageous

business structure, the cooperative may be forced to forego access

to the lender created specifically by Congress to meet the needs of

farmer-owned cooperatives.

CoBank is recommending that Congress amend current law to

ensure that these new generation cooperatives do not jeopardize

their ability to borrow from CoBank. Key components of our recommendation would be to one, authorize associations that have

both a producer and investor class of membership to be eligible for

CoBank financing, provided that the producer class holds at least

50 percent of the voting control, and operates on a cooperative

basis.

30

Second, permit agriculture cooperatives organized consistent

with revised State laws to be eligible for CoBank Financing, and

third, allow cooperatives that are existing CoBank customers, but

which choose to restructure in a manner that would make them ineligible for CoBank financing to remain eligible for a five year transition period while they establish new lending relationships.

In closing, there are few lending institutions in today’s financial

environment with the necessary scale and expertise in capital and,

most importantly, the desire to lead lending efforts to farmerowned cooperatives. In many of the loans we make, there are only

a few other lenders competing. Unless Congress adjusts the Farm

Credit Act to reflect the new structure of cooperatives, many farmer-controlled businesses will lose access to the only consistent competitor for their financing needs.

Nothing in these recommendations expands our scope of lending

to new areas. These changes simply allow us to continue to serve

the same type of farmer-controlled businesses that we have served

for the past 70 years, and these businesses are increasingly more

complex and need increased flexibility.

Mr. Chairman, thank you for holding this important hearing. I

appreciate the opportunity to provide this testimony today and

would be pleased to respond to any questions. Thank you.

[The prepared statement of Mr. Sims appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Mr. Sims. Mr. Hunt, welcome.

STATEMENT OF STEVEN D. HUNT, CHIEF EXECUTIVE

OFFICER, U.S. PREMIUM BEEF, LTD., KANSAS CITY, MO

Mr. HUNT. Thank you. Mr. Chairman and members of the committee, I appreciate this tremendous opportunity to appear before

you today and discuss the challenges facing producer-owned ventures formed as cooperatives. I have provided written testimony. I

encourage you to review that and like for it to be included in the

record. Many of the statements that I have to make today have already been made and made very adequately, including Congressman Stenholm. I don’t think I could say it better than he did already, discussing and outlining some of the challenges that are facing producers in these types of structures, so I will keep my comments brief.

My name is Steve Hunt. I am the CEO of U.S. Premium Beef.

I am also a fifth generation cattle producer. While no longer involved actively in production agriculture, my family is, and certainly, my producer-owners. U.S. Premium Beef is, I guess, called

many times the first large scale beef marketing cooperative owned

entirely by producers. We have enjoyed a tremendous amount of

success. We are formed of, I think, one would identify as a new

generation cooperative or a closed cooperative. I think there is a

number of terms out there or definitions that you would have that

would address the type of structure we are, but we do face some

challenges today.

I want to briefly talk about the success we have, and just so that

you understand that there are opportunities out there today for

producers. There are success stories, and I think at this point in

time, we would consider ours one of those.

31

We started out with close to 300 producers when we began U.S.

Premium Beef, and went out to raise capital and combine that capital with bank debt and cattle production to go out and address the

needs of cattle producers, and eventually get us to the point where

we are selling meat and meals instead of cattle.

Since we began, our membership has increased to over 1,800

members in 34 States. We have marketed more than 3.7 million

cattle through U.S. Premium Beef since we began in 1997. We have

paid out over $64 million in cash premiums over the stated market

to our producer-owners. Additionally, we have earned over $80 million in profits to our producer-owners. Our share value has increased from $55 at the original offering to $150 today on the market. Again, I think that you can look to U.S. Premium Beef as a

model of what producers can do by effectively cooperating and entering into these value added products and markets.

Another event that occurred just recently you may be aware of,

we did enter into processing through a joint venture with Farmland Industries. Due to their difficulties, we bought out their interest in our beef partnership this past August, and so U.S. Premium

Beef is majority owner of National Beef Processing, the fourth largest beef processor in the United States.

In many ways, we are the victim of our success. We have many

challenges and most of those have been outlined today, but just to

recap, the two primary challenges we have today as we grow to

compete in a very competitive marketplace. We are not in a niche

business. We are competing with the giants in the food industry

today, as producers, but the challenges we have is attracting outside equity in the cooperative structure. The rules governing cooperatives restrict our ability to go outside of our already cashstrapped producers to raise equity.

No. 2, and it was alluded to earlier, we are restricted from entering into business ventures that are not directly related to patron

business, that is, in our case, we have entered into a food safety

initiative. We plan to commercialize and license that to our competitors. That is not deemed a producer-driven patron business,

and therefore, under the cooperative rules, we are restricted from

doing this. Under LLC rules or Wyoming co-op rules and other ventures or other structures, you are able to do this, and so today, we

face a challenge of what do we do as U.S. Premium Beef to compete

and continue to grow? Do we go forward and try to pursue changes

in the cooperative rules, or do we convert to other structures like

LLCs?

If we are to convert to other structure, there are barriers. One,

again, we are a victim of our success. We have succeeded. We have

done well, and if we convert, we have a tax on our gain. That tax

on the gain would already strap or exacerbate an already difficult

situation for a company that is continuing to grow.

One of the other challenges we have is that we could no longer

borrow from our lender CoBank. Now, we don’t just borrow from

CoBank. We borrow from a host of banks as a consortium that

have loaned money to U.S. Premium Beef and National Beef, enable us to succeed, but CoBank was the one that stepped up on day

one and loaned U.S. Premium Beef the $35 million to get started,

32

and so it is important for this committee to also understand the

role that this bank and all banks can play in ventures that succeed.

I am a firm believer, as was stated earlier in one of the other

testimonies, that if you really have a good venture, it should be

supported by lenders, okay. It starts with the economics. We are

not in the business of economic development, we are in a business

of developing return for our investors, and so again, we have to be

driven by the economics.

Getting to the solutions, today, I would suggest and recommend

that we aggressively pursue either changes to the rules governing

cooperatives or that we relax the rules on converting to other entities, and that would mean a conversion transaction would not be

treated as a sale or an exchange of property, that there would not

be a tax on the gain to the member, or the cooperative, if it chooses

to convert, under this condition, that this entity remains controlled

and owned by producers. If it is controlled and owned by producers,

then we should allow it to convert to these other entities and allow

the freedom of operation.

Those are my comments today. I look forward to questions that

would come up later. I very much appreciate this opportunity to

present my solution to the challenges facing us today. Thank you.

[The prepared statement of Mr. Hunt appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Mr. Hunt. Dr. Graves, welcome.

STATEMENT OF DAVID R. GRAVES, PRESIDENT AND CHIEF EXECUTIVE OFFICER, NATIONAL COUNCIL OF FARMER COOPERATIVES, WASHINGTON, DC

Mr. GRAVES. Thank you, Mr. Chairman. My name is David

Graves, and I am president of the National Council of Farmer Cooperatives. On behalf of NCFC and America’s farmer cooperatives,

I want to commend you and Congressman Stenholm for your leadership in holding this hearing on the state of farmers working together for their mutual benefit. We also want to commend Congressmen Sam Graves and Earl Pomeroy for their leadership as

House co-Chairs of the Congressional Farmer Cooperative Caucus,

and to express appreciation to all members of the Caucus for their

interest and participation in this important farmer forum.

The need for public policy to enhance the ability of farmers to

join together successfully in cooperative efforts to improve their

ability to earn income from the marketplace is more critical today

than when Congress passed the Capper-Volstead Act and other

measures in the 1920’s to encourage and promote such efforts.

In fact, some argue that farmers have even less relative market

power today than at that time. The chart attached to my testimony

helps illustrate the challenge facing farmers today as they seek to

improve their overall income from the marketplace. It shows how

the farmer’s share of the consumer food dollars has continued to

decline, where it is now a record low of just 15 percent. At the

same time, the farmer’s share of net cash income derived from government support programs has continued to reflect a rising trend.

There are many reasons for both of these trends. Further, it is

highly likely that the current trends will continue without a change

in policy to reflect modern national and international market condiVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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tions. The critical question is what can be done to help farmers be

more successful in capturing a greater share of their income from

the marketplace.

It is within this environment that public policy aimed at helping

farmers join together in cooperative self-help efforts need to be reexamined and strengthened. To begin this process, we believe Congress and the administration should focus on the following three

major objectives.

The first objective that we recommend is that USDA programs

to help farmers help themselves through cooperative efforts should

be revitalized and given highest priority. Regarding this point, I

want to highlight three specific recommendations.

The first recommendation, a separate agency should be established within USDA whose primary mission would be to carry out

programs including research and technical assistance to encourage

and promote these cooperative self-help efforts. Such an agency existed, as others have pointed out here today, especially Congressman Stenholm, prior to 1994. Congress and the administration recently combined, as Congressman Stenholm pointed out earlier, to

establish the position of Assistant Secretary of Commerce for Manufacturing to give greater priority to the challenges facing the manufacturing sector.

We at the National Council of Farmer Cooperatives believe challenges facing farmers and their cooperatively owned businesses are

critical and should be given a similar priority and standing.

The second specific recommendation, USDA research and technical assistance programs to assist farmers and their cooperatives

should be specifically authorized and fully funded. These are now

funded through USDA salaries and expense budgets as part of the

annual appropriation process resulting in considerable uncertainty

and planning and of course, then, lack of accountability.

The USDA, third point, the USDA’s Value Added Grant Program, which provides matching grants to farmers through cooperative efforts to capitalize on new value added opportunities, should

continue to be funded at not less than the $40 million level as contained in the 2002 farm bill.

The third major recommendation is the Farm Credit Act should

be modernized to ensure that farmers continue to have access to

a competitive source of credit capital for their cooperatively owned

businesses. I know you have heard this recommendation already,

but it is important for the committee to understand where this national trade organization that serves farmer cooperatives across the

Nation stand on this point.

We believe that in addition to the changes that have already

been made in the States of Minnesota and Wyoming, there will be

other States to follow. In fact, we are aware that the National

Commission on Uniform State Laws now has a project underway

to determine whether to recommend adoption of a similar statute

by all States as a uniform law.

Mr. Chairman, in addition to our statement, I have a letter that

I want included in the record that contains over 125 names of national, regional and state agricultural groups that also support this

recommendation. Our last and final recommendation, and this has

been alluded to already today, generally in the discussion, that curVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
34

rent tax policy should be modified to provide farmer cooperatives

with improved access to equity capital needed to modernize and expand, meet costly government regulations, especially as we have

seen recently in the petroleum industry and take advantage of new

market opportunities for the benefit of their farmer-members.

While we recognize this committee does not have jurisdiction

over such issues, we would like to take this opportunity to urge

your support of these initiatives.

Mr. Chairman, strengthening the ability of farmers to join together in cooperative efforts is critical to any long term strategy to

help farmers improve their ability to earn income from the marketplace, better manage their risks, capitalize on potential value

added market opportunities and compete more effectively in a rapidly changing domestic and international marketplace.

Thank you again, Mr. Chairman, for the opportunity to appear

here today. I look forward to answering any questions.

[The prepared statement of Mr. Graves appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Dr. Graves. We have three votes

pending on the floor, which are going to take us away for probably

about 30 minutes, so the committee will stand in recess. When we

come back, Mr. Kisling, we will start with your testimony, and

then we will move to the questions. I thank you for all for your forbearance. The committee will stand in recess.

[Recess.]

The CHAIRMAN. The committee will be in order. Mr. Kisling, welcome. Pleased to have your testimony.

STATEMENT OF KEITH KISLING, FARMER, BURLINGTON, OK

Mr. KISLING. Thank you, Mr. Chairman, and members of the

committee. I sincerely appreciate the opportunity to be here today.

The topic of this hearing is very important to the future of agriculture and to farmers and ranchers like me who are looking for

ways to get more of our income from the marketplace, to take advantage of new value added business opportunities and to help create wealth in our rural communities.

For these reasons, I want to commend you for your leadership in

holding this hearing. I also want to commend Congressmen Sam

Graves and Earl Pomeroy for their leadership as House co-Chairs

of the new Congressional Farmer Cooperative Caucus.

My name is Keith Kisling and I am a third generation farmer

from Burlington in the Third Congressional District of Oklahoma

proudly represented by the Honorable Frank Lucas.

I currently serve as secretary-treasurer of the Oklahoma Wheat

Commission, and I am the vice chairman of U.S. Wheat Associations. U.S. Wheat is an organization funded by the Wheat Checkoff

Program, whose purpose is to market our wheat products both here

and abroad and research new ways for farmers to do business. We

greatly appreciate your support of agricultural research through

our land, because without that financial support, our industry

would suffer immensely.

My farm is typical of most in my part of the country, with a majority of our revenue deri,ved from wheat, stocker cattle, alfalfa,

winter wheat pasture and a 1500 head feedlot. For all of my career

35

as a farmer, I have enjoyed incredible benefits as a member of our

local Burlington Co-op Association where I served as director for 12

years, and as a member of four other agricultural cooperatives in

Oklahoma and Kansas. I have always viewed the cooperative system as a vital instrument in producing and marketing agricultural

commodities, but in the past four years, I have seen firsthand that

cooperatives can be much more.

In 1996, a group of producers in our part of Oklahoma started

looking at options on how we would add value to the high quality

wheat product we were selling. This thought process hatched what

is known today as Value Added Products, a new generation cooperative in Alva, Oklahoma that takes our wheat production and

transforms it into frozen pizza crusts that are sold throughout the

Midwest. We take 642,000 bushels of wheat and yield $20 million

worth of pizza crusts per year, making us the largest single preproofed and frozen dough plant in the United States after only 4

years in operation.

But getting from the idea stage to the production stage was no

easy task, and this is where your help is vital for this type of value

added venture to work throughout rural America. Of course, our

biggest challenge was collecting upfront capital in order to convince

our lenders to buy into the deal. We held 40 meetings with a goal

of raising $10 million to use against our $18 million total project

cost.

One tool made this possible. In Oklahoma, we have a 30 percent

State tax credit that can be utilized over 7 years when you invest

in a value added venture. This tax credit was the only reason we

were able to bring 850 producers in as investors, and it is a model

we would like to ask you to consider. I was asked constantly in

those 40 meetings we held if there was a similar Federal tax credit,

and my response had to be no. A yes answer would be much more

helpful in the future.

After raising the necessary equity capital, we were able to obtain

the financing we needed with the help of USDA’s Guaranteed Loan

Program. We also obtained a grant under USDA’s Value Added

Grant Program, which provides funds on a matching basis to assist

startup value added ventures and provide working capital for existing businesses in order to market their products better. Two years

ago, value added products received an existing business grant,

which allowed us to expand into new products.

We are now selling the world pizza crusts instead of a railroad

car full of wheat. More jobs are available for our young people, and

more sales tax revenue is going into our community to provide

basic infrastructure and technology.

The 2002 farm bill, with the inclusion of Rural Development and

Energy titles, sent a message to rural America that farm policy and

rural policy are not necessarily the same thing. Granted, farming

is the backbone of the rural economy, but for a body to function

properly, it must also have arms and legs, which include our rural

infrastructure and rural employers. We cannot survive without the

full package.

If we are going to survive as an industry, we have to find new

and better ways to capture more of the value of what we produce

after our commodities and products leave the farm.

36

Farmer cooperatives, including new generation co-ops such as the

value added products, can play an important role, but we also need

programs in place that help encourage and promote such efforts.

Attracting equity capital is a critical challenge. Again, Federal

tax incentives similar to our Oklahoma tax credit would help encourage investment in cooperatives. Value added grant programs

should continue to be funded at no less than $40 million as provided in the 2002 farm bill. In fact, I believe the program should

be expanded in dollars and eligibility to help make more rural business and producers bring more value added projects to the table.

As a food producer from America’s breadbasket, I again thank

you for the opportunity to testify. Your willingness to listen is what

will ensure a strong tomorrow for American agriculture. It has

been a real honor for a dirt farmer from Oklahoma to be here today

to testify here to the House Agriculture Committee, and I would

definitely encourage any questions that you might have for me at

this time.

[The prepared statement of Mr. Kisling appears at the conclusion

of the hearing.]

The CHAIRMAN. Well, thank you very much. I have got some

questions for all of you. Let me start with the question about the

climate which we are operating, with concern about corporate governance and disclosure of business and accounting practices. What

are the risks for the Congress in undertaking to exempt from the

securities laws any new, relatively undefined entities? Anybody

want to jump in on that?

Mr. SIMS. Mr. Chairman, I will jump in and tackle that, because

CoBank has 10 stockholder meetings across the country a year, and

it is interesting you raised it, because the center focus of part of

our stockholder meetings this year with our customers was to talk

about the importance of all cooperatives embracing the spirit and

intent of this new era in transparency and governance, that while

cooperatives may not be required under Sarbanes-Oxley or SEC to

do this, we have recommended to all our customers that they enhance their transparency and think about the corporate governance

issues such as financial experts, outside advice, the audit committee, and I think you are seeing and we see cooperatives embracing

this as a best practice, not because it is something that they have

to do.

The CHAIRMAN. All this is a rather complicated area of tax and

corporation law, which this committee doesn’t usually delve into.

However, let me see how you would respond to this general question, which is directed to any of you. If you change the structure

of your cooperative so that it conforms to the Minnesota statute,

won’t the co-op lose its protections under Capper-Volstead, and is

there any risk that a single non-producer investor could put the

producer-members at risk for civil and possibly criminal liabilities?

We will start with you, Mr. Smith.

Mr. SMITH. Well, Mr. Chairman, I come from a pretty different

background than the new generation co-ops and Southern States,

the traditional one. I would say any time you deal with someone

who has the possibility of these outside partners being unethical,

you would certainly be at risk and your board in anything you did,

but some things in life can’t be legislated. You just have to move

37

forward on faith that you are going to deal with good, honest people and do the best job you can, and some of that may be in this

situation. My colleagues may have a better answer to that than I.

The CHAIRMAN. Mr. Sims.

Mr. SIMS. Well, we have seen instances where an individual producer wanted to dominate a particular cooperative, and that group

of producers resisted that, and I think what you see, and at least

what we see, these outside investments aren’t always by one party.

They are multiple parties, and I think the issue here is that we

have producer associations that are controlled by farmers doing

business on a cooperative basis with the maximum flexibility for

those farmers that control that business to decide who they want

to bring in or don’t want to bring in. In the earlier discussion, I

think it was Congressman Peterson talked about a cooperative that

had sold to a proprietary business, and I would just say in order

for that to happen, that group of farmers had to make that decision

that that was in the best interests of farmers, and I agree with Mr.

Smith. My experience of 35 years working with farmers and their

cooperatives, when the facts are there, transparency that you

talked about and the facts are laid on the table, they will come to

the right kinds of decisions in their fiduciary duty in representing

other farmers.

The CHAIRMAN. Mr. Hunt.

Mr. HUNT. I don’t really have anything in addition to add to that.

There is probably counsel of others in the room that might be

speaking on later panels that could address this more specifically,

but again, I would just echo what the prior gentlemen have commented as well. Tremendous transparency, you have got a group of

widely held, an entity owned widely by producers of all sizes that

don’t want an individual to control that entity. They operate

through governing rules provided for in the articles and by-laws, so

I have not heard anything as of yet in our research into looking at

different entities as that would be an issue, as long as we are prudent and observe best practices, which I think as Mr. Sims has

pointed out, we are all very cognizant of today and spending a tremendous amount of time reviewing and understanding.

The CHAIRMAN. Dr. Graves.

Mr. GRAVES. Mr. Chairman, not to try to offer up a legal comment, which I am not capable of doing, but I think your question

surfaces again, the idea of oversight and accountability at our U.S.

Department of Agriculture on these kind of initiatives. We don’t see

any other way to move forward in assisting farmers to earn income

out of the marketplace without the farmer being able to have an

equity stake in a business that is competitively structured, competitively operated in today’s market environment.

There is a role there, then, we sincerely believe, for the Department of Agriculture to be engaged on an ongoing, continuous basis,

and so we would just offer up the mere fact that as Chairman, you

have raised those questions today suggests that, to us, again, that

our recommendation is a very valid one that we move rapidly to

establish within the Department of Agriculture pools of resources,

both human and capital, who have a specific responsibility to

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38

mittee on the development and operation and soundness especially

of those type of ventures.

The CHAIRMAN. Thank you, Mr. Kisling.

Mr. KISLING. I am not familiar with other States, but I know in

our situation with value added products and the way that we designed ours was that you had to prove, had to have proof that you

were a producer of agriculture. Now, you didn’t have to produce

wheat. You had a to be a producer of agriculture, and the proof was

on the person that was trying to buy membership, and they filled

out a sheet saying that they were a producer of agriculture, and

I think that was part of the reason, or part of the problem that we

had that we—I would like to see some correction done.

The influx of initial investment is very important to a startup

value added project, and by not being able to get some outside entities to come in, say my local co-op mill sells and some outside investor comes in from a large city and buys the mill and adds value

to corn, wheat, soybeans that run through that mill. He owns that

mill, but he is not a producer of agriculture, but he is adding value

to what we raise. I think he should be an investor in that and a

lot of times, those people have money to invest in something like

that, which some farmers may not have, so it puts us at a jeopardy

a little bit in being able to get some outside capital.

The CHAIRMAN. Well, I think that is a very valid point. What we

are trying to achieve is some kind of balance here to maintain the

original identity of a cooperative. Our legal—and I am going over

my time here, but I just want to raise this last point. Our legal

analysis of the new Minnesota law indicates that it theoretically allows for outside investor-members to hold as much as 99.9 percent

of the equity of the cooperative and receive up to 85 percent of the

profits from the cooperative.

I don’t know if any of you are familiar with that enough to know

whether you would agree with that and maybe somebody on the

next panel can address it, but do we want to go that far in that

direction to accomplish your goal? Because I think the goal you

have cited is a good one, but I wonder if that really is a cooperative

when you get to those kind of numbers.

Mr. KISLING. In my opinion, Mr. Chairman, that would be no.

The farmers need to have 51 percent control of the operation as

producers.

Mr. HUNT. I would agree with that statement as well.

Mr. SIMS. And I would, too. We have looked at that law and at

least we don’t think that some farmer-controlled businesses could

be done under that law, but our view is it needs to be at least 50

percent control and do business on a cooperative basis.

