Testimony 

Before the Committee on Agriculture, 

House of Representatives 

United States General Accounting Office 

GAO

For Release on Delivery 

Expected at 10:00 a.m. EDT 

Wednesday, June 2, 2004 FARMER MAC

Greater Attention to Risk 

Management, Mission, 

Public Purpose, and 

Corporate Governance Is 

Needed 

Statement of Davi M. D'Agostino 

Director, Financial Markets and 

Community Investment 

Jeanette Franzel 

Director, Financial Management 

and Assurance 

GAO-04-827T 
www.gao.gov/cgi-bin/getrpt?GAO-04-827T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Davi M. 

D'Agostino at (202) 512-8678 or 

dagostinod@gao.gov. 

Highlights of GAO-04-827T, a testimony to 

the Committee on Agriculture, House of 

Representatives 

June 2, 2004

FARMER MAC

Greater Attention to Risk Management, 

Mission, Public Purpose, and Corporate 

Governance Is Needed 

Farmer Mac, a government-sponsored enterprise (GSE), was established to 

provide a secondary market for agricultural real estate and rural housing 

loans and to increase agricultural mortgage credit. In 2003, GAO reported 

that several aspects of Farmer Mac’s financial risk management practices 

had not kept pace with its increasing risk profile. First, Farmer Mac had $3.1 

billion in off-balance-sheet commitments and other agreements that could 

obligate it to buy the underlying loans or cover related losses under certain 

conditions. Farmer Mac and the Farm Credit System institutions that 

participate in the agreements are required to hold far less capital than is 

otherwise required. Because Farmer Mac’s loan activities are concentrated 

in a small number of financial institutions and in the West, the risk is not 

reduced while less capital is required to be held. Under stressful agricultural 

economic conditions, Farmer Mac could be required to purchase large 

amounts of impaired or defaulted loans if large amounts of the commitments 

were exercised. Second, the coverage of Farmer Mac’s $1.5 billion line of 

credit with the U.S. Treasury was controversial, as the entities disagreed on 

whether the securities it has issued and kept in its portfolio would be 

eligible. Third, GAO reported that while Farmer Mac had increased its 

mission-related activities since its 1999 report, their impact on the 

agricultural real estate market was unclear. The effects were difficult to 

measure partly because Farmer Mac’s statute lacks specific mission goals. 

For this and other reasons, GAO concluded that the public benefits derived 

from Farmer Mac’s activities are not clear. Finally, for profitability reasons, 

Farmer Mac had a strategy of holding securities it issued in its portfolio 

instead of selling them to investors in the capital markets. As a result, the 

depth and liquidity of the market for Farmer Mac’s securities is unknown. 

Farmer Mac’s board structure, set in federal law, may make it difficult to 

ensure that the board fully represents the interests of all shareholders and 

meets independence and other requirements. The board structure contains 

elements of both a cooperative and an investor-owned publicly traded 

company. For example, two-thirds of the board members do business with 

Farmer Mac and hold the only voting stock, while the common stock holders 

have no vote. GAO also identified challenges FCA faced in its oversight of 

Farmer Mac, including a lack of specific criteria for measuring how well it 

was achieving its mission. Although FCA had taken steps to improve its 

safety and soundness oversight, more needs to be done to improve its offsite monitoring and assessment of risk-based capital. 

Farmer Mac and FCA have efforts underway to address many of GAO’s 

recommendations and it was too early to assess them. 

This testimony is based on GAO’s 

October 2003 report, Farmer Mac: 

Some Progress Made, but Greater 

Attention to Risk Management, 

Mission, and Corporate 

Governance Is Needed (GAO-04-

116). GAO’s testimony presents a 

brief overview of Farmer Mac and 

discusses issues raised in its 2003 

report, including Farmer Mac’s risk 

management practices and line of 

credit with Treasury, missionrelated activities, board structure, 

and oversight, which is provided by 

the Farm Credit Administration 

(FCA). 

GAO’s 2003 report found that 

Farmer Mac, FCA, and Congress 

could all take actions to help 

improve Farmer Mac’s safety and 

soundness and ability to carry out 

its public policy mission. GAO 

recommended that Farmer Mac 

strengthen its risk management and 

corporate governance and 

reevaluate some operational 

strategies. GAO also recommended 

that FCA enhance its oversight 

tools for Farmer Mac and that 

Congress consider establishing 

measurable goals to help FCA 

assess how well Farmer Mac is 

meeting its mission. 
Page 1 GAO-04-827T 

Mr. Chairman, Mr. Ranking Member, and Members of the Committee: 