Mr. SMITH. I would agree, too, with that, Mr. Chairman.

The CHAIRMAN. Thank you. Very good. Well, my time has expired. The gentleman from Texas, Mr. Stenholm.

Mr. STENHOLM. I would like to see the tenor of this discussion,

in which there is some opposition to that which you have proposed

here with the financing of new generational cooperatives. I would

hope that as this proceeds that we would change the tenor of the

debate to cooperation. We really need to be thinking in terms of

how our community banks, our independent banks back home, can

work cooperatively with our Farm Credit System in doing what is

39

necessary to build rural America, instead of constantly looking at

it as we have traditionally in the past in which we have always

had the battle of the co-op versus the independent. Those days are

gone.

Anyone that is trying to survive in agriculture today knows that

we have got to play by the rules that have been dealt to us, and

when we start looking at the world of international finance and the

complexities of international finance and look that very soon, China

will be the largest holder of debt of the United States of America.

That is something that most Americans have not focused on as yet,

but when they do, they get rather alarmed. That is big business,

and that is big business way out of the spirit in which we are talking here today, but when we start looking at how we are going to

do, which we must do, and that is assist our producers, in this

case, we are talking farmers and ranchers, how we are going to assist them in getting more of the consumer dollar from the United

States consumer as well as the international consumer into the

farmer’s pocket.

We have to get a think a little differently than what we have

ever been willing to do in the past, and capital is key, and unless

we are willing to cooperate together by those who are equally concerned about rural America, unless we are willing to find a way to

cooperate together, we are not going to solve the problem, and just

being against what is being proposed will not suffice if you want

a solution, so I would hope we could think cooperatively, and I

would hope that we would begin to realize that we are talking

about all people interested in rural America trying to find ways to

cooperate together. To do that, I think we are going to have to constantly look to see that we have a level playing field. Mr. Sims, do

you pay taxes? Does CoBank pay income taxes?

Mr. SIMS. Yes, sir. We do.

Mr. STENHOLM. How does your tax structure differ from your

competitor?

Mr. SIMS. We are organized as a cooperative, so we pay taxes

under subchapter T concept, where we pay patronage dividends,

anything we retain in the business, we pay taxes on at the corporate rate. Last year, we paid $68 million in income taxes, of

which all but $10 million were Federal income taxes.

Mr. STENHOLM. How do patronage dividends differ from ordinary

corporate dividends?

Mr. SIMS. Well, it is based on the usage of the business, not on

how much money they have invested in the bank, and so we will

pay a portion of earnings, somewhere between 30 and 50 percent

in cash and the rest would be paid to them in stock in the bank,

typically the way most all cooperatives pay their patronage refunds

to their members.

Mr. STENHOLM. Would any of you at the table disagree with a

basic flat statement that all competitive businesses should compete

based on as close as reasonably possible a level playing field? A

level playing field being defined as that which government creates

through tax law, through environmental laws, through labor laws,

through whatever, that if you are going to be a competing business,

competing for the purpose of helping rural America grow, that everybody should basically as best as humanly possible, compete from

40

a level playing field? Period. Anyone choose to differ a little with

that statement?

Mr. GRAVES. May I comment?

Mr. STENHOLM. Sure.

Mr. GRAVES. Congressman, the question that we wrestle with is

how it is farmers can come together to earn income from the marketplace. The chart that is in our testimony indicates that over

these last 80 years or so, while that continues to be a goal, seemingly, we have not made as much progress as many have wished

for, and when you talk about an absolute level playing field, that

is all fine and well, we believe, if there is adequate interest in trying to support the group of people who have very little to no market power actually have a chance to get an equity investment in

that whole chain of commercial activity, for the purpose of earning

income. That would be not an objection, just a question or caveat

to your statement, in terms of asking me to accept it just flatfootedly with that period.

Mr. SIMS. Mr. Stenholm, let me add something to what David

has said. I think my 35 years of business experience is that you

never, I have never seen a perfect playing field. There has been

changes that go on all of the time, and some businesses have more

competitive advantages than others and others have more competitive advantages.

I think one of the things this committee has done, and we applaud and just the fact that you are having this hearing, is what

ways can we use new ideas and new laws to make our cooperative

community more effective, easily attract capital, some of the suggests that I think are coming forward can be very helpful in revitalizing and keeping the cooperative concept, in terms of farmer

ownership, control, as agriculture continues to consolidate and integrate. I don’t think you are ever going to get it perfect.

Mr. STENHOLM. Mr. Sims, I have seen some of those, but they

are always tilted a little ways in my favor when they are considered level, but that is the way we always look at it, but if I might,

Mr. Chairman, present one additional question.

Just for general consumption, give me your, each of you, give me

a definition of what the heck you are talking about with a new

generational cooperative?

Mr. KISLING. I would be happy to address that. It is a closed coop. Ours was a closed co-op. There was 4 months that we went out

and made 40 visits around the State to educate the people of what

the project was, tell them how much stock was going to cost, give

them a business plan as to when they could expect dividends back,

and then, after it was closed, then there would be no more investors, and so, as the thing starts to grow and become profitable,

then dividends can get to be very good, as you could tell in my testimony. So, that is the new concept, the new definition of a co-op

now, as opposed to the co-ops that we are familiar with, where you

pay $100 and you have your stock built and then that is the last

time you pay anything in, and you—there is a lot of people invested

in it, and so, your dividend is diluted quite a bit.

Mr. GRAVES. Congressman, we would just be in the business of

regurgitating what we know other people use in terms of a definition. We haven’t generated the definition, but when we hear the

41

new generation idea discussed, in our minds, we have an image in

terms of a comparison, the old line co-op had open membership,

therefore allowing any farmer who wished to be a member to become a member through patronage, and therefore, the co-operative

was obliged to take, for example, any and all quantities of wheat

that that member, if that is what the member was producing,

would choose to deliver to the cooperative.

Those relationships create challenges in a business world. To

help deal with the challenges in the business world, not only on

volume, but in terms of quality of products received, the new generation idea seemed to evolve around the idea of a closed co-op not

so much solely for keeping farmers out who might wish to join, but

in order to give the co-op, cooperative business, a much better

chance at dealing with the business challenges in terms of the

quantity of grain, or any other product that that co-op would be expected to take in and market and return some benefit to all of the

members.

So, those challenges seem to have set out the need for the cooperative that is described as a new generation cooperative to be more

in control of some of the significant factors that impacts the competitiveness and profitability of the business.

Mr. KISLING. Mr. Chairman, I don’t want to dominate the conversation, but as he was talking, I was thinking about our cooperative again, and what we tried to do was be vertically integrated,

help the farmer get into an organization that he could be vertically

integrated into something using products that he raises, and that

is wheat, Hard Red Winter wheat in our case.

If you listened to the testimony of 640,000 bushels of wheat at

$3 equates to about $1.2 million worth of wheat. From that point,

we produce about $20 million worth of pizza crusts. That is pretty

good increase in what they produce, so we are trying to help the

farmer in this new generation co-op be vertically integrated, be involved farther down the food chain, so that they can get a piece of

that pie.

Mr. HUNT. Congressman, I would say, again, Webster’s doesn’t

have a definition of this, as I said in my testimony, there are plenty of definitions. I guess we are one. We are called one all the time,

and that is U.S. Premium Beef, so I guess just describing what we

are, we are a marketing cooperative versus a traditional concept of

a farm supply cooperative. Our producers commit capital and commodities to this business, in the form of buying shares and attached to those shares are normally delivery rights. Those are

rights and obligations to deliver X quantity to your marketing cooperative. It does tend to be more profit-motivated, and that does

tend to more align with the producer-owners as they are transferring their commodity into their processing company at some value,

and then hoping at the end of the day their processing company

will convert that into a processed good that is sold to the consumer

at a higher price. Again, I think new generation comes from the

standpoint as compared to a traditional cooperative.

Mr. SIMS. I think it is a very interesting question you ask, and

I wouldn’t disagree with anything that has been said up to this

point, with the exception that when cooperatives originally were

formed in the 1920’s and 1930’s, and that is when most of them

42

were formed, farmers were of similar size. Most had 160 acres and

so the one member one vote concept made lots of sense for the cooperative movement. I think as you have moved into this era of

consolidating agriculture, integration that has been talked about

here, when farmers are asked to invest in their cooperative, they

are now beginning to say I want a voice commensurate with what

I invest, and that began to evolve particularly in the upper Midwest.

The first time I heard the term was in North Dakota, but Congressman Stenholm, in many ways, the denim plant that you described at the beginning of this hearing was a closed cooperative

when it was first formed. We were involved in helping get that established, and to assume that all of this has just come about in the

1990’s would be a poor assumption. We have got a lot of very successful cooperatives that have used the concepts, in the tree nut

business, the dairy business, citrus business, and so, I think what

it is doing is really defining, and what Mr. Hunt said, it is going

from anybody can come in that wants to, and as long as you have

a one member one vote, we are going to decide who gets in in this

group, because we have got specific qualities that we want to

produce, certain goals we want to achieve, and we need to have a

common philosophy, and many producers are saying they want to

vote with their investment, and have a voice commensurate with

that, which is not consistent with the old traditional cooperative.

Mr. SMITH. Congressman, although my background is completely

different, I come from a traditional farm supply service cooperative

located in the South, I think the main differences in the new generation is more of a closed cooperative, and ours are, as Doug and

my cohorts have said, an open cooperative with one man one vote.

Someone said that the new generations were more profit-motivated

than the traditional co-ops. I want to reassure my banker that that

is not so, we are very profit-motivated, and I would also like to

stress to your committee that capital is just as important for the

traditional co-ops. We are really struggling. We are limited in how

we can raise capital, and to compete with the marketplace in procurement supplies for your members and your producers. That is

a need that we really have. Thank you, sir.

Mr. LUCAS of Oklahoma [presiding]. The gentleman’s time has

expired. The Chair will turn to the gentleman from Illinois, Mr.

Johnson, for questioning.

Mr. JOHNSON. Thank you, Mr. Chairman. Just very briefly. First

of all, I want to thank you, Mr. Chairman, and the committee for

having the hearing, and these gentlemen for testifying. I think it

is important, given the magnitude of this issue and the competing

interests, or at least competing philosophies, to hear all viewpoints

and that is what we are doing.

I direct this question specifically to Mr. Sims. Mr. Sims, in your

written statement, you had mentioned and indicated that USDA

has recognized the need to update their eligibility provisions for

RUS lending because of changes in business structure. Can you

just briefly expand on that? I know the chairman has questions to

follow, and I don’t mean to preempt the chairman, but if you could

just briefly address that for me, I would appreciate it.

43

Mr. SIMS. Yes. I think in the rural electric business that we are

in, they use some of these same forms that were, structure we are

talking about, the LLCs, and through their RUS lending authorities, I believe it was 1998 or 1999, they went ahead and made the

changes, so that the rural electric cooperative community can use

this form of structure in their business model.

Mr. JOHNSON. Thank you very much, and thank you very much

for your courtesy, Mr. Chairman.

The CHAIRMAN. Indeed, Mr. Johnson. To hearken back for just a

moment to a couple of my earlier questions to previous panel gentlemen, and perhaps, the place to begin, Mr. Sims, with CoBank’s

involvement with so many co-ops across the country, could you just

give us an eyelash analysis of what the financial health and wellbeing is of co-ops generally in this country, and I realize everything

varies from region to region and product to product?

Mr. SIMS. In the agricultural cooperative community, I would

say, in fact we are under examination and being checked by our

regulator as we speak, things are in a very sound situation. That

isn’t to say that there aren’t challenges in some areas, where companies either are dealing with weather issues, and I am going to

use a couple of examples.

We had quite a drought situation that really hit the western

wheat belt last year that affected the grain cooperatives in western

Nebraska, Kansas, Colorado, a little bit into Oklahoma. This year,

the rain here in the east coast, this has been a very difficult year

for some of our cooperatives in that regard, but where you have got

sound capitalization, good management, good focus, we are seeing

a very strong and stable agricultural cooperative community.

Now, that being said, as farmers consolidate and get bigger, they

are consolidating their cooperatives as well, and we are seeing consolidation of cooperatives, and in some cases, that means closing

down some facilities, where the capacity is no longer needed, based

on the changes in the marketplace.

Mr. LUCAS of Oklahoma. Keith, could you touch for a moment on

how our enterprise up in Alva is doing? I mean, it has been an ongoing effort, well, how long now since the initial offering, solicitation?

Mr. KISLING. It has been in the running for 4 years. It started

out, it is like any startup company. The first 3 years, they will tell

you, it is tough, and it was tough. In fact, we had a lawsuit against

us, and then we had 9/11 and we were sending to military bases,

and those all shut down, and so we went for a year with very few

orders, and the problem with that is that your expenses continue

on, so it made it real difficult for us to abide by our business plan,

and that is what we were trying to do was go by the business plan.

The first 3 years probably wouldn’t make any money, but by the

fourth year, there should be a dividend, the fifth year, and some

of them, that is how they invested. They invested enough that they

could use the taxes that they had in Oklahoma the first 3 years,

use up their 30 percent, and by the fourth year, start getting a dividend to help pay on the initial investment. So, I would like for you

to consider that as being an ideal. The only thing that would have

really helped was if we could have included a Federal tax cut of

some type in there, percentage-wise, to be able to encourage more

44

investors, and what you do, you hamstring your big investors by

having only a State income tax credit, because they don’t pay

enough Oklahoma taxes, the $100,000 investors can’t use up in 7

years the amount that they need to to get their 30 percent. So, a

Federal tax incentive would be great.

At the present time, the question you asked was how is it doing.

It went from struggling and everybody knows that it did struggle,

because you can’t get big companies to come in and fill, and ask

for orders on a company they are not sure is going to survive, and

that is just the way it is on new startup companies, but now, we

have started a second shift, and now we are employing a third

shift, which we are up to like 50, 60 employees now at the facility.

It pays well, the benefits are good, we have excellent staff of people

there, and I just think the thing, it looked like from the start of

the business plan, by year 8, you would have your initial investment all paid off.

And it is kind of, for the older people, it was an investment in

time. They probably would not see a huge income from it, but for

young people, it is the startup farmers in our area that new generation co-ops are trying to help, it is a big benefit, it is like an

oil well, Mr. Lucas, to them. It could be a huge income thing for

them, and so I just really encourage the legislators to come up with

some type of help to help pay off their initial investment. A lot of

them, we had three banks in the town that the plant is in, all three

CEOs of those banks were on the Board, and towns surrounding

the Alva area offered to loan the full investment, if it was reasonable, with no collateral, to get investors coming in, and so, the

bankers are a huge item for getting started, and it looks like it is

going to be good.

Mr. LUCAS of Oklahoma. Well, along that line, let us touch for

a moment, in my early question to the previous panel about when

a co-op is still a co-op. We have talked about new generation and

we have talked about things going on in Wyoming and Minnesota

and other places, and I, as you know, Keith, I do lots of town meetings, and I explain to my constituents, or attempt to explain to my

constituents why we do the things, or occasionally, the things we

do not do up here, but also, by the same token, on issues like this

where you have got Tax Code matters and a variety of other situations that directly effect—we also have to work through Ways and

Means, and we have to deal with the Internal Revenue Service and

a variety of those other entities, too, so let us just discuss for a moment some concepts and give me your insights. In my earlier question, I think the comment was made, the response to what a coop was, essentially, it was anything where the producers owned the

majority and the business was run on a co-op basis, so to speak,

on a participation basis. That means, conceivably, from my analysis, that outside investment in some of these concepts could be as

high as 49 percent.

Tell me, from where you gentlemen sit, those of you who work

directly in the industry, those of you who finance the industry,

those of you who are so keenly involved, that 49 percent, that outside investor, do we visualize in this combination co-op, do we visualize that investor having the same kind of a tax circumstance as

the 51 percent who are producers?

45

Mr. HUNT. Mr. Chairman, under our structure, we are currently

a closed marketing cooperative. We are contemplating a Wyoming

co-op or a Minnesota co-op, or just converting just directly to an

LLC, so we have given a lot of thought to this, and under our analysis, the simple answer to your question is yes, that the co-op is

a pass through entity. Just as a partnership, as a pass through entity, as is an LLC a pass through entity. The tax burden, the income is allocated to the owners, and therefore, the tax consequence,

therefore, rests with the owners. So, in that scenario, whether it be

10 percent or 49 percent, an outside investor, they as well would

realize the tax consequences or the income being passed out to

them as owners.

Mr. LUCAS of Oklahoma. How do I explain to a Ways and Means

Committee staffer that this kind of a circumstance wouldn’t create

an environment where investors who are interested in putting good

resources into anything that was ag-related wouldn’t search out opportunities to create co-ops, to create enterprises where, with a

very diverse group of 51 percent ownership, versus a very strongwilled and focused junior owner of 49 percent, how do I explain to

a bean-counter, a committee staff, that this won’t create a huge

number of co-ops, but that ultimately, the producers would wind up

being the tail on the dog, so to speak. How do I explain that to a

Ways and Means staffer?

Mr. HUNT. In all due respect, I think that is a great problem. I

think in rural America today, we need people willing to invest in

these communities, and as long as it is controlled by the producers,

those benefits in these rural communities are great, fantastic, the

producers are ultimately in control of that business, and that is exactly what we are really trying to do. We are trying to develop

these businesses.

I think earlier in testimony, someone related the fact that a gentleman gave up his businesses, because they had challenges in

large cities, and when they realized how easy it might be to invest

in a smaller community, I think those are the types of people we

would like to see, and I will tell you, our producers are savvy people. They are good businesspeople. They understand governance,

they understand the difference between 51 and 50 percent, and the

key here is that we are prudent because the risk would be, and we

have talked a lot about this in U.S. Premium Beef as we face these

challenges is if you need capital, additional capital within your

company, is there a risk that you would become a minority player,

if you were not able to address, let us say, a capital call, and that

is why it is important for producers to treat these businesses as

they would their own, that they keep them financially healthy,

they keep their balance sheets in a place where they don’t get a

in a pickle.

So, again, we have spent a lot of time looking at this, but I would

dare say that having a group of investors look to rural communities

to put money would be a great thing.

Mr. SIMS. Mr. Chairman, I want to underscore that. I think as

we look at these businesses, often these are the largest businesses

in rural America, in the towns, and I thought about this as Congressman Janklow was talking about what he sees out there, and

we need some incentives for people to look at rural America, but

46

I would also say I don’t think people are going to just throw their

money into an organization they don’t have confidence in, the business model, the strategic direction, the management and the kind

of board they are dealing with, because they have got fiduciary

duty over that money as well, and I think whenever we see farmers

deal with this issue, and we have got two here on the panel that

can talk specifically, they think very carefully about who they bring

in and why they bring them in. If they are not there to bring, to

add value to the enterprise, my experience is farmers will say no,

we don’t want you.

Mr. HUNT. If you would allow me, I might add just a similar experience we had this past year. Because of the restriction of the cooperative, we could not bring in equity in U.S. Premium Beef to

buy out farmland, completely. We could buy up to a certain percent, but we couldn’t buy them out completely, because our producers didn’t have enough cash to contribute, to capitalize the leverage, and so we were forced to really go outside of our cooperative

and form an entity to attract an outside investor, and in this case,

an outside investor was a company owned by a man and wife that

had been in business for over 25 years, very successful people, that

now are adding value to our business. They have come in as a minority investor, there in further processing of meets, and they have

come in and contributed greatly to our business, shown us new

technologies. We have done joint ventures with them to reap additional value, so again, I think to Mr. Sims’ point, we have to look

at those potential investors with our eyes wide open. What can

they contribute other than cash, and what kind of veto powers do

they have, what types of abilities do they have to dilute your interest. So, these producers had to step up and hire good management,

good counsel, to advise them as they contemplate these kinds of decisions.

Mr. LUCAS of Oklahoma. I appreciate where you are coming

from, and I am a supporter of the co-op movement, just as I think

this entire committee is, just as Congress has shown down through

the decades, but occasionally, we deal in the realm of unintended

consequences.

Mr. HUNT. Absolutely.

Mr. LUCAS of Oklahoma. I see where, if you don’t craft such language on a Federal basis in a very careful, careful fashion, you

could wind up with your dough plants in the suburbs of Boston or

Atlanta or Los Angeles that individuals who would have the kind

of cash resources to become the 49.9 percent investor would be able

to drive the equation and find the other 51 percent willing to benefit from that capital outlay and that expertise. I just—I want to

make sure that we think carefully through this process, and whatever we come up with, we come up with something that actually

benefits rural America. My home county, as Mr. Kisling knows,

dropped 14 percent of its population in rural western Oklahoma between 1990 and 2000. I live every day with the challenges that

rural America has as I watch my school enrollment numbers decline, reflecting my Census numbers that decline, but we have to

move in a way that creates an end result that we intend for it to

create.

47

Now, that said, as I mentioned at the beginning, we are a committee focused on rural American production agriculture. Many of

the changes that a number of you have spoken to, about the Tax

Code, or potential changes to the Tax Code, require other committees of this body to work with us, and sometimes, that is a challenge. That is an absolute challenge. But that is what we are here

for, isn’t it, Mr. Stenholm, is to rise to the occasion and work for

our folks, and with that, speaking if a dedicated servant of the public from the great State of Kansas, Mr. Moran. Do you have any

questions, sir?

Mr. MORAN. It is probably presumptuous of me to begin to reach

for the mike before you finished your sentence, but since I am the

only other Member here——

Mr. LUCAS of Oklahoma. If there was ever a doubt in your ability, Mr. Stenholm and I would take a private poll and report it you.

There is not.

Mr. MORAN. Mr. Chairman, thank you for recognizing me. Mr.

Hunt, thank you for being here. I appreciate the perspective of a

Kansan, and as you know, U.S. Premium Beef has been a significant component of the economy, and particularly, the economy of

Kansas, and the livestock sector, and we are very pleased with the

success that you have had.

Mr. HUNT. Thank you.

Mr. MORAN. You indicated in your testimony that you have used

CoBank funding, financing. You also indicated that you received

funding from other banks. I assume those are commercial banks.

Mr. HUNT. Yes, sir.

Mr. MORAN. Can you describe for me when you find it appropriate to borrow from CoBank as compared to a commercial bank?

What criteria, what is the difference? What goes into your decisionmaking process? What can the CoBank do that the commercial

bank can’t or vice versa?

Mr. HUNT. That is a very good question. I will attempt to answer

it. We, in the type of borrowing that we are in, I would say in a

medium to large scale borrowing, given the size of our business, it

is, as I understand it, I used to be in banking years ago, but I understand, as banking has evolved, that the cooperative banks and

others have developed a strategy of diversifying their risk greatly,

and so typically, in our size of transactions, there are numerous

banks that do become involved.

When we first started, however, when we entered the marketplace, CoBank was very supportive of the new generation concept,

very supportive of producers getting into value added marketing

strategies, and not to say other commercial lenders weren’t, but

No. 1 they were very knowledgeable about producer-owned ventures and comfortable, No. 2, they were involved in food production

lending and other areas. Their packages were flexible, and their

rates were very competitive.

Today, it is really not much different than when we first started.

Most of our lenders do fill most of these criteria. You come back

to good service, knowledgeable lending officers that do understand

your business because they have the responsibility to their management and boards, to assess the credit quality of the potential

loan, the ability to repay it, the quality of the collateral, and all of

48

the other criteria they use to evaluate it. So I want to be sure that

there is somebody there that knows our business, so a month down

the road or a year down the road, they say well, I didn’t realize

that is the way this business was and start getting uncomfortable.

And in this case, CoBank clearly fills that bill.

I think it is important as we look into agriculture in the future

is we see the lending community concentrating, just like the food

processing industry and other industries are concentrating, we see

the lending community concentrating as well, and I think it is very

important that we keep CoBank viable in our lending to our types

of businesses, whether it be an LLC, Wyoming co-op, or a cooperative, so that we know we have good access to capital out there, debt

equity, as well as a good competitive environment.

Mr. MORAN. Do commercial banks compete for the opportunity to

lend you money?

Mr. HUNT. Yes, they do.

Mr. MORAN. Is there a rate differential that makes a difference

in U.S. Premium Beef’s decision?

Mr. HUNT. In our case, it clearly is part of the decision, but

again, because of the size of our transaction, normally, it takes several of the banks to cooperate together, commercial and CoBank,

and so typically, they end up at the same rate that they would loan

to us.

Mr. MORAN. So, in your case, it is a loan package that is put together by a commercial lender and CoBank.

Mr. HUNT. That is correct, in our case.

Mr. MORAN. We had the Under Secretary here before, which reminds me to ask you, did you also receive funding through Rural

Development and any USDA programs in your initial startup?

Mr. HUNT. We received approval to receive funding. We had

great support from Representatives and Senators from the great

State of Kansas and other surrounding States as well, and we did

receive approval. I will say we didn’t use the funding. The State

of Kansas, however, provided us a loan for a feasibility study which

we paid back the day after we closed our deal and encouraged them

to use that and other good opportunities as well, but we did apply

and receive good support from USDA.

Mr. MORAN. Mr. Sims, not all farmer cooperatives borrow from

CoBank. True?

Mr. SIMS. It is true.

Mr. MORAN. Take a grain elevator, for example. They may be

borrowing money from you or they may be borrowing money from

a local bank. True?

Mr. SIMS. That is correct.

Mr. MORAN. Can you outline for me the kind of description of

those two groups? Is there anything in common about the farmer

cooperatives, the grain elevator that is borrowing money from

CoBank as compared to the one that is borrowing from a bank?

Different sizes, management, different——

Mr. SIMS. I don’t know that there is anything that I would characterize, other than the individual choice of the company, and our

best estimates, there are about $12 billion of debt outstanding to

agricultural cooperatives today. We have just under $10 billion of

that, and there are times when it might be the financial position,

49

it might be relationships on that board and management with the

local bank. We have basically a practice whenever our customers,

and you have just heard Mr. Hunt explain how his is structured,

when we sit down with the customer, we will ask them are there

other financial institutions that they want to have involved in this

transaction because it is important to them, and we will do our

best to meet the needs of that particular customer based on what

they tell us.

Mr. MORAN. Remind me, because the suggestion is that CoBank

or Farm Credit is to be ‘‘the lender of last resort,’’ that it is someone who couldn’t get commercial financing. What is the story

there?

Mr. SIMS. That is absolutely not true, Congressman. Having been

at this 35 years, I have been at this hearing table a time or two,

when it wasn’t as much fun as it is today. We were reminded, as

a system, in the mid-1980’s, that we were not a lender of last resort, that we were here with a mission to serve farmers and their

cooperatives as a system, and that we are to do that on a sound

basis, and that is why we have a regulator, that is why we have

capital requirements, that is why we have reserves, and that is

why we have an insurance fund that was set up. And in fact, one

of the things that I am pleased at, at least I have been CEO of

CoBank 11 years now, I have never received political pressure to

make loans or not make loans because we are a lender of last resort. I think everybody has expected us to run a sound business,

and protect the GSE status that the Farm Credit System, of which

CoBank is a part, has.

Mr. MORAN. I have another question, Mr. Chairman, but my time

has expired. Thank you very much for your answers.

Mr. LUCAS of Oklahoma. Thank you, Mr. Moran. The committee

wishes to thank the panel for your insights, observations, your responses and what you do for rural America out there every day,

and with that, we will dismiss you and bring the next group of

lucky citizens forward. We would like to invite our third and final

panel to come to the table, please.

Mr. Roger Ginder, professor of agricultural economics at Iowa

State University in Ames; Mr. Mark Hanson, attorney-at-law,

Lindquist & Vennum, Minneapolis, MN; Mr. Douglas P. Peterson,

president of the Minnesota Farmers Union, St. Paul, on behalf of

National Farmers Union; and Mr. James Caspary, president of the

First National Bank of Clifton, Clifton, IL, on behalf of the Independent Community Bankers Association; and Mr. Roger Monson,

president and chief executive officer of the Citizens Bank of Finley,

Finley, ND. And I believe by some comments that I have engaged

in earlier, perhaps Mr. Monson is under a bit more of a time frame

even than everyone else, so if it is all right with you, sir, let us

begin with you, Roger, when you are ready.

STATEMENT OF ROGER D. MONSON, PRESIDENT AND CHIEF

EXECUTIVE OFFICER, CITIZENS BANK OF FINLEY, FINLEY, ND

Mr. MONSON. Thank you, Mr. Chairman, and I do appreciate the

opportunity to go first. Mr. Chairman and members of the committee, I am pleased to be here to appear before you. I am Roger Munson, and I am president of the Citizens State Bank of Finley, North

50

Dakota, and I am also chairman of the American Bankers Association Agricultural and Rural Bankers Committee.

Today, I would like to express the banking industry’s opposition

to proposals that would fundamentally change the charter of the

Farm Credit System’s CoBank and to discuss a number of ways

that the banking industry, working in partnership with the public

sector, could do more to provide rural businesses with greater access to capital.

Recent legislation in Wyoming and Minnesota has changed the

definition of a co-op in those States with the intention of attracting

outside capital investment by giving outside investors a stake in

the decision-making of the business and by allowing for a return

on investment that exceeds the traditional cooperative model.

These new laws allow farmer-content businesses to be considered

cooperatives. CoBank is asking Congress to consider very broad

legislative language to rewrite their charter, to allow them to finance these hybrid businesses. CoBank’s proposal would dilute

their obligations to farmer-owned and farmer-controlled cooperatives, and would allow them to finance organizations that merely

have some farmer content.

We are concerned that CoBank is asking Congress to sign away

a major part of their jurisdiction by proposing language that would

allow CoBank to lend to any entity that is defined as a cooperative

by State law, not Federal law. As a GSE, they should be governed

by Federal law.

CoBank wants to continue to lend to businesses that are no

longer cooperatives for up to 5 years. This is unwise. If a farmerowned cooperative disbands or changes its charter, it should no

longer be eligible to borrow from CoBank. CoBank is a $27 billion

institution that dwarfs the vast majority of banks that service rural

America. Granting them authority to lend to farmer-content companies would be a great mistake that would harm access to capital

for farmer-owned cooperatives.

Our bank finances cooperatives because they are good business

for the bank. I would like to make some recommendations to you

on how banks, working with the public sector, could provide more

capital to rural business. I was able to finance an acquisition for

a new cooperative in Finley with a USDA Business and Industry

Loan Guarantee. Our bank was able to provide the loan to the cooperative because the USDA guarantee helps us manage credit risk

and allowed us to exceed our lending limit.

As this committee looks for new ways to help cooperatives access

more capital, please remember that the B&I guaranteed program

works well, so well, in fact, that the funding is often overwhelmed.

We were not able to utilize the B&I program for another cooperative because the B&I regulations do not allow lenders to finance revolving lines of credit, which was the type of credit that best fits

this cooperative’s needs. Instead of using the B&I program, I participated the loans with other local banks, and I recommend that

the B&I regulations be revised to allow USDA to guarantee revolving lines of credit.

Several years ago, USDA announced a new guaranteed loan program that was targeted to help farmer-owned cooperatives. This

program was intended to allow institutions like mine to make guarVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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anteed loans to farmers to enable them to buy cooperative equity.

To date, few loans have been written under this program. Congress

again attempted to resolve some of the operational problems when

it authorized B&I guaranteed loans for individual farmers to buy

cooperative stock in the 2002 farm bill. USDA should undertake a

review of all credit programs intended to help individuals make cooperative equity purchases to streamline a loan program that

works.

Further, administration of the resulting programs should be

turned over to the Farm Service Agency, which has expertise in

loans to farmers. The farm bill authorized a new program to meet

the needs of rural businesses, the Rural Business Investment Company. RBICs would allow banks and farm credit service institutions

to charter institutions that would make equity investments in rural

businesses and cooperatives. ABA is anxiously awaiting USDA’s

rule-making process on RBICs. Once USDA issues the regulations,

we would call upon Congress to appropriate full funding for this

important program to generate more equity capital in rural America.

My bank is in Finley because we have developed a market that

produces a return that satisfies our local stockholders. We have

been successful because we provide services that people in Finley

want and need. If you allow CoBank to expand their lending to

broadly defined farmer-content businesses, we may one day have a

hearing about why there is no bank and maybe no real farmerowned cooperatives left in Finley, North Dakota.

Mr. Chairman, thank you for the opportunity to share our

thoughts about the future of the farmer-owned movement, and I

would be very happy to answer any questions that you may have.

[The prepared statement of Mr. Monson appears at the conclusion of the hearing.]

Mr. LUCAS of Oklahoma. Thank you. Dr. Ginder.

STATEMENT OF ROGER GINDER, PROFESSOR OF AGRICULTURAL ECONOMICS, IOWA STATE UNIVERSITY, AMES, IA

Mr. GINDER. Mr. Chairman, Ranking Member Stenholm, my

name is Roger Ginder. I am a professor of economics in the Department at Iowa State University. I appreciate the opportunity to

present testimony at the hearing today, and I will address the topic

of business structures used by closed cooperatives in my oral comments. As requested, I have also touched on the topic of restructuring occurring now in my written testimony. I would ask that that

be included in the record, and I will be happy to answer questions

on either or both topics.

Closed membership cooperatives differ from the typical open

membership cooperative in several important ways. One of the key

differences are capitalization in direct proportion to use, tradable

shares, specified delivery rights for raw product, equity share values that may rise or fall with the value of the enterprise and a

high fraction of patronage payments paid to members in cash.

When most farm groups begin to organize, a closed cooperative,

with these traits, is what they have in mind. Added to the benefits

cited above are the more traditional cooperative benefits, including

single tax treatment, a patronage distribution, access to credit from

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CoBank, limited exemptions from securities laws and Capper-Volstead antitrust protections. Despite these advantages and their initial intent to use the cooperative form, most farmer groups find

that some of the restrictions associated with the cooperative form

make it comparatively difficult and sometimes less than economic

to use.

Other forms, including the limited liability company can incorporate some but not all the benefits offered by the closed cooperative structure without these restrictions. LLCs can offer the same

single tax treatment as closed membership cooperatives, but they

are not saddled with some of the membership restrictions and outside investment restrictions historically placed on the cooperative

form, but the LLC cannot access the benefits of CoBank credit, or

some of the Capper-Volstead exemptions that cooperatives enjoy.

In addition, the LLC form of organization provides for an even

more favorable self-employment tax treatment than what has thus

far been accorded to cooperatives. The self-employment tax is levied at a rate of slightly more than 15 percent on cooperative patronage distribution to their members. LLCs can make identical

distributions that are completely exempt from the SE tax. All other

things equal, the value of the distribution to the producer is 15 percent higher when received from an LLC than when it is received

from a cooperative.

Limiting membership to active farmers is also a source of difference between the cooperative and the LLC, which may be

formed with both non-farm investors and farmers holding full

memberships.

Several State cooperatives statutes permitting more liberal membership requirements have either been passed or introduced into

the legislature at this point. Iowa will introduce one such law at

the coming session. The intent is to permit the formation of value

added cooperatives that allow more non-farm investors in their

membership.

Cooperatively organized ethanol plants have also encountered

difficulties in passing through the small producer ethanol credits to

their members. The Tall Corn Ethanol Plant in Coon Rapids, Iowa

recently converted from a closed membership to an LLC because it

could raise equity from non-farm sources and because it could distribute the small producer ethanol credit to members through the

LLC form and not as a cooperative.

From a policy perspective, I think it is desirable to make it possible for farmers to enjoy the same benefits from a closed co-op that

they would in an LLC. To the degree possible, they should be able

to select the cooperative form of organization without significant

economic penalties. Starting a value added enterprise is already a

difficult task for producers, and it is useful to have as much flexibility as possible. Currently, the enterprise must select the LLC

form if it is to avoid the SE tax and pass through the small producer ethanol credits, but in doing so, it must give up the ability

to access CoBank credit services and the benefits and protections

of Capper-Volstead.

The inability to access CoBank credit deprives these startup

businesses of a stable, low-cost credit alternative with significant

industry knowledge and a long-term commitment to providing fiVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00056 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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nancing to agricultural processing firms, and abandoning the protections of the Capper-Volstead Act could have future consequences

if the value added enterprises wish to form marketing agencies in

common as they grow.

Mr. Chairman, I see my time is nearing the end. I am grateful

for the interest of this committee in this important topic, and for

holding this hearing. I will be glad to respond to any questions you

may have on either part.

[The prepared statement of Mr. Ginder appears at the conclusion

of the hearing.]

Mr. LUCAS of Oklahoma. Thank you, Doctor. Mr. Hanson.

STATEMENT OF MARK J. HANSON, ATTORNEY-AT-LAW,

LINQUIST & VENNUM, MINNEAPOLIS, MN

Mr. HANSON. Mr. Chairman, members of the committee. I also

have provided written testimony that I would like entered into the

record. My name is Mark Hanson. I am an attorney. My office is

in Minneapolis, but my practice is throughout the country in areas

where there is agricultural production and processing facilities. I

work with a number of the members of my firm, but specifically 12

in an agricultural and cooperative practice group.

Our practice consists mainly of assisting and starting up new

value added cooperatives and producer-owned businesses to process

products, and also, we work with existing cooperatives. Both have

a common issue in that they are looking at restructuring, for a lot

of the reasons that have been mentioned in the testimony today.

Frequently, the question comes up, well, are cooperatives necessary, and they are very necessary. They are an important business structure, and it offers an alternative that other business

structures don’t.

One of the primary things that an attorney looks at when assessing should a business be a cooperative or not is the one single

thread that a cooperative allocates the profits and controls to the

users or the patrons of a business. You don’t have that in a corporation. You don’t have that in a partnership, but you do have

that in a cooperative. So, that is the one common thread that, as

attorneys, we usually look at. In terms of cooperatives, there is another area that is very important for cooperatives, and that is that

they are very important for local development. There is a book just

recently published. I mentioned it in the written testimony. When

I say recently, I got, I think, the first copy on Monday, so it is very

recent, and in that book, there are a number of articles and chapters about how important cooperatives have been traditionally, and

can still be today in terms of local development.

Cooperatives today face two major challenges, in my practice.

One is capital and the other is liquidity. Obviously, when you are

starting, you are looking at capital, and as you are ongoing, you are

looking at liquidity. Now, this faces both the new startup cooperatives as well as the ongoing value added cooperatives. In other

words, once you have invested the capital, and the business is continuing, how do you exit, how do you get your money out of the

business, particularly if it is a growth business.

One of the challenges is that with the traditional form of cooperative, fewer farmers means fewer persons that have capital that

54

can be accessed for the cooperative. Traditional cooperatives are

based on new patrons redeeming the capital of prior patrons, and

so as that base shrinks, it presents a problem. Member liquidity,

we hear more questions and comments and requests and sometimes demands from members, saying as a member, I want to control when my patronage equity is redeemed, so member liquidity is

a bigger issue.

As we look at the big picture, a number of States are responding

to the capital challenges. Value added processing facilities is one of

the most difficult things that we face. As you start a processing facility, as a cooperative, and you have a lot of complaints, not from

investors in New York or Chicago or a large city, but from other

people in the local town where the facility is going to be located.

Why can’t we invest? Or the farmer invests and allocates the crop

from 160 acres, but has additional money they would like to invest

in the project. There are things in the Federal law that would support these changes that States are making in their cooperative

laws. One would be, as I mentioned in the written testimony, that

existing cooperatives that are producer-owned or patron-owned

would be given the benefits that corporate cooperatives have today,

which essentially preclude cooperatives from having outside investors within their structure.

There is a provision called section 521 that have been called the

producer’s cooperative section. That section, again, doesn’t allow

anything but producers to be part of those farmer cooperatives, and

again, if that was a producer-controlled entity, it would provide

benefits.

As was mentioned, a lot of these businesses, when they started,

they are the dominant business venture in the community that

they are in. One of the things that is an impediment, particularly

for facilities that are close to State lines, are the securities laws.

There is a lot of regulation. I think there is opportunities, States

have dealt with it in terms of saying that a cooperative can raise

money from its patrons with proper disclosure, and also other entities that would otherwise be exempt from the securities laws. We

don’t have a similar situation in the Federal securities laws.

Last, the mention of how do cooperatives receive debt financing.

We have been involved, and I am aware of a number of other

projects that raise their equity, raise the 40 percent equity and are

unable to find the debt financing. Sometimes that occurs because

there isn’t capacity in certain sectors, whether it is ethanol or it is

grain processing or others.

So, with that, I think the authorization for the cooperative bank

financing and the Farm Credit System, I would just say from my

experience, I don’t think I consider them the lender of last resort,

but in many cases, they have had the vision to see that whether

it is a pasta plant, or in Oklahoma, or beef processing in Kansas,

that this is a business that the rural communities will benefit from.

Thank you very much.

[The prepared statement of Mr. Hanson appears at the conclusion of the hearing.]

The CHAIRMAN. Thank you, Mr. Hanson. Mr. Peterson.

55

STATEMENT OF DOUGLAS P. PETERSON, PRESIDENT, MINNESOTA FARMERS UNION, ST. PAUL, MN, ON BEHALF OF

THE NATIONAL FARMERS UNION

Mr. PETERSON. Thank you, Mr. Chairman, and members of the

House Agriculture Committee. My name is Doug Peterson, and I

am the president of the Minnesota Farmers Union, and it is a

pleasure to be here today on behalf of the 300,000 family farmers

and ranchers of the National Farmers Union to discuss the roles

of farmer-owned cooperatives and contributing to the financial success of agriculture producers and also to economic prospects of

rural communities.

Farmers Union, the National Farmers Union, has a long history

of development and operation in support of the farm-owned co-ops.

Our involvement in co-ops even predates the Capper-Volstead Act.

Our commitment to success of cooperative development today continues through a variety of national education and consulting activities carried out by the National Farmers Union.

Co-ops were established to deal with the primary needs of production agriculture, and provide a mechanism to address the types

of agriculture market failure in America. The first cooperatives

were provided a broad range of the local available services to production agriculture that were not being met by the private sector.

Second, cooperatives foster market competition to reduce the concentration of market power among limited agribusinesses, companies. Cooperatives also allow farmers to participate in both the governance and earnings of the agricultural sectors in which they do

business, and by creating new jobs.

National Farmers Union believes that the vital role of cooperatives can play in meeting these needs even more important today,

and no one questions that times have change in agriculture, and

we believe and think that we can agree that agriculture cooperatives should be reviewed and modified to reflect the current conditions and future business expectation.

National Farmers Union feels that Congress must take a lead in

this reexamination process, rather than allowing the events or

other institutions to determine the cooperative model that may, in

fact, sacrifice the characteristics of a cooperative that distinguishes

it from other business structures.

We know that there may be problems in this challenge of that

system today. However, Farmers Union also believe that the level

of restraint must be exercised to provide the opportunity for a full

discussion of potential alternatives before engaging in a significant

modification of the cooperative model.

Along with others, Farmers Union sees the largest single challenge facing the existence of our future cooperative business ventures as access to equity capital. For established co-ops, new infusion of capital are critical to the capacity to adapt and compete in

a global setting, where the market power is becoming increasingly

concentrated and integrated through mergers, acquisition and strategic businesses’ alliances, and as many of you know, the recent

farm bill created a Rural Business Investment Program to raise

capital and provide operational assistance to smaller businesses,

and to allow them to participate in government guaranteed programs.

56

The program also ensures that ownership of Rural Business Investment Company is not affiliated with the company’s management. In our judgment, the RBIP program, when coupled with

other cooperative development programs, offers an important opportunity for smaller rural cooperatives. We encourage this committee to impress upon the USDA the importance of expediting the

implementation of this program.

We also further encourage the committee to look at ways to

streamline the whole cooperative development process, and particularly, we believe, the Farmers Union believes that shifting some of

the lending authorities, such as the various guaranteed loan programs to the Farm Service Agency, which has substantial agricultural credit experience, would further encourage farmer participation in new and existing cooperatives and expedite the cooperative

development process.

Many proposals have been suggested, and in some cases, State

governments have already acted. And they have acted in an attempt to enhance the ability of co-ops to attract outside capital.

While we do appreciate the worthy intention of these efforts to address the equity shortfall problem, we are concerned about the

long-term effects these proposals have on basic cooperative principles.