We are pleased to be here today to discuss the results of GAO’s work on 

the Federal Agricultural Mortgage Corporation, commonly referred to as 

Farmer Mac. Our testimony is based on the report we issued on October 

16, 2003, at the request of the Senate Committee on Agriculture, Nutrition, 

and Forestry: Farmer Mac: Some Progress Made, but Greater Attention to 

Risk Management, Mission, and Corporate Governance Is Needed, GAO04-116 (Washington, D.C.: October16, 2003). Our overall objective today is 

to provide the committee with information and perspectives to consider as 

it continues to oversee Farmer Mac. My remarks are divided into two 

sections. First, I will provide an overview of Farmer Mac, its mission and 

portfolio, and potential risks to taxpayers. Second, I will provide our 

report findings on a variety of items associated with Farmer Mac, 

including its risk management practices and its line of credit with 

Treasury, mission-related activities, board structure, and oversight 

provided by the Farm Credit Administration (FCA). Throughout my 

statement, I will comment on Farmer Mac’s and FCA’s responses to the 

findings and recommendations in our report. Information discussed in our 

report was gathered from August 2002 to May 2003 from reviews of 

documents and interviews we had with representatives from Farmer Mac, 

FCA, other market participants, and individuals with expertise in the 

agricultural real estate market. We also reviewed FCA’s examinations of 

Farmer Mac and consultants’ studies related to Farmer Mac. To update our 

report for this testimony, we obtained more recent financial data on 

Farmer Mac and Farmer Mac’s and FCA’s responses to our 

recommendations. We conducted our work in accordance with generally 

accepted government auditing standards. 

In summary, I will first give a brief overview of Farmer Mac. Farmer Mac is 

a government-sponsored enterprise or GSE1

 established by Congress to 

create a secondary market in agricultural real estate and rural housing 

loans, and to improve the availability of agricultural mortgage credit. FCA, 

through its Office of Secondary Market Oversight (OSMO), regulates 

Farmer Mac. In extreme circumstances, Farmer Mac may borrow up to 

$1.5 billion from the U.S. Treasury. Among its program activities, Farmer 

Mac purchases agricultural mortgages from lenders and periodically 

 1

As used in this testimony, a GSE is a federally chartered, privately owned corporation 

established by Congress to provide a continuing source of credit nationwide to a specific 

economic sector. 
Page 2 GAO-04-827T 

securitizes these loans into guaranteed securities or agricultural mortgagebacked securities (AMBS). During the last 2 years, Farmer Mac sold AMBS 

principally to related parties. 

Farmer Mac also issues long-term standby purchase commitments or 

standby agreements for eligible loans. To date, all of these commitments 

are with institutions in the Farm Credit System (FCS), which is also a GSE. 

As of December 31, 2003, loans underlying standby and similar 

agreements2

 totaled $3.1 billion and represent 53 percent of the book value 

of total loans included in Farmer Mac’s programs (see fig. 1). These 

agreements are held off balance sheet because Farmer Mac does not own 

the loans underlying these agreements and is conditionally obligated to 

purchase them. In the case of the $722.3 million of standby agreements 

that was converted into a Farmer Mac I Guaranteed Security, Farmer Mac 

may, at its discretion, repurchase the defaulted loans or choose to pay the 

associated losses under the guarantee without purchasing the loan. 

Although the underlying loans have been performing better than its onbalance sheet loans, the standby agreements include provisions that 

commit Farmer Mac to purchasing the loans under specific conditions—

for example, when they become 120-day delinquent. 

Farmer Mac also faces potential liquidity risk as a result of these standby 

and similar agreements, which can create unexpected demands for 

additional funding. In other words, at a time when either the agricultural 

sector is severely depressed or interest rates are falling, Farmer Mac could 

be required to purchase large amounts of impaired or defaulted loans 

under the agreements, thus subjecting Farmer Mac to increased funding 

liquidity risks and the potential for reduced earnings. Notwithstanding the 

risk these standby and similar agreements could generate for Farmer Mac 

under stressful economic conditions, their off-balance sheet status allows 

Farmer Mac to hold less capital against the loans placed under them 

 2

During third quarter 2003, at the request of Farm Credit West, A.C.A., of which one of 

Farmer Mac’s directors is President, Farmer Mac converted a $722.3 million standby 

agreements that had been established prior to January 1, 2003 into a Farmer Mac I 

Guaranteed Security. To achieve this result, the program participant transferred a pool of 

agricultural loans to Farmer Mac, Farmer Mac transferred the loans to a trust, and the trust 

issued Farmer Mac I Guaranteed Securities that were transferred by Farmer Mac to the 

program participant. Because Farmer Mac received no proceeds other than the beneficial 

interests in the transferred assets, the transfer between Farmer Mac and the trust does not 

qualify as either a sale or a financing; therefore, no gain or loss was recognized in Farmer 

Mac’s financial statements. Additionally, because the trust is a special purpose entity, it 

was not included in Farmer Mac’s financial statements. 
Page 3 GAO-04-827T 

compared with its own on-balance sheet loans. These agreements also 

allow the FCS institutions to hold less capital against the loans placed 

under them. Further, the amount of capital that Farmer Mac would be 

required to hold against these underlying loans if required to buy them is 

less than what the FCS institutions are required to hold against the loans. 

The result of Farmer Mac’s $3.1 billion in standby and similar agreements 

is to significantly reduce the amount of capital held against these loans in 

the FCS as a whole without correspondingly reducing risk because of its 

geographic and lender concentration. 

Figure 1: Percentage of Outstanding Balance of Loans, AMBS and Standby 

Agreements of December 31, 2003 

Note: 

a

These are loans purchased by Farmer Mac prior to the change in its statutory charter in 1996. 

b

Farmer Mac loan programs are divided into two main groups, Farmer Mac I and Farmer Mac II. 

Farmer Mac I consists of agricultural and rural housing mortgage loans that do not have federally 

provided primary mortgage insurance. Farmer Mac II consists of agricultural mortgage loans with 

primary mortgage insurance provided by the U.S. Department of Agriculture. 

Second, we looked at a number of issues associated with Farmer Mac. For 

instance, our findings showed that Farmer Mac’s income had increased 

since 1999 and that its capital continued to exceed required levels. At the 

same time, however, the rapid growth in Farmer Mac’s standby 

agreements presents additional risk. We also identified trends indicating 

certain aspects of Farmer Mac’s risk management systems have not kept 
Page 4 GAO-04-827T 

pace with its increasingly complex portfolio. We made recommendations 

to Farmer Mac to enhance its risk management practices. Our study also 

pointed out that Farmer Mac faces some uncertainty involving its $1.5 

billion line of credit with the U.S. Treasury (Treasury). In particular, while 

the legal opinion of Farmer Mac’s outside counsel disagrees, Treasury has 

taken the position that it is not obligated to cover losses on the AMBS held 

in Farmer Mac’s portfolio because the Treasury line of credit is not for the 

purpose of protecting Farmer Mac shareholders or general creditors. 

AMBS totaled $1.5 billion and made up 35 percent of Farmer Mac’s total 

assets as of December 31, 2003. 

We found that Farmer Mac has increased its mission-related activities 

since we last reported on them in 1999.3

 However, Farmer Mac’s statute 

lacks specific or measurable mission goals beyond providing a secondary 

market and stable long-term financing. Without specific mission goals, it is 

difficult to meaningfully assess whether the increased activities are having 

the desired impact on the agricultural real estate market. In addition, 

Farmer Mac’s loan activities have been largely concentrated in a small 

number of financial institutions—during 2003, 80.8 percent of Farmer Mac 

I loan activities were with ten institutions—and its loan portfolio is 

concentrated in the West. Therefore, we concluded that Farmer Mac has 

increased its mission-related activities, but the public benefits derived 

from these activities are not clear. We suggested that Congress consider 

legislative changes to establish clearer mission goals for Farmer Mac. 

Further, because Farmer Mac has elected to retain nearly all its AMBS in 

its portfolio instead of selling them to investors in the capital markets, we 

could not ascertain the depth and liquidity of the secondary market for 

AMBS, which is unknown even in good market conditions. We made 

recommendations to Farmer Mac to reevaluate its current strategy of 

holding AMBS in its portfolio and issuing debt to obtain funding. 

Next, we found that Farmer Mac’s board structure may make it difficult to 

ensure that the board fully represents the interests of all shareholders and 

could hamper Farmer Mac’s efforts to comply with the independence 

requirements of the New York Stock Exchange’s (NYSE) listing standards. 

As a GSE, Farmer Mac has a board set by statute that contains elements of 

both a cooperative and an investor-owned publicly traded company. In 

 3

U.S. General Accounting Office, Farmer Mac: Revised Charter Enhances Secondary 

Market Activity, but Growth Depends on Various Factors, GAO/GGD-99-85 (Washington, 

D.C.: May 21, 1999). 
Page 5 GAO-04-827T 

most respects, Farmer Mac’s board policies and processes appear 

reasonable, but we found that some processes could be further developed 

and formalized and made recommendations to Farmer Mac to make them 

more transparent and consistent. We further suggested that Congress 

consider legislative changes to amend the structure of the Farmer Mac 

board and the structure of Farmer Mac’s Class C nonvoting common 

stock. 

Finally, we found that FCA had improved its oversight of Farmer Mac and 

strengthened its examination approach but that more needs to be done to 

enhance the assessment of risk-based capital and Farmer Mac’s 

accomplishment of its mission. This enhanced focus is especially 

important given Farmer Mac’s increasing risk profile, its concentration of 

business with few business partners in the West, and its holdings of nonmission related assets. Since the law does not include any measurable 

goals or requirements to assess Farmer Mac’s progress in furthering its 

mission, FCA lacks criteria and procedures to effectively oversee this 

aspect of Farmer Mac. We made several recommendations to FCA to 

enhance the effectiveness of its oversight. To further assist FCA’s with its 

oversight effort, we also suggested that Congress consider a legislative 

change to allow FCA more flexibility in setting minimum capital 

requirements for Farmer Mac. 

To update our information for this testimony, we met with representatives 

from Farmer Mac and FCA to discuss the status of our recommendations. 

We found that Farmer Mac has either taken actions to address or is in the 

process of implementing most of our recommendations. FCA is also 

engaged in efforts to address and implement our recommendations. FCA 

staff told us they considered and decided not to adopt certain elements of 

our recommendation to enhance the risk-based capital model for Farmer 

Mac, including a “run-off” approach, the effect of yield maintenance 

penalties, and the use of land value declines as the independent variable in 

loan loss regression. Since most of the actions undertaken by Farmer Mac 

and FCA will not be fully completed for some time, it is too early for us to 

evaluate their effectiveness. 
Page 6 GAO-04-827T 

Farmer Mac is a government-sponsored enterprise or GSE that was 

chartered by Congress in 1987.4

 It is a federally chartered and privately 

operated corporation that is publicly traded on the New York Stock 

Exchange. Farmer Mac is also an independent entity within the Farm 

Credit System or FCS, which is another GSE. As an FCS institution, 

Farmer Mac is subject to FCA’s regulatory authority. FCA, through OSMO, 

has general regulatory and enforcement authority over Farmer Mac. 