Our concerns include the issue of producer ownership and governance of cooperatives and the ability of cooperative ventures to

provide alternative market opportunities. So-called new generation

co-op schemes that blur the lines between a co-op and other organizational structures may put at risk existing preferential policy

treatment for all co-ops, including but not limited to the issue of

partial antitrust exemptions and tax considerations.

Because these proposals have been a substantial impact on the

application of many Federal laws, we feel that Congress must get

in front of the issue, rather than simply react to the actions taken

by others, and we are very concerned that the new State laws, including one recently adopted in my State of Minnesota to encourage equity investment in cooperatives could effectively, if not technically, eliminate ownership, control and allocation of patronage

earnings to the real producers. In this case, the old adage, who

pays the piper calls the tune could certainly apply to the outside

investors, who may be able to qualify as farmers under the current

definition.

Non-farmer investors may be able to control or influence a majority of co-op board votes to change the traditional allocation of earnings away from patronage to a return on investment. They also

may exert significant and substantial influence on merger, consolidations, liquidations, or other critical business decisions. In effect,

the co-op, by accepting access to outside capital, may become nothing more than a regular stock company, except that the farmer-patrons will have collectively contributed substantial risk, or capital

risk, that is, for a venture that may not be serving in their own

self-interest.

We feel it is important that Congress should review the definition of a farmer as it applies to co-op ownership and governance.

If, after all the thorough assessment, Congress determines that the

benefits of encouraging the type of ownership and outside capital

57

investment of these proposals outweighs and is not inconsistent

with co-op principles and existing statutes, it should establish strict

guidelines and limitations on the level of influence that these investors may exert over co-op business structure. At a minimum,

these rules should be this. No. 1, require diversification among investors, particularly those with interests in competing business. No

2, ensure an adequate majority of voting power is retained by farmer-owners, and the final point, mandate an equitable sharing of any

earnings distribution among outside investors and those who would

be entitled to patronage allocations by the company.

Mr. Chairman and committee, these are our suggestions and observations and we would be glad to stand for any questions. Thank

you.

[The prepared statement of Mr. Peterson appears at the conclusion of the hearing.]

The CHAIRMAN [presiding]. Thank you, Mr. Peterson, and the

Chair now recognizes the gentleman from Illinois, Mr. Johnson, for

an introduction.

Mr. JOHNSON. Thank you very much, Mr. Chairman. It is my distinct pleasure to be able to introduce the next witness, one of my

constituents and very good friends, Jim Caspary of Clifton, IL. Mr.

Caspary is the president of First National Bank in Clifton, the

chairman of IBAA’s Agricultural Rural America Committee and

past president of the Community Bankers Association of Illinois.

His bank, First National Bank of Clifton, is a small midwestern

bank in my district with about $30 million in assets. It has been

serving this community, the community of northern Iroquois County, for over 100 years. It is located in the north central part of the

State, and the primary agricultural commodities, as I assume everybody knows, are corn and soybeans. The bank also owns an insurance agency, which sells crop insurance and is one of the largest

producers of crop insurance in the State of Illinois.

Jim has been active, I know, from personal observation and experience, in the community. He served as chairman of the Nursing

Home Board, past president of the Clifton Lions Club, past vice

chairman of the Central Hospital of Clifton, chaired the community

zoning committee and in various other and numerous community

advisory boards and committees, in addition to begin simply a good

citizen of our area.

Jim and his wife have two very fine sons, John and Jeff, and

with that introduction, it is just my privilege to have you here, Jim,

and I know the committee is anxious to hear from you.

STATEMENT OF JAMES E. CASPARY, PRESIDENT, FIRST NATIONAL BANK OF CLIFTON, CLIFTON, IL, ON BEHALF OF THE

INDEPENDENT COMMUNITY BANKERS OF AMERICA

Mr. CASPARY. Thank you, Congressman, for that kind introduction. Thank you for conducting this hearing. As my Congressman

mentioned, I am Jim Caspary, president of the First National Bank

of Clifton, IL, and chairman of ICBA’s Ag Rural America Committee.

We feel it is appropriate to explore ways to generate more equity

capital for farmer-owned co-ops in rural America. This should be

done in ways that don’t potentially lead to the loss of legitimate

58

farmer control of their cooperatives or in ways that drastically depart from the bedrock principles of what makes a cooperative a cooperative. It is important to ensure that policy actions do not spur

greater consolidations in agriculture and consolidation of the businesses and cooperatives that serve agriculture.

First, let me say that the farmer-owned cooperative movement

has a long and proud history. Many community banks finance

farmer-owned cooperatives, and we believe that they are often essential building blocks of strong local communities. Locally owned,

farmer-controlled cooperatives produce jobs in and around the community and add value to agricultural products, generating greater

cash flows for both farmers and local economies. Several USDA

programs that could help are standing idle, as has been mentioned

before. The Rural Business Investment Corporations, we urge that

the USDA publish regulations and we also urge that significantly

reducing the capitalization threshold necessary for smaller RBICs

to leverage funding.

On the Cooperative Stock Purchase Program, allow individual

farmers and co-ops to receive loan guarantees to purchase stock for

expanding or creating new co-ops. It is virtually unused. The authorities allowing guarantees to individual farmers should be

transferred to the FSA, because of their experience with farm

loans. Then, give the established co-ops the option of which agency

to use, the FSA or the RCBS.

Under simplified loan applications for small B&I loans, the

USDA should immediately publish regulations raising the loan

threshold of the B&I low-doc loans to $400,000.

Wyoming and Minnesota passed laws to add greater flexibility to

attract equity from outside investors. There is, of course, merit in

devising ways to attract that outside equity, but the particular

model used raises questions over governance and financial rights.

Outside investors could form LLCs labeled as farm-owned cooperatives even if farmers lack clear majority ownership or voting

control. Let me share a quote from one cooperative source, and I

quote:

While recent events may seem troublesome, they provide no evidence that the cooperative model is failing. To the contrary, there are many successful cooperatives

in business today. Cooperatives, like any other business structure, experience problems, failures, structures and evolution. Any number of major public stock companies have closed their doors or have been purchased by other entities, yet there is

little talk that the public stock company has failed.

The two State laws allow for both a patron class and an outside

investor class, a minimum of three directors, at least one director

elected by patron-members. The patron-director has at least 50 percent of the voting power, and the patrons are entitled to 15 percent

of the distributions.

Some questions that need to be asked would be should the board

have more than one patron-member? Should patron-members have

more than 50 percent controls? Does a 15 percent level adequately

protect the patrons? If investors withdraw 85 percent of the profits,

does this ensure adequate equity capital remaining in the cooperatives?

The CoBank proposal, we oppose the legislative proposal in its

current form. It fundamentally rewrites CoBank’s lending charter

59

to allow loans to corporations that may have no farmer involvement and that may be unrelated to agriculture. It should not be

adopted this year and more discussion is needed.

Some of our concerns are exactly who is a farmer is undefined,

which raises concern when you consider limiting the farm proportion to either 50 percent ownership or farmer voting control. Combined with the fact that these LLC boards need only have three directors, question arise whether real farmers would be involved in

some of these entities. Is Ted Turner, as a large landowner, a real

farmer? Is Wal-Mart a farmer? Under FCA regulations, they appear like they may be.

CoBank wants to finance entities that become ineligible due to

the decline in farmer ownership and voting control even below the

watered-down 50 percent level. If farmer-owned co-ops are bought

out by a large corporation, they receive the title association as a

legal successor, thus CoBank could finance large corporations

under this authority that are not associations of farmers, not operated on a cooperative basis, have no farmer ownership or farmer

voting control.

Again, a non-farmer-owned parent corporation could be financed,

any legal successor, as well as any entity, even though it may not

be farmer-owned cooperatives, and even though its business may

be completely unrelated to agriculture.

These and other legislative loopholes allow CoBank to completely

alter their mission from farming, or financing farmer-owned co-ops,

to financing corporations with no farmer involvement, the so-called

legal successors.

In conclusion, there could be advantages to seeking outside capital for cooperatives. We must weigh these advantages with the potential for conflicts of interest with farmers who own these co-ops.

The control follows the money. Should large corporations be called

cooperatives under some State laws when they really aren’t? Would

they be eligible for benefits as cooperatives and receive financing

from co-op banks and potentially compete against farmer-owned cooperatives. Will traditional farmer-owned cooperatives seeking financing from CoBank be told in the future that they need to secure

significant outside investor equity and control to receive financing?

With various Federal statues on the books, Congress should help

to ensure that farmers’ interests are protected at the Federal level

in any developing trends that may set the stage for how some cooperatives could be formed in the future.

Caution should be in order to ensure that large U.S. corporations

do not have a tool to unfairly leverage their interests against family farmers. These issues should be thoroughly discussed before

there is any rush to pass CoBank proposal that rewrites their charter to lend to non-cooperatives and non-agricultural corporations.

We look forward to working with you to address these important

issues. Thank you.

[The prepared statement of Mr. Caspary appears at the conclusion of the hearing.]

Mr. MORAN [presiding]. Mr. Caspary, thank you very much, and

I would recognize the gentleman from Texas.

Mr. STENHOLM. Dr. Ginder, I take it from your testimony that

you do not believe existing laws and programs are enough, are sufVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00063 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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ficient for our farmers and ranchers to remain competitive under

current conditions.

Mr. GINDER. Well, if we think back to when a lot of the CapperVolstead provisions were put in, that put cooperatives with the single tax treatment, as a better alternative from a tax standpoint, at

least, for farmers to use. With the advent of LLCs, they have the

single tax treatment and the value added portion of that is not subject to self-employment tax. When farmers sit down and talk about

how will we get the most benefits back, the LLC looks preferable

in many cases to the cooperative structure as a result. In that, they

are trading off, they are having to trade off, having to make the

choice between access to CoBank lending and some of the other

protections provided by Capper-Volstead.

Mr. STENHOLM. Mr. Caspary, in your testimony, you say you oppose the CoBank proposal in its current form. Do you have some

suggestions of how it might be modified in which you might believe

it would be supported? You or Mr. Monson.

Mr. CASPARY. Yes, I think that we would have some suggestions.

I think that the definitions are very loosely defined in the proposal

that they have, and it is subject to interpretations, and I think if

we could get some of those defined, and defined what a farmer really is and what a co-op is, and how the private ownership of these

proposed new co-ops don’t disadvantage private ownership of other

businesses in our towns. As it is proposed, for example, giving the

tax, if a business in my town, the successful and a taxpaying business, if a group of people who have a few acres of ground that may

or may not be, in my opinion, farmers, if they get together and

form a co-op and have a business that would compete directly with

one of my customers, and to call themselves co-ops, how will my

customer, who is a corporation C, for example, that pays taxes and

has to borrow at rates, compete against the other one, not necessarily the largest ones, but I am talking about my real customers, so I think that it really has to be defined as to the cooperative, it has to really be involved in agriculture and the producers

have to really be involved and not in name only, and that is a little

difficult to do when you are talking about 50 percent ownership, for

example.

Mr. STENHOLM. Mr. Monson.

Mr. MONSON. Thank you, Congressman. Yes, I share those some

issues as Mr. Caspary. The Congress chartered the Farm Credit

System for some very definite goals and guidelines, that is to finance agricultural producers who own and control their entities,

and as we look at what is being discussed today about the issue

of bringing capital to agriculture, it is a good discussion, and I applaud you for doing this. I think the caution that we need to take

is when does this entity not become farmer-owned, farmer-controlled and still remain a cooperative and is that within the charter

of the Farm Credit System and particularly CoBank?

Mr. STENHOLM. I can appreciate and find myself in substantial

support of that general thought, because as I represent a rural

area, I have many community banks that, we constantly hear this

concern that you both expressed. But I ask you to continue to pursue a compromise, if you wish, in which we can do what I believe

both of you in your written testimonies acknowledge. There is a

61

terrific need for attracting capital in rural communities, and it is

sometimes difficult for producers alone to come up with the capital.

Therefore, this new term now, new generational cooperative, closed

cooperative, whatever it might be, if it is a structure that can be

put together that everyone at this table and the previous witness

tables could agree that this would offer a change in structure that

might allow us to do things that we have been unable to do under

current law, that most rural communities, I think, would be supportive of that.

I don’t have to tell you in the private banking business, but business is changing. Competition is pretty tough. There is a lot of

folks doing banking today that you complained regularly about,

that they are not operating under the same playing field with you,

and therefore, Congress has tried to be sympathetic to that in making many of the changes in financial laws that we need to make

in order that we might maintain a community bank system in

small town America. We are very receptive to that.

I would hope that we would maintain an open mind regarding

our cooperatives, and that includes we farmers, Mr. Peterson, as

far as things that we would like to see are sometimes difficult for

us to get in the real world today. It is a little bit trying on those

of us that remember things the way they were 20 or 25 years ago,

and we are not going to go back to that any time soon, if ever, and

so the challenge for this committee is to, again, we may not have

the jurisdiction of some of this, but from the standpoint of where

we do have jurisdiction, where we do have the cooperative structure, a closed co-op is still a co-op. If you have got individual producers that have joined together in order to help themselves get a

little bit more of the consumer dollar in their pocket, that benefits

banking and everyone else. That is the kind of borrowers you are

looking for.

You mentioned Wal-Mart a moment ago. One of the areas that

is real challenging to our cooperatives is how do you put a structure together that will cause a Wal-Mart to even look at you, because Wal-Mart is not interested in little people. I say that respectfully, because the very nature of their system is such, and therefore, you have to put together a structure that will be competitive

with whatever you are trying to sell to the Wal-Marts, and I can

say this for any other chain, and many of our producers, in this

case, I am thinking specifically of lamb, is how we are looking at

thinking outside the box in order to provide yes, a Wal-Mart, with

a supply of lamb that might require importing some lamb from

time to time, and having the producers at home benefiting instead

of some other company.

Now, if that structure, under some of the line of testimony today,

that would not be permitted for cooperatives to lend to that entity

if they are going to lend to someone that has perhaps a foreign

partner, as well as a corporate partner. I would rather us think in

terms of how can we have the banks that you represent, by here

today, how can we look at participation loans with cooperatives

that would benefit your customers in your communities that you

represent and do it on a participation, I used the world earlier, cooperative way. You can have cooperation between an independent

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bank and a co-op bank in a community. We heard the previous

panel, in which they said that is the way it works.

In most cases, most cooperatives do, are good customers of their

local bank, and yet, we have this participation question, so as we

continue to pursue this, and why I ask you, Mr. Caspary, you say,

when you said in its current form, that is encouraging to me. That

is not saying we are just opposed to it, we don’t want to look at

anything else, we just—you just point out in your written testimony, you have got some troubles and these are some legitimate

cases or questions that need to be answered. Mr. Monson, the same

way with you.

And I could say the same for each of the witnesses here, but I

would hope that we would not come to the conclusion that status

quo is acceptable, because status quo is going to continue to contribute to the downfall of rural America. We cannot stand on doing

business the way we have been doing it, whether it is cooperatives,

or whether it is any other business structure. We cannot do that

if we have any hopes of maintaining any portion of the remaining

500,000 producers that produce 85 percent of everything that is

produced in America. We can’t do it, and so I hope that you, with

this committee, will maintain an open mind and will look at this

from the standpoint as to how can we create a structure that will

be as fair to the various viewpoints as we possibly can, while at

the same time getting the job done that must be done at that local

level.

So, thank you for your testimony. Your written testimony is excellent. I appreciate very much your participation here today. Very

important, we are laying the foundation, in my opinion, for the future of agriculture in rural America with this discussion today.

This is the foundation, and we haven’t poured any concrete yet. We

are just putting up the forms. We are going to pour the concrete

a little bit later.

Mr. MORAN. I thank the gentleman from Texas. Mr. Caspary or

Mr. Monson, Mr. Stenholm was encouraging you to work with

Farm Credit or CoBank to try to see if there was another approach

or a middle ground. Are those discussions ongoing? Has there been

that kind of dialog, with the American Bankers Association or the

Independent Community Bankers?

Mr. CASPARY. In our Ag Rural America Committee, the last that

I chaired for a few years, I guess, if you want to look at it, each

year, we have the FCA Board, a member of them come and we discuss with them the differences, the way that we can cooperate,

some of the areas that the banks do, and obviously different areas

of the country, react differently. If there is a real competitive nature, there are some bones to pick, but yes, we do work with them

and try to cooperate in every way that we can.

We certainly are not ever opposed to creating equity capital in

rural America and we fully support, and we would be happy to

work with you, to do that as long as we keep that level, or that

field, trying to get more level, or tilt it a little bit toward our favor,

as Congressman Stenholm said. We support that effort. The thing,

I guess, that comes to my mind is that we are talking now about

equity capital, and let us not confuse that with equity lending. In

other words, there is plenty of credit available in rural America.

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We do not have a lack of credit in rural America. What we lack

is that capital input to do, let us not say that because we can make

more loans, we are helping rural America. We want to make sure

that we generate some business opportunities, so that we can enhance the life in rural America.

Mr. MORAN. Mr. Monson.

Mr. MONSON. Thank you, Mr. Chairman. Yes, we have ongoing

dialog, not only with CoBank, but also with the Farm Credit Administration. I have met with Mr. Reyna and others, and so there

is that open dialog and discussion of the issues. We remain committed to this structure and the financial improvement of rural

America. And I would again applaud Congress for making these

tools available. Unfortunately, they have not had a chance to be

implemented, and we go back to these RBIC, these Rural Business

Investment Companies, in which banks and the Farm Credit System come together and make investments, available for these rural

cooperatives. We are still waiting for the rule-making on that, Congress has put the tools out there, and along with the Guaranteed

Cooperative Stock Purchase Program.

Those are good things. Those would allow for additional stock investment by these farmers whereby they wouldn’t have to be committing just their farm assets, but rather, would have the USDA

guarantee behind them, which would allow a bank to make these

things happen, the tools are there. This is a problem that should

be and will be solved.

Mr. MORAN. Do you agree that farmer cooperatives need the ability, this is aside from the issue of who lends to those farmer cooperatives, but is it true within the banking community that it is

recognized that the structure of farmers’ cooperatives need to be altered?

Mr. MONSON. I don’t know in the banking industry if it is a

structural that there needs to be a change in structure of the cooperative. I have financed cooperatives. I belong to one. I belong to

a couple. I think from the lender’s point of view, Mr. Chairman, is

there sufficient profitability, is there sufficient capital, is the program put together correctly?

Mr. MORAN. If I understood Dr. Ginder and Mr. Hanson, there

is a necessity for the structural organization of a cooperative to be

altered to meet today’s requirements for, presumably, raising capital, I assume, as well as tax considerations, and if I understood

Mr. Peterson, there is some reluctance on the part of his organization to see that happen. He wants them remain more farmer-oriented than they might otherwise be with a new structure.

I wasn’t certain whether either the American Bankers Association or the Independent Community Bankers have a position as to

underlying changes in State law regarding the changing structure

of farmer cooperatives, or if your issue is just about the ability for

CoBank or Farm Credit to lend to those structures.

Mr. MONSON. Our position today is probably the latter. There

has only been two States that have, I am looking at law in that

regard, and there is, as you heard today, there are some varying

opinions about how those laws are even applied, so I guess I am

not in a position to talk directly about what structure is appropriate, but I think that we need to be mindful of the benefits and

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the advantages that the co-op, the true cooperative has, and that

that be carried forward and be still used as an advantage in ensuring the success of whatever these new entities have.

Mr. MORAN. Mr. Caspary.

Mr. CASPARY. Yes, we definitely have one as far as the State-controlled, our association does not see how you can have 50 different

States to come up with a definition of a co-op and then have the

Federal Government say that all co-ops are the same. It just absolutely won’t happen. I guess, to a certain extent, when you say they

need to have a new structure, it brings to mind, I think, a little

bit of Congressman Stenholm’s early opening comments.

The people who are members of the co-ops, some of them are getting some age on them. They are interested in getting their capital

back out of it, so it would seem there would be a need to retain

capital, but on the other hand, when you come up with ideas such

as you can have 85 percent of the capital, or 85 percent of the earnings going back to the private investors, to enhance them to come

in, it doesn’t work. I mean, it just doesn’t work. You have to retain

the earnings. You have to retain that earnings to build your business. That is the way we built our bank over the last 100 years.

If we would have said I want to start my bank 100 years ago and

I really think I need to get my money out, and every time somebody died and passed on, you took the money out of the bank, we

wouldn’t have been able to grow and to serve the community, you

have to come up with an internal thought structure for the cooperatives that says I am putting my money in and it needs to stay

in there. The farmers need to come up with that. It is not I will

put my money in and then I want to get it out as soon as I can,

or I want to get a really good return on it. You have to say I am

going to put this money in, and in 20 years from now, if I don’t

get a dime out of it, I will have built my sales, I have built my production, or something. That is the mindset. So, it might be more

the mindset change than a legislative change.

Mr. MORAN. If I can summarize what I am hearing, it is that if

there is a change in the definition, the criteria by which we create

a farmer’s co-op, it needs to be a national change, not State by

State, and then second, you are raising concerns about the opportunity for CoBank and others to lend to those entities. Is that fair?

Mr. CASPARY. I don’t understand the last one.

Mr. MORAN. And then you are raising concerns about if we redefine co-ops, create different criteria by which they are created, then

that may change the opportunity for CoBank to lend to those entities.

Mr. CASPARY. If, in fact, they retain the right to get their funding

from a government-sponsored enterprise and if, in fact, they only

are taxed once on the patrons’ participation in that profit, then yes,

we would oppose that portion of it.

Mr. MORAN. The banking community sees CoBank, sees an independent bank, an independent bank, at a competitive disadvantage, is that—with CoBank?

Mr. CASPARY. We do so in the neighborhood of cost. Their costs

of funds are less because they have the government guaranteed of

the GSE status.

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Mr. MORAN. That is what I want to give you the opportunity to

put on the record is what you think that the advantages that

CoBank has over you as an independent banker.

Mr. CASPARY. Basically, the tax structure of the subchapter T,

and the ability to use the Government Sponsored Enterprise would

be my answer.

Mr. MONSON. Yes, I would agree with that. The ability to access

the bond market as a government-sponsored entity is huge, and results in a lower cost of funds.

Mr. MORAN. And you see that in your ability to compete with interest rates on your borrowers’ loans with CoBank?