According to the 1987 Act, Farmer Mac, in extreme circumstances, may 

borrow up to $1.5 billion from the U.S. Treasury to guarantee timely 

payment of any guarantee obligations of the corporation.5

 Congress 

established Farmer Mac with a mission to create a secondary market—a 

financial market for buying and selling loans, individually or by 

securitizing them—in agricultural real estate and rural housing loans, and 

improve the availability of agricultural mortgage credit. When loans are 

securitized, they are repackaged into a “pool” by a trust in order to be sold 

to investors in the capital markets to generate liquidity. Generally, to carry 

out its mission, Farmer Mac purchases mortgages or bonds directly from 

lenders using cash generated by issuing debt obligations. It also issues 

standby agreements for eligible loans whereby Farmer Mac is committed 

to purchase eligible loans from financial institutions at an undetermined 

future date when a specific event occurs. The intent for these activities is 

to provide real estate credit to farmers at rates or conditions more 

favorable than those that would be available in the absence of Farmer 

Mac. Farmer Mac also securitizes the mortgages it purchases and issues 

AMBS and guarantees the timely payment of interest and principal on 

these securities. However, instead of selling the AMBS in the capital 

markets to generate cash, Farmer Mac holds most of the AMBS that it 

issues in its retained portfolio. 

Farmer Mac faces potential losses primarily from four sources: 

• Credit risk, or the possibility of financial loss resulting from default by 

borrowers on farming assets that have lost value; 

 4

Pub.L. No. 100-233. The Farm Credit Act of 1971, as amended by the Agricultural Credit 

Act of 1987 (the 1987 Act). 

5

Id. 

Farmer Mac Provides 

a Secondary Market 

for Agricultural Real 

Estate but Entails 

Certain Risks 

Farmer Mac Faces a 

Variety of Risks 
Page 7 GAO-04-827T 

• Liquidity risk, or the chance that Farmer Mac will be unable to meet its 

obligations as they come due; 

• Interest rate risk, or possible fluctuations in interest rates that negatively 

impact earnings or the balance sheet; and 

• Operations risk, or the potential that inadequate or failed internal 

processes, people and systems, or external events will affect financial 

condition. 

Although the federal government explicitly does not guarantee Farmer 

Mac’s obligations, it is generally assumed in financial markets that the 

government will not allow the GSE to default on its debt and AMBS 

obligations. In fact, during the 1980s the federal government provided 

financial assistance to both Fannie Mae and the Farm Credit System when 

they experienced difficulties due to sharply rising interest rates and 

declining agricultural land values, respectively. Because the markets 

perceive that there is an implied federal guarantee on Farmer Mac’s 

obligations, Farmer Mac can borrow money at interest rates that are lower 

than those generally available to comparably creditworthy private 

corporations and thus can extend credit and other forms of liquidity to 

financial institutions at favorable rates. 

The assets associated with Farmer Mac’s activities can generally be 

divided into program assets and nonmission investments. Program assets 

are agricultural mortgage loans held by Farmer Mac, the guaranteed 

securities backed by agricultural loans, and loans underlying Farmer Mac’s 

standby agreements. As of December 31, 2003, Farmer Mac’s loan and 

guarantee portfolio and standby agreements totaled about $5.8 billion. Of 

that total, nearly $3.1 billion was in off-balance sheet standby and similar 

agreements. Standby agreements represent a potential obligation of 

Farmer Mac that does not have to be funded until such time as Farmer 

Mac is required to purchase a loan. As such, these commitments are not on 

Farmer Mac’s balance sheet and are subject to a statutory minimum 

requirement of 0.75 percent capital instead of 2.75 percent for on-balance 

sheet assets. Let me point out that whenever Farmer Mac is obligated 

under a standby agreement to purchase a delinquent loan, it must also 

increase the capital held against the loan from 0.75 to 2.75 percent, nearly 

a 270 percent increase. Farmer Mac funds its loan purchases and other 

activities primarily by issuing debt obligations of various maturities. As of 

December 31, 2003, Farmer Mac had $2.8 billion of payable notes due 

within one year and $1.1billion of payable notes due after one year 

The Size and Composition 

of Farmer Mac’s Portfolio 
Page 8 GAO-04-827T 

outstanding. At the same time, Farmer Mac held approximately $1.1 billion 

in nonmission investments. 

Farmer Mac’s net income increased from $4.6 million in 1997 to $27.3 

million in 2003, for a total increase of 493 percent. Farmer Mac’s two 

primary revenue sources are (1) interest income earned on its loan 

portfolio, guaranteed securities, and nonmission investments, and (2) 

commitment fees earned on standby agreements. In recent years, Farmer 

Mac’s earnings growth has principally been driven by fees generated by its 

off-balance sheet standby and similar agreements, which grew rapidly 

from zero in 1998 to $3.1 billion as of December 31, 2003. 