Mr. MONSON. It does become a pricing issue. We have tried our

best and used other methods available to compete, and I believe

there was testimony today from Mr. Sims or rather, the individual

from the beef co-op, that they were able to get similar pricing.

Mr. CASPARY. And one further comment. We are at a disadvantage on price at times, but one advantage we do have is our community banks reside in those rural communities. We don’t, in the

Farm Credit Service, for example, has reduced the offices, and a lot

of the loan officers work out of a car, and I think we have Ford

and Iroquois and Livingston and the counties right around, there

is no office, our banks do have a presence in the community, so

that is an advantage that we have that offsets the—but that is because we live in those communities. It is not because the government has given us a competitive advantage.

Mr. MORAN. Dr. Ginder.

Mr. GINDER. Well, from a standpoint of working with a group

trained to organize, a lot of the projects are of such a size that at

least in my experience, a lot of the banking for LLCs, which Farm

Credit can’t currently serve, have been coming from larger banks

outside the State anyway. There ought to be a way to get consortia

or something to——

Mr. MORAN. Let me join the dialog between the two of you, because that was kind of my next question, was in Kansas, where we

have seen the need for capital for farmer type cooperatives is, for

example, a new ethanol plant. Who is there to put the capital together to create that opportunity?

Mr. CASPARY. We have a perfect entity for that, if they would be

giving access to funding through the GSEs and a tax advantage,

would be the 30 some odd banker’s banks that are in various

States in Texas, in Kansas. Those banker’s banks do put together

consortiums of banks to jointly fund some of the larger ones, so we

do have a facility. The disadvantage is that the banker’s banks do

not have access to the GSE funding at that particular rate and if

they would come up with that and some tax incentives to pass on,

then, the community banks would be an extremely good source of

equity capital.

Mr. MONSON. Community banks have a long history, sir, of working together to finance rural American communities. I was involved

in a consortium that raised $25 million in 10 days to fund an entity

that wanted to disengage themselves from a former cooperative

bank, and so the capital is there, and the infrastructure there is

quite honestly through the banker’s banks. The pricing can be a

problem at time to time.

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Mr. MORAN. So the capital is available, it is a pricing issue in

many circumstances.

Mr. MONSON. Well, they are definitely, the GSE access to the

capital market is an advantage.

Mr. MORAN. Mr. Stenholm.

Mr. STENHOLM. We have other GSEs. Who is the beneficiary of

Ready Mac, Fanny Mae. Who benefits from the cheaper money that

is made available by GSEs?

Mr. CASPARY. And that would be the homeowners at that point

in time.

Mr. STENHOLM. Yeah. Who benefits from farm cooperatives’ access to the GSE?

Mr. MONSON. It would be, I assume, their borrowers.

Mr. STENHOLM. That is my point. I mean, we have other GSEs

which are designed to benefit the people. What we are talking

about here is how do you maintain a so-called level playing field

between competitors who are trying to serve the same people? And

we seem to have been able to do that in Housing, which is the

HUD, how the GSEs benefit the average consumer. We are a tremendous beneficiary of that approach. It has grown so large it is

beginning to get a little bit concerning to a lot of folks today, myself included. And that is another story for another committee to

continue to look at oversight.

We have a Farmer Mac program. Are you participating in that?

And how is that working?

Mr. MONSON. I am a stockholder in the Farmer Mac organization. We have not utilized their product because, quite frankly,

they have some stipulations in there relative to prepayment penalties and also some pricing structures that do not fit our particular needs. We were able to place the business elsewhere.

In regard to the other GSEs, that is an excellent point, Mr. Congressman. However, those GSEs are accessible, are accessed by all

lenders. His bank, my bank, can access that, and in the case of the

Farm Credit System, we can’t access that pool of funds.

Mr. CASPARY. Again, if you give banks access to some of that

GSA funding for specific portions in rural America, it would be

very beneficial.

Mr. STENHOLM. That may be one way that we might end up

wanting to go if we are trying to help rural lenders for the purposes of, that is always a possibility. That is what we were hoping

to accomplish through Farmer Mac, and if we have still got some

rough spots there, we will get out to sign paper and work on it, but

we have got to think outside the box, because I don’t think anybody

has offered a different opinion.

From a rural America standpoint, we are dying. I don’t know

about your communities and what, but back home in rural Texas,

small towns and communities are struggling, and we can say all we

want to about the competitive nature, et cetera, but unless we find

some ways to bring some capital and jobs in some nontraditional

ways, we are going to have a very difficult time. That is what this

is all about, and that is why I am encouraged by you continuing

to be willing to look at how to take this proposal and make it work,

because I think we need all of the capital we can manage in a responsible way, because you make the points, I mean lending to

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somebody that can’t pay it back is not too smart, and I will not

take any more time, except to say this. When we talk about some

of our government, what used to be Farmer’s Home lending and

some of the aspects of the Guaranteed Lending Program, I get very

perturbed at how little progress we have made in reducing the

complexity of a guaranteed loan that a bank or a PCA or anyone

else could be able to make so much more efficiently, if we could just

the bureaucracy to adapt and do that which Congress has told

them to do over and over and over again.

There is a real fertile field out there of things under current law

that we could do to be extremely helpful that we seem to be incapable of doing at this moment.

Thank you all very much for your time.

Mr. MORAN. Yes, thank you very much, panel, for your testimony. Without objection, the record of today’s hearing will remain

open for 10 days to receive additional material and supplementary

written responses from witnesses to any questions asked by a

member of the panel. The hearing on the House Committee on Agriculture is adjourned.

[Whereupon, at 2:34 p.m., the committee was adjourned.]

[Material submitted for inclusion in the record follows:]

STATEMENT OF DOUG SIMS

Chairman Goodlatte, Ranking Member Stenholm and distinguished members of

the committee, my name is Doug Sims. I am the chief executive officer of CoBank.

I appreciate the opportunity to present testimony on business structures being used

by new generation cooperatives and associations of producers. We commend the

committee for holding this important hearing.

CoBank provides financial services to about 2,600 customers throughout the

United States. These customers are also CoBank’s member-owners and include

farmer-owned cooperatives, rural telecommunication companies, and rural electric

cooperatives. We also provide financing to support the export of agricultural products. CoBank is part of the federally chartered Farm Credit System and we, like

the vast majority of our customers, are a cooperative.

Farmer-owned cooperatives (referred to as associations of producers in the Farm

Credit Act) have and continue to play a vitally important role in support of the

American farmer. Moreover there is a new generation of cooperatives emerging in

rural America that offer future opportunities to enhance farmer income.

For 70 years, CoBank has been the principal source of financing for the vast majority of farmer-owned cooperatives. The mission of serving the financial needs of

farmer-owned cooperatives was assigned to us by this Committee and Congress, as

set forth in the Farm Credit Act of 1971, as amended. I am here today because

dated provisions of that Act will increasingly make it difficult for new generation

farmer-owned cooperatives serving the interest of their farmer members to obtain

financing from CoBank.

We estimate that CoBank provides about 80 percent of all credit extended to

farmer owned cooperatives. We have customers in most rural counties and our cooperative members are often the cornerstone businesses in the communities the members of this committee represent. Our members serve a wide variety of farm interests from wheat and corn to rice and cotton to fruits, vegetables and dairy. While

other large lenders may at times be an important source of credit to agricultural

cooperatives, their interest in cooperative lending varies over time based on agricultural conditions and other business objectives. Congress has assigned us, as a cooperative owned by our customers, the mission to be there in good and bad economic

times.

A USDA study entitled ‘‘The Impact of New Generation Cooperatives on Their

Communities’’ found that farmer-owned cooperatives added $9.6 billion in net value

to their members’ products. Simple economics is the driving force for farmers to

form businesses that provide a better chance for increased profits and of success in

the marketplace.

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My comments today will focus on finance related matters, but CoBank is also a

member of the National Council of Farmer Cooperatives (NCFC) and strongly supports the recommendations made by NCFC at this hearing to strengthen the role

of the Agricultural Cooperative Service in USDA, to support programs such as the

value-added technical assistance grants and commodity purchase program and to

address key tax issues that negatively impact cooperatives.

As we view the farmer-cooperative marketplace today and our role as a lender I

would summarize a few key points:

Farmers and their cooperatives are changing as the marketplace and competition

change and they aggressively seeking ways to enhance returns to farmers and address new challenges and opportunities. Being able to adjust quickly to changing

market conditions is a critical factor in the success of farmer-owned cooperatives.

Increasingly, farmer-owned cooperatives are seeking new ways to return more income to their farmer-members through value-added enterprises and creative partnerships. We believe these new approaches when based on sound management and

strong capitalization, should be encouraged and enhanced. Farmers often do not

have the financial capacity to provide all the equity capital required for many value

added enterprises.

To adjust to the marketplace, cooperatives are adopting new business models,

which allow more flexibility in raising equity capital from non-producer sources,

minimize tax liabilities and provide more operational flexibility. These new structures will often make the cooperative ineligible for CoBank financing.

As cooperatives and associations adjust to better serve their farmer-members,

CoBank needs to support these farmer-controlled businesses without the current restrictions that are placed on cooperatives under the Farm Credit Act. State laws are

changing to reflect the needs of cooperatives in today’s economic environment and

Federal laws will also need to be modernized. Under the current situation, a farmer

cooperative could be organized under the new Minnesota cooperative law, have

farmer control on their board, and not be eligible for financing from CoBank, the

bank established by Congress to serve farmer cooperatives.

Without action by Congress to update the cooperative eligibility provisions in the

Farm Credit Act, CoBank will be unable to fulfill the mission it has for 70 years

of providing credit to farmer-owned cooperatives.

THE ECONOMICS OF FARMER OWNERSHIP

Farmer-owned cooperatives are economic tools that exist for the purpose of providing farmers the means to improve their financial condition. This committee is well

aware that most of the profits in the food system are generated after the farmer’s

product leaves the farm. A new generation of value added cooperatives offer farmers

an opportunity to capture an increased part of the consumer food and fiber dollar.

Cooperatives enable farmers to diversify their risk and earn greater returns through

investments in our Nation’s processing, marketing and farm supply systems.

A study conducted by the Quentin Burdick Center for Cooperatives in North Dakota identified the benefits to farmers of value added cooperatives. These benefits

include:

• Increase farm income and productivity,

• Reduce marketing risk,

• Increase market access,

• Increase member networking and market knowledge,

• Provide new services, and

• Increase membership share values or economic returns to farmer-owners.

We are optimistic about the changes in approaches that we see with many farmerowned cooperatives. They are seeking new market opportunities to strengthen returns to farmers. More than ever we are seeing farmer boards and management

working to evaluate the best business approach that will create more value back to

the farmer. Part of the discussion on how to be successful evolves around the most

appropriate business structure to attract investment, minimize tax liabilities and

allow operational flexibility necessary for dealing with market changes.

The ethanol sector is one of the areas where business changes are being contemplated. CoBank currently finances about 20 ethanol facilities that operate in

Minnesota, Iowa, Missouri, South Dakota and Nebraska. Financing for plants in Illinois and Kentucky have been approved. The financing for these companies involves

over $200 million in credit and they produce about 620 million gallons of ethanol

annually. On an ongoing basis, the return on equity to the farmer-owners of these

plants is typically 10 to 15 percent

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For the new ethanol plants being planned and even for some existing facilities,

the farmer-owners are faced with a choice of selecting the most appropriate business

structure that maintains farmer-control. In some cases the best business structure

will not be eligible for CoBank financing. Attached to my statement is a letter from

Howard Roe, Treasurer of Tall Corn Ethanol in Coon Rapids, Iowa. Tall Corn has

recently altered their corporate structure to attract equity investment from nonmembers. As noted in the letter, capital was not available from farmer members.

Tall Corn Ethanol has been able to attract outside investment and will continue to

be controlled by farmers. As a result of their business change, Tall Corn is no longer

eligible for credit through CoBank. Another example of a business that has changed

their business structure to benefit their farmers and therefore will no longer be eligible for loans from CoBank is South Dakota Soybean Processors. SDSP has been

a customer of CoBank’s since their inception in 1996 (note attached letter).

This current situation is putting the farmer-owners of cooperatives in a very difficult position—by choosing the most advantageous corporate structure, the cooperative may be forced to forgo access to the lender created specifically to meet the needs

of farmer-owned cooperatives.

The need to update lending eligibility provisions to reflect new business structures

is not unique to CoBank and the Farm Credit Act. In 1999 USDA took action to

allow the Rural Utility Service to finance Limited Liability Companies (LLC). In

making this rule change (7 CFR Part 1735), USDA states, ‘‘This direct rule is part

of an ongoing RUS project to modernize agency policies in order to provide borrowers with the flexibility they need to continue providing reliable telephone service at

reasonable costs in rural areas.’’

FINANCIAL NEEDS OF NEW GENERATION COOPERATIVES

As an organization dedicated to helping cooperatives thrive and maximizing benefits to farmers, we are excited about the new business models that farmer cooperatives are considering. These models will at times work to minimize farmer risk and

obtain greater returns to their members. Farmers are attracted to them for a variety of reasons: • Enhance Profits to Farmers—In the past, cooperatives often focused on being

‘‘not-for-profit’’ organizations. The purpose of the cooperative was to provide a market for the product, not a return for the owner. Most cooperatives today recognize

that the business must be able to provide a reasonable return to farmers. • Commodity Margins Are Razor Thin—The farmer who grows the wheat enjoys

the smallest portion of the profit derived from the loaf of bread. By becoming an

owner in the processing and marketing system, farmers can improve returns and

diversify to reduce risks. • Access to Capital From Multiple Sources—New companies often require a 40 to

50 percent level of equity. In today’s economic environment, that level of capital is

not available solely from farmers participating in the enterprise. Cooperatives with

solid business plans and achievable profitability targets can attract outside nonmember capital to supplement the farmer investment. Often times this investment

can come from the non-farmers living in the rural community. Non-farmer investment does not mean the farmer class of owners must give up control or forgo operating on a cooperative basis. • Tax Advantages of New Structures—The new cooperative structures may also

have tax advantages that are generally available to limited liability companies—a

key consideration for farmer owners. An example is self-employment taxes, which

are paid on cooperative dividends, but not on LLC distributions.

While we are enthused about these new models, the committee needs to be aware

of some of the realities facing cooperatives. As noted above, CoBank finances the

vast majority of cooperatives including a high percentage of the smaller ones. Nationwide, there are fewer than 1,500 farmer-owned cooperatives with credit needs.

CoBank considers it part of our mission to work with groups of farmers who are

interested in establishing new cooperatives. The risks of new ventures are high and

must be carefully considered. By bringing in outside equity capital, farmers share

the risk with non-farmers. A farm cooperative business that adds value to a product

rather than just passing it up the processing chain can bring diversity and profitability to a farmer’s investment—the opportunity to share that risk and reward with

others is often a key indicator of success.

POLICY IMPLICATIONS

Cooperatives are chartered under State laws and many States where cooperatives

are prominent are on the verge of changing their laws to define a new generation

of cooperatives. Minnesota and Wyoming already have changed their laws. Further

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a cooperative does not need to be located in these States to charter in Minnesota

and Wyoming. Cooperatives physically located in other States can simply organize

themselves under the Wyoming and Minnesota laws similar to the way in which

many corporations organize under Delaware corporate laws. As a consequence, we

believe that virtually no new cooperative will be chartered under the old statutory

provisions that restrict the operation of farmer cooperatives. The key impediments

of the old laws are outmoded dividend requirements and voting and ownership limitations for non-farmer members of the cooperative.

For CoBank, specific requirements that farmer-owned cooperative associations

must meet in order to be eligible to borrow from the bank are spelled out in section

3.8(a) of the Farm Credit Act. As noted, these traditional requirements are based

on a cooperative model that may no longer be suitable for many farmer-owned cooperative enterprises. The specific reason that an association of farmers under a new

business structure may no longer be eligible to borrow from CoBank varies by each

case, but may include the following:

• Because of the need to attract outside investment, the traditional Farm Credit

Act requirement that a cooperative either operate on a one-member one-vote basis

or restrict dividends to 10 percent (or less if further limited by State law), may not

be met as a separate investor group is established and the cooperative utilizes more

flexible voting requirements. Attracting outside investment may be done to enhance

operations, build new markets with value-added products, or to help a cooperative

avoid asking hard-pressed farmer-members to make additional capital contributions.

Because of the need to flexibly source some products from producers other than

members, the new cooperative entity may not meet the Farm Credit Act requirement that non-member business not exceed member business.

CoBank is recommending that Congress amend current law to ensure that these

new generation cooperatives do not jeopardize their ability to borrow from CoBank

as they structure themselves to compete in the marketplace. Key components of this

proposal would:

• Authorize associations of producers that have both a producer and investor class

of membership to be eligible for CoBank financing, provided that the producer class

holds at least 50 percent of the voting control and operates on a cooperative basis.

• Permit agricultural cooperatives organized consistent with revised State cooperative laws to be eligible for CoBank financing.

Allow cooperative customers that are adopting new business structures to continue to be eligible for CoBank financing as long as the customer maintains at least

50 percent farmer control or continues to be cooperative under State law.

• Provide that cooperatives that are existing CoBank customers, but which restructure in a manner that would make them ineligible for CoBank financing, can

remain eligible for a five-year transition period while the cooperative establishes

new lending relationships.

In today’s financial environment there are very few lending institutions with the

necessary scale, expertise—and most importantly—the desire to lead lending efforts

to farmer-owned cooperatives. Nothing in these recommendations expands our scope

of lending to new areas. These changes will allow us to continue to serve the same

type of farmer-controlled businesses that we have served well for 70 years. Without

this action, CoBank will not be able to meet its mission of serving farmer-owned

cooperatives. The reality is that in many of the cooperative businesses that we finance, there are only three or four lenders that may be interested in considering

the business because of the complexity and size of the loan. To eliminate the bank

with the biggest and most consistent market share and the one with the greatest

expertise does not make sense. Nor does it make sense to force an association of

producers to use a traditional cooperative model in order to obtain financing from

CoBank.

So that CoBank can continue to carry out our mission as established by Congress,

we would appreciate the opportunity to work with you to update CoBank’s eligibility

requirements along the lines we have suggested for agricultural cooperatives. Without this legislation, farmers and the cooperatives they own will be denied access to

CoBank as a source of financing as these new cooperative structures are employed.

This proposal has already received the endorsement of dozens of national, local

and regional farm groups and cooperative organizations—including the American

Farm Bureau Federation, Farm Credit Council and the National Council of Farmer

Cooperatives. We encourage you to give this matter your most serious consideration.

Mr. Chairman, thank you for holding this important hearing. I appreciate the opportunity to provide this testimony and would be pleased to respond to any questions.

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STATEMENT OF THOMAS C. DORR

Mr. Chairman, Members of the Committee, on behalf of the President and Secretary Veneman, I appreciate the opportunity to come before this committee to discuss ways in which the Federal Government can help farmers and other rural residents increase their incomes and improve their quality of life through more effective

cooperative organizations.

It goes without saying that we are living in some of the most challenging times

in our Nation’s history and foremost—next to homeland security—our rural Americans desire increased economic opportunities and an improved quality of life. Our

realization that this is important to our constituents is critical to succeeding at

rural economic development.

This is the foundation on which President Bush unveiled his Jobs and Economic

Growth Plan. The President understands that a key element to economic success in

rural America is allowing our farmers and ranchers to retain more of their earnings.

By reducing the tax burdens on Americans—farmers and ranchers and their families will have greater opportunity to invest in their own future.

USDA RURAL DEVELOPMENT

At USDA Rural Development, our vision is to serve rural America. The Rural Development mission area provides financial and technical assistance to foster growth

in existing and new opportunities for business development, home ownership, and

critical community and technology infrastructure. The return on this assistance is

the economic growth realized through our direct investment and, more importantly,

that stimulated by private market leveraged investment.

It is with this vision in mind that Rural Development’s mission has been designed

to deliver programs that will support our two goals: 1) increasing economic opportunity; and 2) improving the quality of life of rural residents.

In order to properly address these mission goals, it is important to recognize the

changes that have occurred throughout rural America and within USDA. With this

understanding and a renewed sense of purpose, Rural Development must utilize the

tools and resources at hand to support new economic growth in rural America.

TRADITIONAL COOPERATIVES

For over 100 years, cooperatives have organized and operated according to a relatively static model. Equity financing and control were the responsibility of the

member-patrons. Earnings were allocated to patrons on the basis of use. It was a

corporate vehicle designed to provide access to beneficial interests generated by

members. It was not designed to be an investment tool. This model has heretofore

served rural America well, and has provided many important benefits to farmers

and other rural residents.

Today, cooperatives, like much of rural America, face serious challenges. The companies they buy from and sell to are becoming larger, fewer in number, and more

sophisticated at reducing costs and improving returns within their industry sector,

which can impact other participants in these industries. Sweeping innovations in

areas such as biotechnology, information services, transportation, and global

sourcing have made many cooperative facilities and equipment obsolete. Also, governance structures and the resulting transparency have helped to make non-cooperative enterprises more responsive to change.

It is more evident than ever that global economic challenges are here to stay.

Many foreign investors are using technology and lower labor costs to become lower

cost producers of the same products we produce in rural areas. In many cases, they

are becoming competitors rather than customers. One of our top initiatives at Rural

Development is to look at the effectiveness of the current cooperative model for assisting farmers and ranchers in this increasingly competitive environment.

The traditional model has had a history of change and responsiveness. However,

cooperatives are presently struggling to convert the equity and dreams of many

rural Americans into the kinds of economic opportunity they need and desire. As

Under Secretary, I am looking at ways to increase the profitability of producer cooperatives. I am also focusing our efforts on how the cooperative model can utilize

local equity to stimulate economic stability and growth that will be beneficial to all

rural Americans. Given the opportunity, Americans will create strength through investment in their own economic future. I also believe it is our role at Rural Development to support these efforts in order to maximize the effect on local economies.

But first we must ask ourselves how we might keep rural America competitive?

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ponent in many rural areas, and I firmly believe that American agriculture is at

a crucial crossroad. When we look at what drives our local and regional rural economies, along with our agricultural industry, and in the context of global markets—

we must accept that in the future, the agriculture industry will require new strategies and an openness to adapting to new environments.