Farmer Mac’s risk levels have increased along with its income. First, 

increased risk is apparent in the growing number of impaired loans, real 

estate owned, and write-offs of bad loans, as well as in the rapid growth in 

its on- and off-balance sheet loans, guarantees, and standby agreements. 

Impaired loans totaled $69.96 million at December 31, 2003, compared to 

zero at December 31, 1997. Part of our concern about the increased credit 

risk involves Farmer Mac’s loan loss model, which is based on loans that 

differ from those held in the corporation’s own portfolios and those 

covered under its standby agreements in terms of geographic distribution 

and interest rate terms. This lack of comparability and other limitations of 

the model may affect the reasonableness and accuracy of Farmer Mac’s 

estimated losses from credit risk either upward or downward. A 

complicating factor is that notwithstanding the quality of the loans 

underlying standby agreements, which have been performing better than 

the loans on Farmer Mac’s balance sheet, Farmer Mac lacks the historical 

experience with standby agreements that is needed to accurately estimate 

the type and amount of loans it may ultimately be obligated to purchase 

and any associated losses. 

Farmer Mac also faces potential liquidity risk as a result of these standby 

and similar agreements, which can create unexpected demands for 

additional funding. In other words, at a time when either the agricultural 

sector is severely depressed or interest rates are falling, Farmer Mac could 

be required to purchase large amounts of impaired or defaulted loans 

under the agreements, thus subjecting Farmer Mac to increased funding 

liquidity risks and the potential for reduced earnings. Although our study 

found that Farmer Mac has maintained sufficient liquidity to support its 

loan purchase and guarantee activity, Farmer Mac’s liquidity may not be 

adequate to cover its obligations under its standby or similar agreements. 

We did not have the necessary historical information to project the 

Farmer Mac’s Income 

and Risk Levels Have 

Increased 
Page 9 GAO-04-827T 

number of covered loans that Farmer Mac might need to purchase in the 

future. Thus, we could not determine the extent of the liquidity risk 

Farmer Mac might face. At the same time, Farmer Mac management did 

not have the quantitative data it needed to make accurate risk 

management and other operating decisions. 

As noted earlier, we made recommendations to Farmer Mac to enhance its 

risk management practices. We would like to report that Farmer Mac has 

responded to our recommendations but it is too early for us to assess the 

actions taken to implement them. Farmer Mac management recently 

showed us a loan classification system that will be completed in 2005 that 

is based on Farmer Mac’s loan loss experience. Staff are also now 

documenting the supporting underwriting decisions for loans that Farmer 

Mac management approved by overriding one or more specific criteria 

based on the compensating strengths of those loans. Farmer Mac has also 

adopted a formal contingency funding and liquidity plan but this plan does 

not address our concerns about providing for liquidity if a large amount of 

standby and similar agreement loans were put to Farmer Mac 

unexpectedly. Farmer Mac representatives told us they are also developing 

a capital adequacy model. In addition, Farmer Mac management said that 

they are working with an outside consultant to develop a prepayment 

model to ensure accurate interest rate risk measurements. 

Now I want to focus on an issue involving Farmer Mac’s $1.5 billion line of 

credit with Treasury that could impact the corporation’s long-term 

financial condition. This issue is significant because it centers around the 

AMBS in Farmer Mac’s retained portfolio, which as we have seen, makes 

up 35 percent of its total on-balance sheet assets of $4.3 billion and 26% 

percent of Farmer Mac’s total program assets of $5.8 billion—including 

off-balance sheet loans underlying the standby and other agreements. 

Treasury has expressed serious questions about whether it is required to 

purchase Farmer Mac obligations to meet Farmer Mac-guaranteed 

liabilities on AMBS that Farmer Mac or its affiliates hold.6

 On the other 

hand, a legal opinion from Farmer Mac’s outside counsel states that 

Treasury would be required to purchase the debt obligations whether the 

obligations are held by a subsidiary of Farmer Mac or by an unrelated third 

 6

Both Treasury and Farmer Mac are in agreement that the authority of Treasury to 

purchase obligations to enable Farmer Mac to fulfill its guarantee obligations does not 

extend to the standby agreements because they do not involve Farmer Mac’s guarantee 

liabilities. 

Disagreements about the 

Extent of Coverage of 

Treasury’s Line of Credit 

Could Generate 

Uncertainty 
Page 10 GAO-04-827T 

party. This disagreement could create uncertainty as to whether Treasury 

would purchase obligations held in Farmer Mac’s portfolio in times of 

economic stress. This uncertainty also relates to statements made by 

Farmer Mac to investors concerning Treasury’s obligation to Farmer Mac, 

which in turn, could affect Farmer Mac’s ability to issue debt at favorable 

rates. Ultimately, this uncertainty could impact its long-term financial 

condition. 