I believe the key for farmers, cooperative businesses, and rural areas to remain

competitive is our ability to grasp and utilize the power of technology. The Internet,

and the technology that has flowed from it, has resulted in a freer flow of capital

and easy access to knowledge across borders. It has made it possible for competition

to develop and build production and value-added systems unconstrained by yesterday’s foundations. It has served to create international and non-traditional competitive pressures.

Embracing the benefits of technology will not alone provide our producers and

business ventures the competitive edge needed in today’s markets. We need to look

at agriculture as a business, and in America that is often easier said than done.

The global economic realities that we face force us to understand and accept that

while we hold dear the attributes of the traditional ways of life—we have a responsibility to our farm families and the future of American agriculture to paint a new

picture—one that allows us to respect our traditions and expand our tolerance and

acceptance of new and innovative approaches to support our farmers and ranchers

and the rural communities in which they live. It is time we paint a new portrait

for the 21st Century.

Many suggest that the limited off-farm investment of farmers and ranchers means

they don’t have enough capital to invest. I don’t agree.

Farmers have an enormous asset base—their land—that can provide investment

capital. Instead of just rolling land assets into the relatively low returns from farming, producers could move some of that capital to other areas. If done effectively,

this would simultaneously raise farm incomes, enable more farmers to stay on the

farm, and promote rural growth.

Many farmers and ranchers have assets that can be used to make major investments in businesses that ultimately can exact a strong return on their investment.

If the business plan is sound and convincing—and if farmers understand the untapped potential of their capital, I suspect they will invest.

We are challenged today to develop strategies for rural America that are effective

and programs that make sense. We, in the public sector, simply have to do a better

job. We have bound ourselves up with procedures, regulations, and approaches that

reflect a rural America of the 1950’s, using concepts from the 1930’s.

We must work with our farmers and ranchers to help identify opportunities to use

the untapped equity in their land to make serious investments in their local communities. This approach doesn’t mean encouraging producers to leave farming or to

take senseless risks. It’s just the opposite. By increasing their return on investment—the value of their land—their ability to stay in farming and ranching can be

enhanced, not lessened. That age-old solution of how to protect the family farm

comes, as we have always known, in diversification.

But utilization of land equity as a form of capital investment must be accompanied by an evolution in how cooperatives support producers and value-added ventures. Cooperatives must be prepared to sail in relatively unchartered waters to

bring the maximum benefit to producers who look to them for economic opportunities and security.

Patron cooperatives were designed to provide members a beneficial interest. The

benefit they received as a patron member was either a cheaper price if they bought

something from or through the cooperative, or a better price if they sold something

to the cooperative. Any earnings derived from patron cooperative operations had to

be returned to the members as cash patronage dividends or additional equity retained by the cooperative.

The effect was two-fold. Cooperatives had to commit most of their earned income

to patronage dividends. Second, they have never been able to become investment vehicles. The result was that the primary way for either patron or federated coops to

grow their business was through the use of debt. That worked reasonably well when

competition for traditional U.S. agricultural commodities was limited and U.S. production agriculture was in a substantial growth mode.

There were occasions when local patron cooperatives, even in good times, made

poor business decisions and were unable to sustain themselves. Usually these resulted in mergers with neighboring patron cooperatives. As a federated cooperative,

Farmland went through these difficulties at least twice before their present bankruptcy.

As a cooperative business venture, the patron cooperative is the traditional institutional vehicle. Its purpose is well intended. The cooperative, as an institution,

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however, is struggling to convert the equity and dreams of many rural Americans

and agricultural producers into the kinds of economic opportunity they need and desire.

We must change that. Rural Development should be at the focal point of this discussion and we intend to be.

To diversify farmer investment in businesses that add value to the products that

rural Americans produce through processing, distribution, and perhaps even branding is paramount. This will allow producers to capture some of the dollars now going

to the middlemen between producers and consumers. It creates jobs, payrolls, and

tax revenues that support the entire community.

NEW GENERATION COOPERATIVES

If we begin to look at cooperatives with the idea that they can serve not only as

a form of security, an outlet for farm production, but also as investment vehicles

that pay dividends to their members—one that is focused on creating an acceptable

return on investment—we will have gone a long way to strengthening rural America. The ‘‘new generation’’ cooperative model is a step forward toward meeting this

objective.

Let me make it clear what we at Rural Development mean by a ‘‘new generation’’

cooperative. Some people use the term to include virtually any cooperative that adds

value to agricultural production through processing and merchandising. We expand

the term to refer to cooperatives that not only engage in value-added processing and

merchandising, but also adhere to a fairly specific set of characteristics that provide

producer-owners with economic incentives to patronize and invest in them.

A ‘‘new generation’’ cooperative will usually have several organizational and operational traits that include:

The membership is closed. The amount of product it will accept from a producer

is limited.

The investment of a member is tied to patronage rights. (I.e., in a traditional cooperative, each new member usually makes the same, relatively small, initial investment.)

The patronage rights are transferable at market value. (I.e., in a traditional cooperative, equity is only redeemed at the discretion of the board of directors. It is usually redeemed years after it is issued and rarely for more than face value.)

‘‘New generation’’ cooperatives link producer equity contributions and product delivery rights. The delivery arrangement is more than a right, it is also an obligation.

So if the member doesn’t raise enough corn, for example, to meet the delivery commitment, he or she must purchase product on the open market to fulfill the contract.

The risks of fluctuations in production are borne by the individual producer-members, not the cooperative.

In a ‘‘new generation’’ cooperative, the members are free to sell their interest in

the cooperative and the linked delivery rights to other producers at whatever price

another producer is willing to pay.

BUILDING ON TODAY’S NEW GENERATION COOPERATIVES

While USDA Rural Development encourages and works with ‘‘new generation’’ cooperatives, we aren’t convinced that they are the only improvement on the traditional model that can and should be developed. We must build on today’s ‘‘new generation’’ cooperative model by developing strategies and structures that will overcome obstacles, such as tax law and governance structures, still limiting cooperative

success, most notably the difficulty cooperatives have in attracting sufficient equity

capital. These approaches should be directed at encouraging greater investment by

producers and opening avenues for investment by non-producers.

Farmers also have the resources to make these investments. Agricultural Statistics 2003, published by USDA’s National Agricultural Statistics Service, reports that

farm real estate in this country has an aggregate value of approximately $1.1 trillion (p. IX–8). Outstanding debt on that farm real estate totals only about $110 billion (p. X–9), only 10 percent of its value.

Our challenge is to help producers develop cooperative structures that will generate a return on the untapped value of their real estate sufficiently large and safe

enough to entice them to invest in off-farm operations.

There is nothing magical about organizing a business on a cooperative basis. But

if the business plan is strong and the implementation of that plan is focused and

visionary, farmers and other rural Americans can expect a strong return on their

investment.

There is another consideration. While many producers have substantial assets

that are minimally leveraged, their numbers are declining. The amount of funds

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needed to finance a potentially lucrative agriculture-related business may be more

than potential member-patrons can, or should prudently, invest. Steps should be

taken to make investing in a cooperative attractive to local non-producers, and,

when advantageous to the producers and the community, non-producer outside investing interests.

Impediments to non-producer equity are found in Federal and State laws enacted

several decades ago. If non-producer outsiders are to invest in a cooperative, they

may well expect to have a voice in its affairs and the opportunity to earn a return

on their investment commensurate with the success of the cooperative. Good governance and increased transparency could also help improve the cooperative model.

Modifying rules could give cooperatives some of the flexibility enjoyed by limited

liability companies. Cooperatives could be provided some options to pursue outside

equity if the producer members believe doing so would strengthen their association.

Such legislative reform must be done carefully and with much thought.

Non-producer outside investors will also not want to have their money locked up

in a cooperative. Easy transferability of investment vehicles will need to be included

in any package of incentives aimed at non-producer equity.

USDA RURAL DEVELOPMENT’S ROLE

The public sector, and those of us in Rural Development at USDA in particular,

must adopt new approaches in providing our services to rural America. Today, Rural

Development is developing a multi-dimensional program to strengthen cooperatives

as part of a bigger overall initiative to revitalize our rural economy and improve the

quality of life for our rural residents.

Financial investment. In Fiscal Year 2003, USDA Rural Development placed nearly $16 billion into rural America at a cost of only $2.9 billion of discretionary budget

authority. We invest in rural America through a variety of direct loan, loan guarantee, and grant programs in our 3 primary service areas—housing, utilities, and businesses and cooperatives. I believe we do a good job of identifying worthy recipients

and distributing the funds. These programs play a major role in sustaining our

rural economy.

One area where Rural Development can do better than we have in the past is in

monitoring and evaluating the effectiveness of these various efforts. We are developing tools to measure the return rural America gets for each dollar expended under

these programs and to identify strengths and weaknesses in each initiative. In the

future, we will be in a better position to work with this Committee and others in

the Congress to explore possible changes in these programs that maximize the impact of the moneys we administer.

Financial assistance. We have some exciting new tools to use in this effort. For

example, the Value-Added Producer Grant Program provides planning money and

working capital for independent producers and producer groups to develop new

value-added agricultural products. In 2001 and 2002, grants totaling $57.5 million

were awarded to 291 recipients in 43 States. An additional $40 million is anticipated to be awarded this year.

The 2002 farm bill added a new dimension to our value-added efforts, by authorizing grants to establish Agricultural Innovation Centers. These centers will provide

technical and business development assistance to producers and groups of producers, including cooperatives, who want to develop and market value-added agricultural products. The centers will be controlled by a board consisting primarily of representatives of the largest general farm organizations and highest grossing commodities in the State where the center is located.

On September 26, 2003, Secretary Veneman announced the awarding of grants

totaling $10 million as start-up funding for 10 Agricultural Innovation Centers. We

have high expectations that these centers will serve as incubators for new ideas,

new products, and new strategies that stimulate economic growth in rural America.

Education and technical assistance. Rural Development is more than a source of

funding, especially where cooperatives are involved. Our technical assistance and research efforts are used throughout the country by producers interested in developing

new cooperatives and making existing cooperatives better able to serve the needs

of their members.

We will be working harder to help improve business knowledge and skills in rural

America. Serious education on business strategies, finance, marketing, and decision

making will enable farmers, and business and community leaders, to lead dynamic,

creative cooperative businesses that can succeed.

We in Rural Development need to make sure our efforts are focused on recognizing challenges and using techniques that look to the future and not the past. To

achieve this goal, I am in the process of creating an Outside Program Review to

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study the research and technical assistance provided by our Cooperative Services

area. Its purpose will be to identify steps we can take to make sure our support

of cooperatives is provided as efficiently and effectively as possible.

Mr. Chairman, let me offer a few concluding thoughts on where I think, and hope,

we are headed with regard to cooperatives in rural America.

I’m concerned about the long-term health of an agricultural system that focuses

only on production, especially the production of basic commodities that are being

grown at less cost in an increasing number of countries around the world. Cooperatives offer a vehicle to allow producers to turn their production into food, clothing,

energy, pharmaceuticals, and, in the future, other value-added products that may

not have even been imagined as yet.

To take advantage of these opportunities will require substantial new investments

of equity capital. Farmers can, and should be expected to, invest in their own future.

But steps should also be taken to facilitate and encourage non-producer outside investors to be part of the farmer-based cooperative businesses.

Creating new ways to invest equity capital in cooperatives may offer more flexibility in the organization and operation of cooperatives. While accomplishing this,

these changes should not subvert the basic cooperative principle that they exist primarily for the benefit of their member-patrons and not non-producer outside investors.

Rural Development continues to work to ensure that both funding programs and

research and technical assistance efforts that meet the challenges and seize the opportunities that lie ahead.

In addition, we look forward to working with Congress to encourage the changes

and new initiatives that are needed for cooperatives and other rural entities to meet

the challenges of the 21st century.

Thank you for inviting me to be here today and I look forward to answering any

questions you may have.

STATEMENT OF DAVID GRAVES

Thank you, Mr. Chairman. My name is David Graves and I am President of the

National Council of Farmer Cooperatives (NCFC). On behalf of NCFC and America’s

farmer cooperatives, I want to commend you and Congressman Stenholm for your

leadership and for holding this hearing on the state of farmers working together for

their mutual benefit.

We also want to commend Congressmen Sam Graves and Earl Pomeroy for their

leadership as House co-chairs of the Congressional Farmer Cooperative Caucus and

to express appreciation to all members of the Caucus for their interest and participation in this important farmer forum.

NCFC is a national association representing America’s farmer cooperatives. There

are nearly 3,000 farmer cooperatives across the U.S. whose members include a majority of our Nation’s more than 2 million farmers, ranchers and growers. These

farmer cooperative businesses handle, process and market agricultural commodities

and related products, furnish farm supplies, and provide credit and related financial

services. Earnings from these activities are returned to their members on a patronage basis. Farmer cooperatives also provide jobs for nearly 300,000 Americans,

many in rural areas, with a combined payroll of over $8 billion.

The need for public policy to enhance the ability of farmers to join together successfully in cooperative efforts to improve their ability to earn income from the marketplace is more critical today than when Congress passed the Capper-Volstead Act

and other measures in the 1920’s to encourage and promote such efforts. In fact,

it can be argued that farmers have even less relative market power today.

This chart, attached to my testimony, helps illustrate the challenge facing farmers

today as they seek to improve their overall income from the marketplace. It shows

how the farmer’s share of the consumer food dollar—the blue line—has continued

to decline to where it is now a record low of just 15 percent. At the same time, the

farmer’s share of net cash income derived from government support payments—the

green line—has, though volatile, continued to reflect a rising trend. Even with improving grain, oilseed and livestock prices, direct government assistance is projected

by USDA to account for over 30 percent of net cash farm income this year. Clearly,

without such assistance as provided under the 2002 farm bill, the farm income picture would look very different.

There are many reasons for both of these trends. Further, it is highly likely that

the current trends will continue without a change in policy to reflect modern national and international market conditions. The critical question is what can be

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done to help farmers be more successful in capturing a greater share of their income

from the marketplace?

As farmers attempt to seek more income from the marketplace they are challenged by the new realities of a rapidly changing food and fiber system. The speed

and breadth of change in the food, natural fiber and agriculture system in the last

five years has been one of the most dramatic transformations in history. The path

of globalization, new technology and an exploding equity market have fueled the

transformation.

Farmers face rapidly emerging competition in the export markets and a rising

tide of imported food products in the domestic market. In addition, the rapid consolidation throughout the food system has challenged traditional business structures

and forced a reexamination, realignment and restructuring of business relationships

from the combine to the consumer.

It is within this environment that public policy aimed at helping farmers join together in cooperative self-help efforts needs to be reexamined and strengthened. To

begin this process, we believe Congress and the Administration should focus on

three major initiatives:

USDA Programs to help farmers help themselves through cooperative efforts

should be revitalized and given the highest priority. • A separate Agency should be established within USDA whose primary mission

would be to carry out programs, including research and technical assistance, to encourage and promote cooperative self-help efforts. Such an agency existed prior to

1994. Congress and the Administration recently combined to establish the position

of Assistant Secretary of Commerce for Manufacturing to give greater priority to the

challenges facing the manufacturing sector. We believe the challenges facing farmers and their cooperatively owned businesses are critical and should be given a similar priority and standing. • USDA research and technical assistance programs to assist farmers and their

cooperatives should be specifically authorized and fully funded. These are now funded through USDA salaries and expense budget as part of the annual appropriations

process, resulting in considerable uncertainty and lack of accountability. • USDA’s Value-Added Grant Program, which provides matching grants to farmers through cooperative efforts capitalize on new value-added opportunities, should

continue to be funded at not less than $40 million as contained in the 2002 farm

bill. • There should also be ongoing review of USDA and Federal programs to ensure

they continue to encourage and protect the ability of farmers to join together in cooperative self-help efforts.

The Federal Farm Credit Act should be modernized to ensure that farmers continue to have access to a competitive source of credit capital for their cooperatively

owned businesses.

This change is especially needed in response to new and evolving State laws to

provide farmers and their cooperatives with more flexibility in terms of how they

organize and capitalize their businesses. Minnesota, the largest State in terms of

number of farmer cooperatives, and Wyoming recently changed their cooperative

statutes, and other States are looking at similar changes. In addition, the National

Commission on Uniform State Laws has a project underway to determine whether

to recommend adoption of a similar statute by all States as a uniform law.

The problem, however, is that existing cooperatives that choose to reorganize as

well as new cooperative ventures formed under these new laws, do not satisfy Federal law regarding eligibility requirements to borrow from CoBank, which itself is

a cooperatively owned lender.

Legislation is needed to address this issue so that farmer cooperatives, including

these newer generation cooperatives, continue to have as many choices as possible

when it comes to seeking the financing and capital they need for the mutual benefit

of their farmer members.

Current tax policy should be modified to provide farmer cooperatives with improved access to equity capital needed to modernize and expand, meet costly government regulations, and take advantage of new market opportunities for the benefit

of their farmer members.

While we recognize this Committee does not have jurisdiction over such issues,

we would like to take this opportunity to urge your support of such initiatives, including H.R. 1671 sponsored by Congressmen Wally Herger, Earl Pomeroy and Sam

Graves to eliminate what is now an effective triple tax on farmer cooperative dividends on capital stock under the Dividend Allocation Rule. Such an unfair tax penalty puts farmers and farmer cooperatives at a competitive disadvantage relative to

other types of businesses whose dividends are taxed twice and makes it difficult to

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tions and postponements, should also be considered to further promote farmer cooperative capital formation.

Mr. Chairman, strengthening the ability of farmers to join together in cooperative

efforts is critical to any long term strategy to help farmers improve their ability to

earn income from the marketplace; better manage their risk; capitalize on potential

value-added market opportunities; and compete more effectively in a rapidly changing domestic and international marketplace.

NCFC and our membership look forward to working with this Committee in addressing this important need of America’s farmers, ranchers and growers.

Thank you again, Mr. Chairman, for the opportunity to appear before you. This

concludes my testimony, and I look forward to responding to any questions you or

members of the Committee may have.

STATEMENT OF DOUG PETERSON

Chairman Goodlatte, Ranking Member Stenholm, and members of the House Agriculture Committee, my name is Doug Peterson and I am the President of the Minnesota Farmers Union. It is a pleasure to appear before you today on behalf of the

300,000 family farmer and rancher members of the National Farmers Union to discuss the role of farmer-owned cooperatives in contributing to the financial success

of agricultural producers and improving the economic prospects for our rural communities.

The National Farmers Union (NFU) has a long history in the development, operation and support of farmer-owned cooperatives. Our involvement in cooperatives

even pre-dates the Capper-Volstead Act which enabled and encouraged the formation of agricultural cooperatives over 80 years ago and was the basis for the enactment of other public policies to further the objectives and provide special treatment

for this unique business structure. Our commitment to successful cooperative development continues today through a variety of support activities carried out by both

the NFU and our affiliated State organizations.

Historically, cooperatives were established to deal with four primary needs of production agriculture. They provided a mechanism to address two types of market failure that have existed in rural America throughout our history—providing a broad

range of locally available services to production agriculture that were not being

made available by the private sector and fostering market competition within the

input, processing and merchandising sectors to reduce the concentration of market

power among a limited number of agribusiness companies. Cooperatives also allowed farmers to participate in both the governance and earnings of the other agricultural sectors with which they do business. Finally, cooperatives contributed directly to the functioning of local economies by creating new jobs and added rural

business activities and services. We believe the vital role cooperatives can play in

meeting these needs is even more important today than it was throughout the last

century.

No one questions that times have changed in agriculture. And I think we all can

agree that the strategies employed in the public/private partnership that have fostered the development of agricultural cooperatives should be reviewed and modified

to reflect current conditions and future business expectations. Congress must take

the lead in this reexamination process rather than allowing events or other institutions to define a new cooperative model that may in fact sacrifice the characteristics

of cooperatives that distinguish it from other business structures. We know that

there are problems that continue to challenge the system, however, we also believe

that a level of restraint must be exercised to provide the opportunity for a full discussion of potential alternatives and outcomes before engaging in a significant modification of the cooperative model.

Specifically, the largest single challenge facing existing or proposed cooperative

business ventures is access to equity capital. For established co-ops, new infusions

of capital are critical to enhancing their capacity to adapt to and compete in a global

setting where market power is becoming increasingly concentrated and integrated

through mergers, acquisitions and strategic business alliances.

In the case of start-up cooperatives, access to additional sources of equity is equally important if these new generation cooperatives are to have a reasonable chance

of filling the existing void in local and regional market structures in a way that allows their member patrons the opportunity to participate in value-added opportunities and receive the benefits of enhanced market transparency and competition.

The 2002 farm bill authorized programs and appropriations to provide grants and

loans to facilitate the development of new rural business ventures, including cooperatives, and also maintains a mechanism to provide access to loan guarantees

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in order to facilitate the purchase of participation shares in cooperatives by individuals. In addition, the farm bill created the Rural Business Investment Program

(RBIP). The RBIP is designed to encourage venture capital investments in rural enterprises through rural business investment companies that are created to raise capital, provide operational assistance to smaller businesses and participate in a government guaranteed debenture program. The program also ensures that ownership

of the rural business investment company is not affiliated with the company’s management. We encourage this committee to impress upon USDA the importance of

expediting the implementation of this program.

In our judgment, the RBIP, when coupled with other cooperative development programs, offers an important opportunity for smaller rural cooperatives to access the

resources that are vital to their success. We also believe, however, that Congress

should review the technical requirements of the enabling legislation to determine

if they are too restrictive in terms of the net worth of the participating enterprise,

limitations on participation by financial institutions and the capital requirements

for participation in the guaranteed debenture program.

In addition, we encourage the committee to consider ways to streamline the whole

cooperative development process. In particular, we believe that shifting some of the

lending authorities, such as the various guaranteed loan programs, to the Farm

Service Agency, which has substantial agricultural credit experience, would further

encourage farmer participation in new or existing cooperatives and expedite the cooperative development process.

Numerous proposals have been suggested, and in some cases State governments

have already acted, in an attempt to enhance the ability of cooperatives to attract

outside capital. While we appreciate the worthy intentions of these efforts to address the equity shortfall experienced by many cooperatives, we are concerned about

the longer term effects of these proposals on the basic cooperative principles. These

include producer ownership and governance of coops and the ability of cooperative

ventures to provide alternative market opportunities and enhance market competition. In addition, schemes that blur the lines between cooperatives and other organizational structures may put at risk existing preferential public policy treatment for

all cooperatives, including but not limited to the issues of the partial anti-trust exemption and tax considerations.

Because these proposals may have a substantial impact on the application of numerous Federal laws, Congress must ‘‘get in front’’ of the issue rather than simply

react to the actions taken by others.

We are concerned that new State laws, including one recently adopted in my State

of Minnesota, as well as many other suggestions to encourage equity investment in

cooperatives could effectively, if not technically, eliminate the ownership, control

and allocation of patronage earnings to ‘‘real’’ producers. The old adage, ‘‘he who

pays the piper calls the tune’’ could certainly apply to outside investors, who may

in fact be able to qualify as farmers under the current definition. Non-farmer investors may be able to control or influence a majority of cooperative board votes to

change the traditional allocation of earnings away from patronage to a return on

investment. They may also exert substantial influence on merger, consolidation, liquidation or other critical business decisions. In effect, the cooperative, by accepting

access to outside capital, may become nothing more than a regular stock company

except that the farmer patrons will have collectively contributed substantial risk

capital for a venture that may not be serving their own self interest.

Congress should review the definition of farmer as it applies to cooperative ownership and governance. Furthermore, if, after a thorough assessment, Congress determines that the benefits of encouraging the type of outside capital investment envisioned by these proposals outweighs and is not inconsistent with cooperative principles and existing statutes, it should establish strict guidelines and limitations on

the level of influence these investors may exert over any cooperative business structure. At a minimum, these rules should require diversification among investors, particularly those with interests in competing businesses, ensure an adequate majority

of voting power is retained by the farmer-owners and mandate an equitable sharing

of any earnings distribution among outside investors and those who would be entitled to patronage allocations by the company.

Mr. Chairman, we believe the partnership between agricultural producers and the

Federal Government to ensure the success of new and existing cooperatives can resolve the issues we have discussed today. We look forward to working with you and

your House and Senate colleagues in an expedited, but well considered process that

addresses these challenges without destroying the farmer-owned cooperative system.

I will be glad to respond to any questions you or Members of the committee may

have.

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STATEMENT OF JOHN HENRY SMITH

Chairman Goodlatte, Congressman Stenholm, other members of the committee

and guests, my sincere thanks for the opportunity to testify here today on a subject

that is of great importance to me and my fellow producer-members of Southern

States Cooperative, Inc., as well as members of other farmer cooperatives throughout the Nation.

My name is John Henry Smith and I am a cattleman and tobacco producer in

Russell County in southwest Virginia near the community of Rosedale. I have been

a member of Southern States Cooperative since 1958 and use many of its products

and services in my farming operation. Southern States is a farmer-owned, 80-yearold farm supply and service cooperative based in Richmond, VA. Our cooperative

serves more than 300,000 farmer members and other customers in Virginia and the

11 eastern and southeastern States—from Maryland to Florida. It also includes

some 237 retail store locations owned or managed by Southern States and some

three dozen other facilities such as feed mills, distribution centers, fertilizer facilities, etc. In total, these operations provide more than 3,200 full-time jobs and more

than 600 seasonal or part-time jobs, with most located in rural communities. Being

farmer owned, Southern States is focused on providing its farmer members with a

dependable supply of farm inputs and other services on a cost-effective basis that

will help contribute to their economic well being and success.

One of the other ways we are trying to help farmers is through the Southern

States Cooperative Foundation. We established this in 1999 specifically to help

farmers explore ways to develop value-added agricultural products. We have worked

with more than a dozen producer groups who have developed new cooperatives in

a variety of value-added endeavors. With each project, we help them develop strategic and business plans, conduct board and management training, and market development.

Mr. Chairman, we’ve been able to do a great deal through USDA’s Rural Cooperative Development Grant Program, and we certainly support continued funding for

it. In our case, it has allowed us to bring sound business development to producer

groups that might not otherwise have the resources for such development.

Since 1991, I have had the honor of serving on the Southern States board of directors. I recently was elected by producer-delegates in the geographic district I represent to a fifth, three-year term on the board and have served as chairman of the

board for the past three years.

While I have always been a firm believer in and supporter of farmer cooperatives,

those attitudes have been strengthened in the past 12–18 months. That period has

been one of considerable challenge for Southern States and many other cooperatives.

Due to a combination of drought and other adverse weather conditions, a difficult

farm economy and some diversification and growth steps that did not generate the

returns Southern States had expected, our cooperative has been confronted with

major financial challenges. I’m happy to report that steps the cooperative has taken

during the past year have gotten us back on what I believe is the right track. We’re

not out of the woods yet, but we already are seeing improvements and I’m confident

we are headed in the right direction. The point in all this is to note the reactions

of our members during this difficult period. At Southern States meetings and elsewhere, I and my fellow directors on the board have been approached by Southern

States member-producers. More times than I can count, these member-producers

have told us how much they need Southern States and how much the well being

of their farming operations depends on Southern States. Hearing these and similar

comments repeated scores of times has been a welcome, but at the same time, sobering reminder of what Southern States means to the farmers it serves.

If my history and math are correct, it has been 81 years since the Capper-Volstead Act was enacted by the U.S. Congress to better pave the way for farmers to

work together in cooperatives in meeting their farm supply, service and marketing

needs. Much has changed during those eight decades. But as the comments from

my Southern States producer-colleagues attest, farmers today still need and rely on

their cooperatives as much as they ever did. All of which explains why we were

pleased to see the formation of the Congressional Farmer Cooperative Caucus. We

appreciate the leadership of Congressmen Graves and Pomeroy in serving as House

co-chairs of this group.

I mentioned a moment ago the challenges Southern States has been facing recently. One of the reasons the picture has improved markedly is because our cooperative has moved aggressively to reduce debt, cut overhead expenses and focus on

our core market of production agriculture. Quite frankly another reason has been

an improving farm economy. And there’s no doubt in my mind that the 2002 farm

bill, along with disaster assistance and other steps Congress has taken to bolster

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farm income, have played a key role in the improvement we’ve seen thus far and

in what is projected. The producers I know prefer to generate their income through

the marketplace, as opposed to ‘‘farming the mailbox.’’ Nonetheless, we appreciate

Congress’s recognition that actions were needed to address issues faced by our Nation’s most basic and important industry, agriculture.

As noted earlier, today’s marketplace and the challenges it poses to farmers are

different in many respects from what prevailed when Capper-Volstead went into effect, but they are no less daunting. For example, the consolidation of input providers

and food processing companies has been dramatic in recent years and we see no halt

in that trend. Similarly, a farmer’s market no longer is limited to a nearby town

or a plant in an adjoining county or State. Not only does today’s U.S. farmer

produce for a national marketplace, he also must compete with producers around

the globe. I personally do not know of any farmer who is large enough to tackle any

of these and other similar challenges on his own. Whether it involves securing the

needed inputs and related services as efficiently as possible to gain the cost-effective

production required to compete and generate an adequate return, whether it involves the marketing and/or processing of what he grows to gain a greater share

of the food and fiber dollar, today’s farmer needs a reliable place to turn.

When it comes to inputs and related services, the comments I mentioned earlier

have made it clear to me that many producers in Virginia and other eastern and

southeastern States rely on Southern States. I’m sure co-op members in other parts

of the Nation would say the same thing about their cooperatives, including those

engaged in marketing and value-added processing activities.

So the issue, in my mind, is precisely what this hearing is all about—namely, the

actions Congress can and should take to improve the ability of cooperatives to serve

their producer-members. While there are many possible actions, I’ll limit my recommendations to those applying to farm supply and service cooperatives because

that’s the area I’m most familiar with from my involvement with Southern States.

I know my colleagues representing other types of cooperatives here today can and

will address the needs that they see.

First, Southern States believes that existing programs and tools within the U.S.

Department of Agriculture-programs and tools created to help farmers help themselves—can be strengthened as a way of meeting that goal. Among other things, we

strongly support the establishment of a separate farmer cooperative agency within

USDA, an agency with the resources needed to carry out existing programs, as well

as new ones, to maintain and improve the ability of farmers to join together in cooperative self-help activities. From our perspective, having a separate farmer cooperative agency would provide for greater accountability and promote greater support.

We recognize that a separate agency for cooperative research, education and technical assistance existed within USDA from the early 1950’s to the mid–90’s, when

it became part of an expanded Rural Business-Cooperative Service. That loss of

agency status, as well as specific budget authority, has posed problems in program

continuity and in the ability to respond effectively to issues posed by the rapid

changes in today’s global marketplace.

Second, we urge Congress to approve legislation (H.R. 1671) as introduced by Congressmen Herger, Graves and Pomeroy, to clarify what’s known as the Dividend Allocation Rule. Because of the Dividend Allocation Rule, cooperative dividends are

subject to a triple tax , while regular corporate dividends are taxed only twice.

Eliminating this unfair tax penalty—an issue that both houses of Congress have

acted on favorably in the past—would be an important step in helping farmer cooperatives attract equity capital.

Third, to make sure that farmer cooperatives have continued access to a competitive source of credit, we support an updating of the Federal Farm Credit Act—especially in view of changing State laws. The problem is that some of the newer business forms available to farmers interested in working together in the marketplace

are very appealing. However, they do not now qualify as potential CoBank borrowers even though they clearly are cooperative in nature. Updating the law would

allow farmers to continue to have choices when it comes to organizing and financing

their cooperative businesses.

My fourth and final point probably could be a sub-point of my first comments

about strengthening existing tools within USDA. However, it’s an issue important

enough to us that we wanted to make note of it separately. Our understanding is

that new provisions of the Business and Industry (B&I) Guaranteed Loan Program

in the 2002 farm bill could provide loan guarantees up to 90 percent on maximum

loans to cooperatives of up to $40 million. That and other new B&I loan program

provisions represent a considerable improvement over what they replaced. However,

I would note that in today’s environment, the $40 million cap doesn’t meet the needs

of many cooperatives, including Southern States. We’re not advocating a re-opening

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of the farm bill to deal with this issue. However, from a realistic standpoint, having

Federal guarantees behind loans of up to $100 million as originally proposed by this

Committee in the 2002 farm bill would come much closer to meeting the needs of

today’s larger, capital-intensive cooperatives. One of the challenges cooperatives historically have faced, and continue to face today, is generating capital required for

meeting operating needs and capital improvements. Many new generation cooperatives have addressed the latter by requiring substantial up-front investments from

the producers they serve. Other cooperatives find that approach difficult to implement due to the nature of their business. Regardless of the circumstances a particular cooperative may or may not face, boosting the guarantee to the $100 million

range would be extremely helpful.

Exactly 50 years ago, Southern States observed the 30th anniversary of its founding by producing a movie entitled ‘‘We.’’ The main point of that movie was that cooperatives are not a set of buildings and facilities that represent the ‘‘them’’ in a

‘‘we and them’’ scenario. Rather, cooperatives are farmers themselves working together to accomplish what none of them could do by themselves. In short, a more

appropriate way to view our organizations is with an equal sign between the words

‘‘we,’’ ‘‘farmers,’’ and ‘‘cooperatives.’’ That was true in 1923 when Southern States

was founded as Virginia Seed Service to provide farmers with a reliable supply of

quality seed. It was true 50 years ago when ‘‘We’’ was produced, and it remains true

today.

Mr. Chairman, should members of this committee or its staff have an interest in

seeing the operations of a farm supply cooperative, I would note that Southern

States has a number of locations with an hour’s drive or so of the Capitol. We would

be happy to show any of them to you.

Thank you again for the opportunity to share these thoughts with you.

STATEMENT OF STEVEN D. HUNT

Mr. Chairman and members of the committee, I appreciate the opportunity to appear before you today and discuss solutions to the challenges and opportunities facing producer owned and controlled businesses that are formed as cooperatives. My

name is Steve Hunt. I am a fifth generation cattle producer and the CEO of U.S.

Premium Beef (USPB), the first large-scale producer-owned beef marketing cooperative in the United States. I am proud of the history of independence that is a stalwart of the beef industry. Historically, this has enabled us to survive and prosper.

Though, today and in the future it will be our ability to build on our independent

legacy through cooperative efforts that may ensure our survival and prosperity for

years to come. By cooperatively and strategically aligning ourselves among the

many segments of the beef industry, we are better positioned to compete in today’s

increasingly competitive marketplace, respond to consumer preferences and improve

the safety of our products. Our unique integrated strategy has allowed producers

the opportunity to move up the value-added ladder enabling them to profitably sell

meat and meals instead of cattle. Please refer to exhibit A.

We will look back on this time as a watershed moment for a growing number of

producer-owned cooperative businesses who are faced with the challenges of a restrictive cooperative structure and seeking a change. For producer owned ventures

to compete and succeed today and into the future, they must have the ability to attract non-producer equity and diversify their business; both are restricted under the

current laws governing cooperative structures. There exists today, alternative business structures in the form of L.L.C.’s that provide the benefits of a pass through

tax structure, link producer ownership to the delivery of a commodity, allow unlimited earnings diversification and provide for recruitment of outside capital; all while

maintaining control in the hands of the producer. While the issues surrounding this

topic can be complex, it is my intent to present solutions that will insure producers

can organize and cooperate in a way that enables them to compete and survive.

CHANGES IN THE MARKETPLACE

As one reviews the history of producer formed cooperative ventures, we see a

structure that offered producers of commodities the opportunity to pool their resources, their commodities and capital, and move up the integrated value chain that

no other structure allowed. Initially cooperatives were formed to deal with both social and economic needs in a much different marketplace. Today as we witness an

acceleration of concentration among food industry participants, the need to achieve

size, scale and market leverage is becoming paramount to their success. These

changes require vast amounts of capital.

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In the years ahead, cooperatives, like much of rural America, will face these serious challenges. Their customers and competitors are becoming larger, more sophisticated and utilize the latest technologies including biotechnology, information services and transportation. These evolving businesses can mass large amounts of equity

through multiple sources. Under today’s rules, cooperatives have only to look toward

cash strapped producers to secure equity. The alternative is to leverage their business through debt equity; a strategy that has resulted in numerous public failures.

One has only to read the headlines over the past several years to see the evidence

of the growing number of agricultural cooperatives’ inability to compete.

USPB ACQUIRES MAJORITY INTEREST IN NATIONAL BEEF

While since 1997, USPB has enjoyed a successful partnership with Farmland Industries, in May of 2002, Farmland Industries’ financial challenges, exasperated by

its lack of liquidity, filed for bankruptcy. USPB ultimately acquired Farmland’s interest in the National Beef partnership in August of this year through the bankruptcy process. As a result of the acquisition, USPB was able to secure a majority

interest in the business. However, due to the restrictions in attracting equity outside of a pool of cattle producers, USPB was forced to form its venture outside of

the cooperative and seek outside investors as partners in the beef business. Had

USPB been able to attract alternative sources of capital within the cooperative, we

would have owned a larger percentage of the beef business and increased our odds

of maintaining producer control into an uncertain and very competitive future. Additionally, in order to achieve a majority position, since equity capital was limited, we

were forced to rely more heavily on riskier debt equity thereby leveraging the company.

CHALLENGES OF THE COOPERATIVE STRUCTURE

The wave of new marketing cooperative businesses that dotted the high plains

and Midwest over the last decades provided a vehicle for producers to pool their

commodities and capital and enter further processing or value added ventures.

These entities were formed under the cooperative pass through tax principal. As

long as the cooperative is fully owned and doing business for and with its qualified

members, it will achieve a single tax much like a partnership or LLC. If it fails to

maintain its producer ownership or pursue non-patron business, the cooperative will

lose its tax efficiency and be taxed at both the company and producer level.

In recent years we have witnessed many farmer owned cooperatives fail or convert to other corporate structures. The cause for these two events is related. Producer / member equity can not compete with the capital intensive, value-added processing prevalent in food processing. Today’s cooperatives are faced with an ever

growing and consolidating marketplace. To succeed requires vast amounts of capital

in order to achieve economies of size and market leverage. Very public failures, such

as Farmland Industries, have been observed to be the victim of their own cooperative structure where essential capital sources of liquidity were limited to a narrow

pool of already cash strapped producers. Likewise, many other cooperatives, seeing

the challenges of raising necessary equity in the future, are considering converted

to other business structures that allow alternative sources of non-producer equity.

Additionally, many successful cooperatives, like USPB, have been exploring alternative business ventures that fall outside the scope of patron or producer sourced

income. These alternative businesses can be essential to diversify a cooperatives’

business. In the case of USPB, we have invested in a food safety initiative that we

plan to commercialize and license to other food processors thereby generating income not directly associated with producer cattle delivered, processed and marketed

through their company. Once again, in other forms of pass through entities, the

owners realize a pass through tax while engaging in a wide range of diversified

businesses. As a cooperative, we are restricted from pursuing these alternative businesses. While converting to an alternative business structure seems the simple solution;

unfortunately, there exists several sizable barriers to converting from a cooperative

to a partnership entity such as an LLC. Successful companies like USPB and its

members could be assessed a tax on the gain realized through the termination required in current tax law. The tax liability itself further exasperates the lack of liquidity many cooperatives face.

Converting to a non-cooperative structure could also restrict our company from

maintaining a bank relationship with CoBank. CoBank has been an important provider of credit and financial services to USPB since inception. Their knowledge and

expertise in lending to agricultural producer-owned businesses nationwide is invaluable. Their presence in a consolidating lending marketplace is key to maintaining

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access to credit and competition. Congressional action is needed to insure that farmer owned and controlled businesses, not formed as cooperatives, are eligible to borrow from CoBank.

SOLUTIONS

There is however, a solution to the challenges facing cooperatives considering a

conversion. This solution is in the form of an amendment to the Internal Revenue

Code providing for special rules for cooperative conversion transactions. In order to

be defined as an association eligible for the special rules, the resulting association

of the conversion would be required to maintain agricultural producer majority ownership and governance rights immediately following the conversion. I propose the

following rule changes for eligible associations:

The conversion transaction shall not be treated as a sale or exchange of property;

the shareholder or member of the cooperative shall not recognize a gain or a loss

as a result of the conversion; the cooperative shall not recognize a gain or a loss

as a result of the conversion; the basis of property that becomes property of the eligible association in the conversion shall be the basis of the cooperative before the

conversion; the eligible association may adopt the same fiscal tax year as the cooperative before the conversion

A one-time conversion tax exemption on those cooperatives that convert to an LLC

and still maintain producer control would allow for a viable solution to a critical

problem. By requiring the converted entity to be majority owned and controlled by

producers maintains the integrity of benefits flowing to agricultural producers. By

targeting the most successful producer-owned ventures (those who have realized a

gain) to aid in these changes, you have naturally selected a group who is most likely

to succeed in furthering the integration of producers into value added markets. We

must realize that achieving size and strength are essential to our success as producer-owned ventures and should not be considered a burden on the marketplace.

USPB, like many other successful producer-owned ventures formed as cooperatives, is facing significant challenges as it plans for its future. In order to survive

and compete in our ever changing and consolidating food industry, we are going to

need ready access to equity and have the ability to pursue diversified businesses.

Under the restrictions placed on the cooperative business structure, we are forced

to consider alternative business structures that provide the needed flexibility to succeed. In order to provide us the opportunity to convert to these alternative structures, we need help in the form of an exemption from tax on gain realized at conversion and other cost savings such as maintaining the current fiscal year and an easing of securities requirements in the raising of equity. By requiring that the converting entity maintains producer ownership and control, you can be assured that this

change will allow successful grass roots producer-owned ventures to succeed by

showing up with the tools to compete with widely held public companies with unlimited access to equity.

We appreciate your continued support for our unique business. And, I respectfully

ask that you consider supporting our need for changes in the tax rules that will facilitate changes necessary to continue the growth and development of producer

owned ventures.

Thank you for the opportunity to testify before you today. I will be happy to respond to questions.

EXHIBIT A

THE USPB SUCCESS STORY

As early as the fall of 1995, midwestern producers from all segments of the cattle

industry, seed-stock, cow-calf, farmer-feeder, and feedlot, began meeting to discuss

the problems plaguing the current cattle marketing system and also to examine

some solutions. After much research by a steering committee of these cattlemen

committed to taking control of their own destiny, U.S. Premium Beef, Ltd. was

formed. Founded on July 1, 1996, U.S. Premium Beef was structured as a new generation beef marketing cooperative, the first and only in the United States. Shortly

thereafter, a business plan was established and a mission statement was adopted.

This mission reads:

‘‘To increase the quality of beef and the long-term profitability of cattle producers

by creating a fully integrated producer-owned beef processing system that is a global

supplier of high quality value-added beef products responsive to consumers’ desires.’’

From there, more than 765 producers from 24 States committed both cattle production and capital to seek out the most economically feasible inroad into further

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processing and value-added products. After extensive research into the different alternatives of acquisition, building or joint venture, it became evident that the only

viable avenue for producers to gain a greater share of their marketing dollar was

through a joint venture.

In July of 1997, we announced that U.S. Premium Beef (USPB) had signed an

agreement to enter a partnership with Farmland Industries, the Nation’s largest

farmer-owned cooperative, to purchase 29 percent of Farmland’s National Beef

Packing Company. Farmland National Beef is the only producer-owned beef processing company, and additionally an international leader in value-added branded products.

During the fall of 1997 USPB mounted a stock offering drive through the United

States. By December 1, 1997 our efforts were successful. We had commitments for

nearly 700,000 cattle annually, and over $72 million in capital raised. The following

week USPB began operations, buying more than 10,000 member cattle on an individual animal basis over a progressive carcass value based grid.

At USPB, we designed a progressive grid system to increase the quality of cattle

and the returns to our producer owners by providing monetary incentives based

solely on quality. Since we began delivering cattle in December of 1997, USPB cattle

have exceeded industry quality levels, and our producers have earned significant

premiums over cash price.

By working together to produce a better product, it is our intention to improve

the overall image of beef and hopefully earn more of the consumer’s trust and business with our efforts.