Farmer Mac’s subsidiary, Farmer Mac Mortgage Securities Corporation, 

holds the majority of AMBS that Farmer Mac issued. Farmer Mac’s charter 

(the 1987 Act) gives it the authority to issue obligations to the Secretary of 

the Treasury to fulfill its guarantee obligations. According to the 1987 Act, 

the Secretary of the Treasury may purchase Farmer Mac’s obligations only 

if Farmer Mac certifies that (1) its reserves against losses arising out of its 

guarantee activities have been exhausted and (2) the proceeds of the 

obligations are needed to fulfill Farmer Mac’s obligations under any of its 

guarantees.7

 In addition, Treasury is required to purchase obligations 

issued by Farmer Mac in an amount determined by Farmer Mac to be 

sufficient to meet its guarantee liabilities not later than 10 business days 

after receipt of the certification. However, Treasury has indicated that the 

requirement to purchase Farmer Mac obligations may extend only to those 

obligations issued and sold to outside investors. 

In a comment letter dated June 13, 1997, and submitted to FCA in 

connection with a proposed regulation on conservatorship and 

receivership for Farmer Mac (1997 Treasury letter),8

 Treasury stated “...we 

have ‘serious questions’ as to whether the Treasury would be obligated to 

make advances to Farmer Mac to allow it to perform on its guarantee with 

respect to securities held in its own portfolio—-that is, where the Farmer 

Mac guarantee essentially runs to Farmer Mac itself.” The 1997 Treasury 

letter indicated that if the purchase of obligations extended to guaranteed 

securities held by Farmer Mac this would belie the fact that the securities 

are not backed by the full faith and credit of the United States, since a loan 

to Farmer Mac to fulfill the guarantee would benefit holders of Farmer 

Mac’s general debt obligations. The 1997 Treasury letter stated “Treasury’s 

obligation extends to Farmer Mac only in the prescribed circumstances, 

and is not a blanket guarantee protecting Farmer Mac’s guaranteed 

 7

12 U.S.C.2279aa-13. 

8

Letter dated April 13, 1997, from then-Under Secretary for Domestic Finance, John D. 

Hawke, Jr., to Marsha P. Martin, then-Chairman of the Farm Credit Administration. 
Page 11 GAO-04-827T 

securities holders from loss. Nor is the purpose of the Treasury’s 

obligation to protect Farmer Mac shareholders or general creditors.” 

According to Treasury, the 1997 letter remains its position concerning 

Farmer Mac’s line of credit. 

Meanwhile, the legal opinion of Farmer Mac’s outside counsel is that the 

guarantee is enforceable whether AMBS are held by a subsidiary of 

Farmer Mac or by an unrelated third party. Farmer Mac’s legal opinion 

also states that Treasury could not decline to purchase the debt 

obligations issued by Farmer Mac merely because the proceeds of the 

obligations are to be used to satisfy Farmer Mac’s guarantee with respect 

to AMBS held by a subsidiary. According to Farmer Mac, if the conditions 

set forth in the 1987 Act are met—required certification and a limitation on 

the amount of obligations of $1.5 billion—then there is no exception in the 

1997 Act that authorizes Treasury to decline to purchase the obligations. 

Farmer Mac states that discriminating among Farmer Mac guaranteed 

securities based on the identity of the holder in determining whether 

Farmer Mac could fulfill its guarantee obligations would lead to an 

anomalous situation in the marketplace and thereby hinder the 

achievement of Congress’ mandate to establish a secondary market for 

agricultural loans. 

Before I go into whether Farmer Mac’s activities have had an impact on 

the agricultural real estate loan market, I want to point out that the 

enabling legislation contains only broad statements of the corporation’s 

mission and purpose. The legislation is not specific and does not provide 

measurable mission-related criteria that would allow for a meaningful 

assessment of Farmer Mac’s progress in meeting its public policy goals. 

Our attempt to determine the extent to which Farmer Mac had met its 

public policy mission led us to conclude that although Farmer Mac has 

increased its mission-related activities since our previous review, the 

public benefits derived from these activities are not clear. 

In trying to assess whether Farmer Mac had made long-term credit 

available to farmers and ranchers at stable interest rates, we found that 

from 2001 to 2002, its long-term fixed interest rates on Farmer Mac I loans 

were similar to the rates offered by commercial banks and FCS 

institutions. We also found that since 1998, Farmer Mac had been 

operating under a strategy of retaining the loans it purchased and 

securitized as AMBS in its portfolio. Farmer Mac stated that this strategy 

would lower funding costs and increase profitability but as a result, the 

Mission-related 

Activities Have 

Increased, but the 

Impact of Activities 

on Agricultural Real 

Estate Market Is 

Unclear 

Farmer Mac’s Strategy of 

Retaining AMBS Has 

Limited the Development 

of a Liquid Secondary 

Market for AMBS 
Page 12 GAO-04-827T 

depth and liquidity of the secondary market for AMBS is unknown. In our 

report, we recommended that Farmer Mac reevaluate this strategy. 

Recently, Farmer Mac management said that the corporation had 

reevaluated its strategy for holding AMBS but determined to continue 

holding them for economic reasons. However, Farmer Mac management 

also indicated that the corporation was committed to selling newly issued 

AMBS periodically, when the conditions of the capital markets and the 

size of loan pool made such transactions efficient. 