USPB ACQUIRES MAJORITY INTEREST IN NATIONAL BEEF

USPB ultimately acquired Farmland’s interest in the National Beef partnership

in August of this year through the bankruptcy process. As a result of the acquisition, USPB was able to secure a majority interest in the business. However, due

to the restrictions in attracting equity outside of a pool of cattle producers, USPB

was forced to seek outside investors as partners in the beef business.

Current USPB Operations

To date, USPB and its members have marketed over 3.7 million cattle through

its plants and beef company. Membership totals include over 1800 producers from

all segments in 34 States. While still in its infancy, USPB has paid out over $64

million in cash premiums over the USDA reported live cattle market. In addition,

our stock holders / members have realized earnings of over $80 million through the

profits of the Beef Company they own. Stock, initially issued at $55 per share, now

trades at $155 per share.

Additionally, every producer member is insured a competitive carcass merit grid

pricing, carcass data on individual animals, transportation credit up to 110 miles

or $6 per head, and livestock and meat consulting, all at no charge.

Our results have far exceeded expectations. The level of premiums has steadily

increased over the past six years. This has occurred in great part due to the utilization of carcass data and the financial incentives in place through grid pricing. Any

producer armed with the correct system and information can achieve these results.

STATEMENT OF KEITH KISLING

Thank you Mr. Chairman and members of the committee. I sincerely appreciate

the opportunity to be here today.

The topic of this hearing is very important to the future of agriculture and to

farmers and ranchers like me who are looking for ways to get more of our income

from the marketplace, take advantage of new value-added business opportunities,

and to help create wealth in our rural communities. For these reasons, I want to

commend you for your leadership in holding this hearing. I also want to commend

Congressmen Sam Graves and Earl Pomeroy for their leadership as House co-chairs

of the new Congressional Farmer Cooperative Caucus.

My name is Keith Kisling and I am a third generation farmer from Burlington,

in the Third Congressional District of Oklahoma proudly represented by the Honorable Frank Lucas.

I currently serve as secretary/treasurer of the Oklahoma Wheat Commission and

I am the vice chairman of US Wheat Associates. US wheat is an organization funded by the wheat check off program whose purpose is to market our wheat products

both here and abroad and research new ways for farmers to do business. We greatly

appreciate your support of agricultural research through our Land Grant Universities because without that financial support, our industry would suffer immensely.

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My farm is typical of most in my part of the country with a majority of our revenue derived from wheat, stocker cattle, alfalfa, winter wheat pasture and a 1500

head feedlot. For all of my career as a farmer I have enjoyed incredible benefits as

a member of our local Burlington Cooperative Association, where I served as director for 12 years, and as a member of four other agricultural cooperatives in Oklahoma and Kansas. I have always viewed the cooperative system as a vital instrument in producing and marketing agricultural commodities, but in the past four

years I have seen first hand that cooperatives can be much more.

In 1996, a group of producers in our part of Oklahoma started looking at options

on how we could ‘‘add value’’ to the high quality wheat product we were selling. This

thought process hatched what is known today as value added products, a New Generation Cooperative in Alva, Oklahoma that takes our wheat production and transforms it into frozen pizza crusts that are sold throughout the Midwest. We take

642,000 bushels of wheat and yield $20 million of pizza crust per year making us

the largest single pre-proofed and frozen dough plant in the United States after only

four years in operation.

But getting from the ‘‘idea’’ stage to the ‘‘production’’ stage was no easy task and

this is where your help is vital for this type of value added venture to work throughout rural America.

Of course our biggest challenge was collecting up front capital in order to convince our lenders to buy into the deal. We held 40 meetings with a goal of raising $10

million to use against our $18 million total project cost.

One tool made this possible. In Oklahoma, we have a 30% State Tax Credit that

can be utilized over seven years when you invest in a value-added venture. This tax

credit was the only reason we were able to bring 850 producers in as investors, and

it is a model we would ask you to consider. I was asked constantly in those forty

meetings we held if there was a similar Federal tax credit and my response had

to be ‘‘no’’. A ‘‘yes’’ answer would be much more helpful in the future.

After raising the necessary equity capital, we were able to obtain the financing

we needed with the help of USDA’s guaranteed loan program. We also obtained a

grant under USDA’s Value-Added Grant Program, which provides funds on a matching basis to assist start up value added ventures and provide working capital for

existing businesses in order to market their products better. Two years ago, value

added products received an existing business grant which allowed us to expand into

new products.

We are now selling the world pizza crust instead of a railroad car full of wheat.

More jobs are available for our young people and more sales tax revenue is going

into our community to provide basic infrastructure and technology.

The 2002 farm bill with the inclusion of Rural Development and Energy titles

sent a message to Rural America that Farm Policy and Rural Policy are not necessarily the same thing. Granted, farming is the backbone of the rural economy, but

for a body to function properly it must also have arms and legs, which include our

rural infrastructure, and rural employers. We cannot survive without the full package.

If we are going to survive as an industry, we have to find new and better ways

to capture more of the value of what we produce after our commodities and products

leave the farm.

Farmer cooperatives, including New Generation Cooperatives such as value added

products, can play an important role. But we also need programs in place that help

encourage and promote such efforts.

Attracting equity capital is a critical challenge. Again, Federal tax incentives similar to our Oklahoma tax credit would help encourage investment in cooperatives. Value-Added Grant Program should continue to be funded at no less than $40

million as provided in the 2002 farm bill. In fact, I believe the program should be

expanded in dollars and eligibility to help more rural business and producers bring

more value-added projects to the table.

As a food producer from America’s breadbasket I again thank you for the opportunity to testify. Your willingness to listen is what will ensure a strong tomorrow

for American Agriculture.

STATEMENT OF STEPHEN WRIGHT

Pro-Fac Cooperative, Inc. is an agricultural marketing cooperative doing business

with over 2,000 fruit, vegetable and grain producers in 12 States across the country.

Our members produce 20 different commodities that are marketed through the Cooperative to nine different processing companies, including Birds Eye Foods, of

which Pro-Fac is a significant minority owner.

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We thank you and Congressman Stenholm for conducting hearings on farmer cooperatives on October 16, 2003. We also commend Congressmen Graves and Pomeroy for their leadership as House co-chairs of the Congressional Farmer Cooperative Caucus and thank all members of the Caucus for their interest and support.

For many decades, cooperatives have enabled farmers and ranchers to realize a

larger portion of the consumer food dollar than they could garner individually. As

farmers’ share of that dollar is now at an all-time low, strong and efficient cooperatives are needed more than ever before.

Since Pro-Fac’s inception in 1961, its members have not only enjoyed secure markets for their raw products at competitive prices, but they have also shared in the

Cooperative’s earnings. Through member investments in capital stock and retained

earnings, Pro-Fac owned its marketing arm, Curtice Burns Foods (now Birds Eye

Foods). However, burdensome debt levels and the inability of a cooperative to access

reasonably priced capital resulted in the sale of controlling interest in Birds Eye

just over a year ago. That restructuring has proven successful to date and we are

confident that members’ equity has been protected. However, we are saddened that

a well-known and respected company like Birds Eye can no longer boast that it is

100 percent farmer-owned.

We urge Congress to strengthen the marketing capabilities of farmers and ranchers through cooperative self-help efforts. This can be done by:

• Strengthening USDA programs designed to help farmers help themselves.

Establish a separate agency within USDA for farmer cooperatives to ensure that

farmers have access to the tools they need to be successful.

Provide specific authority for USDA farmer cooperative research and technical assistance programs, to provide adequate funding for the benefit of farmers.

Maintain the ability of farmers, through their cooperatives, to participate in

USDA programs, including agricultural, export, commodity purchase and other programs.

Maintain funding for the Value-Added Development Grants program at the full

$40 million level authorized in the 2002 farm bill, so that farmer cooperatives and

their members might capitalize on value-added opportunities.

• Modernizing the Federal Farm Credit Act to ensure that farmer cooperatives

have continued access to a competitive source of credit and capital through CoBank

for the benefit of their farmer-members.

• Changing tax laws to improve access to equity capital, including H.R. 1671

(Herger-Graves-Pomeroy), to eliminate the unfair triple tax on cooperative dividends

under the Dividend Allocation Rule. Other tax changes are needed to help farmer

cooperatives attract equity capital and encourage cooperative self-help efforts.

Thank you once again for your committee’s interest in America’s farmer cooperatives.

STATEMENT OF JOHN G. REIFSTECK

My name is John G. Reifsteck, and I operate a 1,500-acre cash grain farm in

Champaign County, Illinois. I have been a board member of our locally farmer

owned cooperative, Illini FS, Inc., since 1975 and currently serve as president. I also

serve as vice chairman of the Board for GROWMARK, Inc., a regional farm supply

and grain marketing cooperative headquartered in Bloomington, Illinois, which is

owned by the local farmer cooperatives.

I want to thank you and ranking member, Rep. Stenholm, for holding the October

16 hearing on Farmer Cooperatives. Additionally, I commend the committee’s efforts

and those of Congress for the 2002 farm bill and other actions which have helped

support farm income.

As an involved producer active in a local cooperative and GROWMARK, Inc. a regional cooperative, I fully support the testimony presented by David Graves, president of the National Council of Farmer Cooperatives (NCFC) at the House Agriculture Committee hearing. GROWMARK, a NCFC member, has discussed and will

continue to address Congress on these issues of concern: (1) modify current tax policy improving farmer cooperative access to equity capital and support of H.R. 1671

to eliminate the triple tax on farmer cooperative dividends on capital stock under

the Dividend Allocation Rule, (2) improve USDA programs developed to help farmers help themselves, and (3) modernize our farm credit system important to farmers

and farmer cooperatives working hard to support themselves in rural America.

Chairman Goodlatte, thank you, I appreciate the opportunity the House Agriculture Committee provided to submit comments.

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STATEMENT OF BRUCE ANDERSON

My name is Bruce Anderson. I am a farmer from Glenburn, North Dakota, as well

as a director for the past 8 years for CHS Inc—a regional agricultural cooperative.

In a moment, I will tell you more about my own farming operation and my longtime involvement in producer-owned cooperatives, as well as their role in the ability

of American farmers to succeed today.

First, however, I would like to thank Chairman Goodlatte and Representative

Stenholm for scheduling this hearing and providing me—on behalf of CHS—an opportunity to speak on this important subject.

Second, I would also like to extend our appreciation to Representatives Graves

and Pomeroy of the Agriculture Committee for their leadership as the House cochairs of the newly formed Congressional Farmer Cooperatives Caucus. The establishment of this caucus last spring was an important step in bringing together a

broad range of members of Congress to focus on issues that are extremely important

to producers and rural America.

Finally, as harvest is wrapping up in much of the country, I would like to thank

the House Agriculture Committee and the entire Congress for their efforts on the

2002 farm bill, as well as their leadership on a host of other issues including disaster assistance and measures to maintain and improve farm income.

As I address you today, I wear two hats. First, that of a third-generation North

Dakota farmer. Our family has relied on cooperatives to help us succeed for more

than 75 years. Today, my wife, Pam, and I raise small grains—primarily wheat—

on our 1,000-acre operation located just north of Minot in the State’s north central

area. I am a member of Farmer Union Oil Company and Sun Prairie Grain, both

co-ops that have undergone tremendous change, including mergers and joint ventures, in the years I’ve been associated with them, in an effort to continue meeting

the needs of their producer-owners.

Beyond that, I’ve often said that I’ve literally been a member of a co-op my whole

life. My father opened my first credit union account when I was a week old. I’ve

also been a life-long user of electric and telephone cooperatives and been active on

many boards.

From a farmer perspective, cooperatives are extremely important to me. I rely on

them for all of my supplies and for access to grain markets. They offer me a chance

to do business with a company I own and to share in that success when the cooperative does well. They provide opportunities I likely would not have on my own.Now

I’ll put on my other hat. Since 1995, I’ve been a director, representing the producers

of North Dakota, on the board of what is now CHS.

For those of you who are not familiar with CHS, I will provide a brief background

and scope of our cooperative. Although we’re just over five years old as a company,

our roots reach back to cooperatives formed in the 1920’s to meet both the agricultural inputs and grain marketing needs of producers in many areas of the central

and western States.

During the last seven decades, those original organizations have grown and

changed dramatically. Many of you were probably familiar with us as the former

Cenex and Harvest States cooperatives. Today CHS is a diversified supply and agricultural foods company committed to providing the essential resources that enrich

the lives of those whose lives we touch. We are owned by farmers, ranchers and cooperatives from the Great Lakes to the Pacific Northwest and from the Canadian

border to Texas.

The CHS of today provides products and services ranging from grain marketing

to food processing to meet the needs of customers around the world—from the producers’ farm to the consumer’s table. We operate petroleum refineries/pipelines and,

through a broad range of working partnerships, market and distribute Cenex brand

energy products, along with agronomic inputs and feed to rural America. We’re a

Fortune 500 company and we do some type of business—from ag supply to energy

to food products—in every State of the U.S. and market grain in 90 countries

around the world.

We’re owned by nearly 1,200 member cooperatives in 26 States who represent an

estimated 350,000 farmers and ranchers. We’re just finalizing our fiscal 2003 financial figures, but in fiscal 2002 our earnings were $126.1 million on sales of nearly

$8 billion. Based on those earnings, we returned $56.5 million in cash—as cash patronage and equity redemptions—to our members in fiscal 2003.

Clearly we’ve grown in seven decades, but what hasn’t changed is our commitment to the farmers, ranchers and the cooperatives who own us and our unwavering

belief that the success of producer-owned co-ops—including CHS—is a vital self-help

tool for American agriculture.

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As a producer, I believe that for the long-term future of agriculture, it is essential

that producers have an ownership stake in the businesses they need. It’s important

for American agriculture, as a whole, that the people who produce our food have

a commitment to a business they own and that business, their cooperative, has a

commitment to them in return.

Maintaining successful cooperatives that ultimately help producers and American

agriculture succeed is no easy assignment today. It takes a multi-faceted approach.

First, cooperatives themselves must operate as economically viable businesses. At

CHS, we spell that out in our vision and mission statements that say we exist to

be an integrated supply and grain-based foods system that improves company profitability and stakeholder value by linking producers with consumers. Clearly our producer and member cooperative owners are the most important of our stakeholders.

In achieving this, we are committed to operating our cooperative business with financial stability and the highest of integrity.

Equally important, however, is having a solid basis of support for producer-owned

cooperatives within our Nation’s governmental structure. This leads me to my primary purpose today, which is to urge this committee and Congress to take three

important steps to strengthen the ability of farmers to join together in cooperative

self-help efforts.

First of all, we call on Congress to strengthen U.S. Department of Agriculture programs designed to help farmers help themselves. Specifically, we ask Congress to: • Establish a separate agency within USDA for farmer cooperatives, to help ensure that farmers have access to tools they need to be successful; • Provide specific authority for USDA farmer cooperative research and technical

assistance programs, to provide adequate funding for the benefit of farmers; • Maintain ability of farmers, through their cooperatives, to participate in USDA

programs, including agricultural, export, commodity purchase and other programs;

and finally, • Maintain funding for value-added Technical Assistance Grants Program under

the 2002 Farm Bill to help farmer cooperatives and their members capitalize on

value-added opportunities.

Second, we urge the modernization of the Federal Farm Credit Act to ensure that

farmer cooperatives have continued access to a competitive source of credit and capital through CoBank for the benefit of their farmer-members.

Finally, we call for support for changes in tax laws to improve access to equity

capital. This includes passage of H.R. 1671, which eliminates the unfair triple tax

on cooperative dividends of capital stock under the Dividend Allocation Rule, along

with other tax changes to help farmer cooperatives attract equity capital and encourage cooperative self-help efforts.

Approval of legislation in each of these three critical areas will do much toward

the overall goal of helping farmers help themselves through the cooperatives they

own, cooperatives that serve as the most useful tools available today for ensuring

the long-term success of our Nation’s production agriculture sector.

On behalf of CHS, and more importantly, on behalf of the millions of producers

like myself who rely on cooperatives as tools for success in this rapidly changing

global marketplace, I thank you for this opportunity to testify today. I respectfully

urge this committee to provide leadership for the passage by Congress of these vital

provisions for American agriculture.

STATEMENT OF MICHAEL M. REYNA

Chairman Goodlatte, Ranking Member Stenholm, and members of the House Agriculture Committee, I am Michael M. Reyna, chairman and chief Executive Officer

of the Farm Credit Administration (FCA or Agency). Joining me today are my colleagues on the FCA Board, Doug Flory and Nancy Pellett.

On behalf of the FCA Board, I wish to thank you for the invitation to discuss the

changing structure of agricultural cooperatives and the challenges that cooperatives

face as they seek to increase the income of their farmer-members while, at the same

time, finding new ways to finance their operations. These challenges, and how Congress chooses to address them, are of prime importance.

As you know, I have provided the committee detailed written testimony on the

topic of today’s hearing; hence, my opening remarks will be brief so as to be respectful of the committee’s time and the time of other witnesses scheduled to testify.

As you know, the Farm Credit Administration is the independent Federal financial regulatory agency that is responsible for overseeing the mission and the safety

and soundness of two separate, but related, agricultural Government Sponsored Enterprises (GSEs), including the Farm Credit System (FCS) and the Federal AgriculVerDate 11-SEP-98 10:04 Jan 13, 2004 Jkt 091099 PO 00000 Frm 00092 Fmt 6633 Sfmt 6633 F:\DOCS\10818 HAGRI PsN: HAGRI
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tural Mortgage Corporation (Farmer Mac). We achieve our objective by conducting

periodic financial safety and soundness examinations and by adopting regulations

that provide for necessary guidance.

The System is a nationwide cooperative network of borrower owned financial institutions that lend to agriculture and rural America. Established it in 1916, it is

the oldest Government Sponsored Enterprise (GSE) in the United States, and is the

only GSE that engages in lending at the retail level.

The mission of the System is to improve the income and well being of American

farmers and ranchers by furnishing sound, adequate, and constructive credit and

closely related services to them, their cooperatives, and to selected farm-related

businesses necessary for efficient farm operations. It does this by serving all eligible

borrowers having a basis for credit and, as required by Congress, by placing a high

priority on financing young, beginning and small farmers.

Cooperatives have played a crucial role in making American agriculture prosperous, productive, and efficient. They increase the sales revenue of farmers and

lower the costs that farmers pay for supplies and business services. In addition to

increasing revenues and lowering costs, cooperatives are a vital and integral part

of rural America.

Cooperatives strengthen the agricultural economy and improve living conditions

in rural areas in many different ways. For example, earnings in the form of patronage are returned to farmers, who contribute to the local economy. Cooperatives

strengthen the economic base of the local community by adding to the tax base, creating new jobs, and spurring retail sales and services. Cooperatives also help provide consumers with more choices and or new products.

It is the unique structure of cooperatives that strengthens the market power of

farmers so they can earn more and live better. The characteristics of traditional

farmer cooperatives include the following:

• Agricultural producers are a large majority of the voting members;

• Each member has only one vote, regardless of the amount of equity capital

owned;

• Members earn patronage based on the amount of business they do with the cooperative,

• Dividend payments on equity capital are restricted, and

• The cooperative does more business with members than non-members.

For more than 80 years, Congress has sought to preserve and expand the benefits

that cooperatives have to offer. Specifically, Congress has devised a public policy

that grants cooperatives certain legal protections, tax benefits, and other advantages

that are not conferred on investor-owned agribusinesses. As a result, farmer cooperatives have direct access to GSE funding that their competitors, which are investor-owned agribusinesses, generally lack.

It is important to note that farmer cooperatives play an important role in America’s agricultural economy, with the share of overall farm commodities marketed

through cooperatives being fairly steady over the past five years. And, although the

number of farmer cooperatives has declined 25 percent in the past decade, the net

business volume of cooperatives actually increased.

While no empirical data is available to determine whether farmers have been reducing their use of the traditional cooperative form of structure in recent years, our

agency did, however, conduct a limited survey in which we contacted the ten states

with the greatest number of cooperatives to identify annual trends in new cooperative filings.

Specifically, FCA staff found no consistent trend in the number of new filings over

the period 1993 to 2003. While half of the states did display a declining trend in

the number of cooperative filings, two states displayed an increasing trend and one

state showed no change. Two states were unable to provide the data. A broader survey, as well as further study, may be warranted.

Notwithstanding numbers, trends and limited surveys, there are concerns being

raised by some individuals and groups that traditional cooperatives are not resilient

enough to endure the economic changes facing agriculture today and help farmers

overcome new challenges.

It is not uncommon for farmers to struggle to find sufficient capital to enable

them to invest in their own value-added enterprises. And, when farmers cannot

raise sufficient capital on their own, they must turn to outside sources of equity.

To attract outside equity capital or increase their business with nonmembers,

some farmer groups are forming hybrid organizations or restructuring existing cooperatives. FCA staff has identified numerous examples of value-added cooperatives

that had changed to the LLC form or that had formed a joint venture LLC with

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other cooperatives or Subchapter C firms. In addition, some groups of farmers have

chosen to form new value-added enterprises as LLCs rather than cooperatives.

LLCs offer many advantages that cooperatives do not. Among other advantages

for example, LLCs attract outside investors by giving them a say in management

and a return in proportion to their investment.

And, while a few well-established cooperatives have been able to attract outside

equity successfully, for a host of reasons most outside investors have little incentive

to invest in agricultural cooperatives. This is especially true for start-up cooperatives.

Recognizing the limitations of the traditional cooperative structure, Wyoming and

Minnesota have enacted new laws that allow farmers and investors to join together

to form new types of cooperatives. The two state laws are not identical, and their

treatment of certain issues differs. These cooperatives can best be described as hybrids between traditional cooperatives and LLCs.

These laws are newly enacted, and at this early stage it is unknown how many

traditional cooperatives plan to convert into hybrid cooperatives, or how many entities will be formed under these new state laws.

The FCA Board is aware that CoBank is developing a legislative proposal that

would give it more flexibility to finance cooperatives that are adjusting their structure in response to changing market.

While Congress is ultimately responsible for deciding the scope of CoBank’s lending powers, please rest assured that the FCA is prepared to implement and enforce

any policy that Congress enacts.

As always, the FCA is ready to offer you assistance in crafting any changes to

the Farm Credit Act, and we look forward to working with this Committee as it considers issues that are important to agriculture and rural America.

Thank you for the opportunity to testify at today’s important hearing.

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