As I mentioned earlier, Farmer Mac has increased its mission-related 

activities, primarily by developing the standby agreement program. As of 

December 31, 2003, all of Farmer Mac’s standby agreements are with FCS 

institutions and 3 FCS institutions represented 51 percent of the standby 

agreement program. While standby agreements provide greater lending 

capacity for those institutions, they also lower the amount of capital 

lending institutions are required to hold against their loans. Fig. 2 shows 

the effect of standby agreements on the total capital required to be held 

against the underlying loans in the entire FCS. 

Standby Agreements 

Reduced Total Capital 

Required To Be Held in 

FCS 
Page 13 GAO-04-827T 

Figure 2: Impact of Standby and Similar Agreements on Total Required Capital Of 

Farm Credit System and Farmer Mac 

Our concern is that standby and similar agreements reduce the sum of 

capital required to be held by the Farm Credit System and Farmer Mac. 

Generally, institutions can help mitigate the risks associated with lower 

capital by maintaining a relatively large number of participating lenders 

and a geographically diverse portfolio. However, Farmer Mac’s business 

activities are concentrated among a small number of business partners and 

its portfolio is concentrated largely in the western United States. 
Page 14 GAO-04-827T 

Before discussing governance issues at Farmer Mac, I want to describe 

how Farmer Mac’s board of directors is structured in federal law. Farmer 

Mac’s 15-member board of directors includes 5 members elected by Class 

A stockholders, which include banks, insurance companies, and other 

financial institutions that do business with Farmer Mac; 5 members 

elected by Class B stockholders, which are FCS institutions that do 

business with Farmer Mac; and 5 members appointed by the President of 

the United States. Farmer Mac also issues nonvoting Class C stock to the 

general public. Class A and Class B shareholders are concerned with the 

use of Farmer Mac services, while Class C shareholders are generally 

investors concerned with maximizing their profits. 

According to statements made at the time Farmer Mac’s enabling 

legislation was being considered, this structure was intended to protect 

the interests of both FCS and commercial lenders by providing for equal 

representation by FCS, commercial lenders, and the public sector. Under 

this structure, Farmer Mac resembles a cooperative. At the same time, 

however, it is a publicly traded company, because its Class A and C stock 

are traded on the NYSE. But unlike most other publicly traded 

corporations, Farmer Mac is controlled by institutions with which it has a 

business relationship. For this reason, the board may face difficulties 

representing the interests of all shareholders. Good corporate governance 

requires that the incentives and loyalties of the board of directors of 

publicly traded companies reflect the fact that the directors are to serve 

the interests of all the shareholders. However, we found that the statutory 

structure of Farmer Mac’s board and the voting structure of its common 

stock hamper Farmer Mac’s ability to have such a focus. 

Farmer Mac is subject to NYSE listing standards on corporate governance, 

as well as statutory and regulatory requirements such as the SarbanesOxley Act of 2002. Collectively, these standards and provisions require that 

a majority of the board be independent and that key committees (audit, 

nominating or corporate governance, and compensation) consist entirely 

of independent directors. During our review, the listing standards were 

being revised and criteria for independence had not been finalized. 9

 Based 

on the proposed standards, our assessment was that business 

relationships between Farmer Mac and the directors of its board may have 

prevented these individuals from meeting the standards of independence 

under NYSE rules. In updating our information for this testimony, we 

 9

SEC approved NYSE listing standards SEC on November 4, 2003. 

Farmer Mac’s Board 

of Directors May Not 

Reflect All 

Shareholder Interests, 

Be Fully Independent, 

or Use Clear and 

Transparent 

Processes 
Page 15 GAO-04-827T 

noted that Farmer Mac’s 2004 annual proxy statements had identified 2 of 

15 directors as not meeting the independence standards. One of the 2 

directors is not a nominee for re-election. The other director has decided 

to withdraw as a member of the corporate governance committee if 

elected as a director at 2004 annual meeting. 

We found that Farmer Mac’s board nomination process, director training, 

and management succession planning were not as concise, formal, or well 

documented as best practices would suggest. We also found that Farmer 

Mac’s stock option vesting program appears generous compared to 

general industry practices. We made recommendations to Farmer Mac’s 

board to improve the transparency and disclosure of these processes and 

to reevaluate stock option levels and vesting period. Since our 2003 report, 

according to Farmer Mac management, the board has reviewed and 

confirmed that all board members fully understand the nomination 

process and that it has established a formal executive management 

succession plan. Further, the board has initiated a formal training program 

for its members that included external training and briefings on subjects 

relevant to the operations of Farmer Mac. Finally, the board had extended 

the vesting period of the corporation’s stock options. 

The final area of our 2003 review involved regulatory oversight of Farmer 

Mac. We reported that since 2002 FCA had taken several steps to enhance 

supervisory oversight of Farmer Mac but it faced significant challenges 

that could limit its regulatory effectiveness. We made several 

recommendations to FCA designed to enhance the risk-based capital 

model, improve off-site monitoring of Farmer Mac, and help assess and 

report how well Farmer Mac is achieving its mission. In updating our 

information for this testimony, we found that FCA had taken or planned to 

take a number of actions to further address many of our concerns and 

recommendations. 

During our 2003 review, we noted that FCA had begun strengthening its 

oversight of Farmer Mac by doing a more comprehensive safety and 

soundness examination and undertaking initiatives to expand its 

regulatory framework. These initiatives included developing regulations to 

limit the level and quality of Farmer Mac’s nonmission investments and 

issue specific liquidity standards, and studying the implications of 

regulatory capital arbitrage between FCS institutions and Farmer Mac. 

However, we found that FCA continued to face significant challenges in 

sustaining and improving its oversight and more remained to be done to 

FCA Has Continued to 

Take Steps to 

Enhance Its Oversight 

of Farmer Mac 

FCA Has Taken Steps to 

Enhance Oversight of 

Farmer Mac, but Faces 

Challenges That Could 

Limit the Effectiveness of 

Its Oversight 
Page 16 GAO-04-827T 

improve its off-site monitoring, assessment of risk-based capital, and 

mission oversight. For example, FCA had not been updating and 

reformatting Farmer Mac’s call report schedules and corresponding 

instructions to fully conform to FCA regulations and to reflect recent 

accounting changes. We also identified a number of issues related to the 

data used in and structure of FCA’s risk-based capital model, but the 

overall impact these issues have on the estimate of risk-based capital for 

Farmer Mac’s credit risk is uncertain. Some concerns, such as the 

potential undercounting of loans which experienced credit losses, or 

greater prepayment of the loans in the database used to build FCA’s credit 

risk model relative to the kinds of loans that Farmer Mac now purchases, 

may result in the FCA credit risk model underestimating the credit risk 

capital requirement. Other issues, such as lacking a variable to track land 

price changes for any but the year with the most economic stresses, may 

cause the model to overestimate the credit risk capital requirement. 

Augmented data and more analysis could better determine the relative 

magnitudes of these effects. 

Our study found that FCA’s oversight of Farmer Mac had typically focused 

on safety and soundness and that FCA lacked criteria and procedures to 

effectively oversee how well Farmer Mac achieves its mission. At the same 

time, Farmer Mac’s enabling legislation is broadly stated and does not 

include any measurable goals or requirements to assess progress toward 

meeting its mission. More explicit mission goals or requirements would 

help FCA in improving its oversight of Farmer Mac. 

Since our 2003 report, FCA has continued to make a concerted effort to 

further enhance its oversight of Farmer Mac. First, FCA staff are drafting 

regulatory revisions to the risk-based capital model that covers a range of 

issues. They plan to present a proposed rule to the FCA board for 

consideration in the fall of 2004. According to FCA officials, they are 

engaged in efforts to address the issues related to the risk-based model 

raised in our report but there are certain elements of our recommendation 

they have considered and decided not to adopt, including a “run-off” 

approach, the effect of yield maintenance penalties, and the use of land 

value declines as the independent variable in loan loss regression. Second, 

FCA has made some revisions to the Farmer Mac quarterly call reports, 

and is in process of making additional revisions. These initial revisions 

included adjustments to call report schedules that were identified during 

our 2003 review. FCA has a number of capital-related projects in progress 

that, taken collectively, may address the issue of capital arbitrage within 

the Farm Credit System. In addition, FCA has a number of ongoing 

projects that may address our recommendation related to requiring 
Page 17 GAO-04-827T 

Farmer Mac to obtain a credit rating. Finally, FCA has begun planning for 

a project that will consider different approaches for assessing the impact 

Farmer Mac’s activities have on the agricultural real estate lending market. 

Our 2003 review showed that Farmer Mac’s income, mission-related 

activities and risks have all increased since we last reported in 1999. At the 

same time, we found that Farmer Mac, FCA, and Congress could each take 

actions to ensure that Farmer Mac operates in a safe and sound manner 

while fulfilling its public policy mission. We recommended in our report 

that Farmer Mac strengthen its risk management and corporate 

governance practices and reevaluate its strategies to carry out its mission. 

Our report also recommended that FCA make several enhancements to its 

oversight tools to more effectively oversee both the safety and soundness 

and mission of Farmer Mac. Farmer Mac and FCA agreed with several of 

our report’s findings and conclusions. During our recent discussions with 

Farmer Mac and FCA, both entities demonstrated that they are taking 

steps to implement many of our recommendations. Finally, our report 

suggested that Congress consider making legislative changes to ensure 

that Farmer Mac’s public benefits can be measured and FCA has the 

necessary flexibilities to carry out its oversight responsibilities. 

Mr. Chairman, this concludes our prepared statement. We would be happy 

to respond to any questions you or other members of the Committee may 

have at this time. 

For information about this testimony, contact Davi D’Agostino, Director, 

Financial Markets and Community Investment, at (202) 512-8678, or 

Jeanette Franzel, Director at (202) 512-9471. In addition to the individuals 

named above, Rachel DeMarcus, Debra Johnson, Austin Kelly, Paul 

Kinney, Bettye Massenburg, Kimberley McGatlin, John Treanor, and Karen 

Tremba made key contributions to this testimony. 

Conclusions 

GAO Contacts and 

Staff 

Acknowledgements 

(250174) 
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