FSA, established by the Federal Crop Insurance Reform and Department of Agriculture Reorganization Act of 1994 (P.L. 103-354, Oct. 13, 1994), provides, among other things, direct government-funded loans to farmers and ranchers who are unable to obtain financing elsewhere at reasonable rates and terms. For example, direct farm ownership loans are made for buying farm real estate and making capital improvements. Direct farm operating loans are made for purposes such as buying feed, seed, fertilizer, livestock, and farm equipment and paying family living expenses. Additionally, emergency disaster loans are made to farmers and ranchers whose operations have been substantially damaged by adverse weather or other natural disasters. When a borrower does not repay his or her loans, FSA has various tools to resolve the delinquency, such as (1) restructuring the loans, which may include reducing debt; (2) allowing a borrower who does not qualify for restructuring to make a payment for less than the amount owed, which results in FSA’s forgiving the balance; and (3) reaching a final resolution of the debt that may or may not include a payment by the borrower, which also results in debt forgiveness. The Consolidated Farm and Rural Development Act, as amended (P.L. 87-128, Aug. 8, 1961), which is referred to as the Con Act, is the basic authority for the farm loan programs. Table 1 shows that as of September 30, 1997, about 110,000 borrowers owed FSA about $9.7 billion on active direct farm loans; these figures represent 9.5 percent fewer borrowers and 14.8 percent less debt compared with those of September 1995. About 18,600 borrowers were delinquent at the end of September 1997; these borrowers owed about $2.7 billion, or 28.2 percent of the total outstanding principal. This delinquency rate is an improvement from the delinquency rates in September 1996 and 1995, which were 34.2 percent and 40.7 percent, respectively. Table 1 also shows that borrowers with larger amounts of debt had higher delinquency rates than borrowers owing smaller amounts. In 1997, for example, about 72 percent of the principal held by borrowers with loans totaling $500,000 or more was held by delinquent borrowers, whereas about 25 percent of the principal held by borrowers with loans totaling less than $500,000 was held by delinquent borrowers. Borrowers in a small number of states accounted for a disproportionate share of the total delinquent debt in FSA’s farm loan portfolio. For example, borrowers in five states owed slightly over 40 percent of the total delinquent debt at the end of fiscal year 1997. This compares with about 36 percent and 34 percent at the end of fiscal years 1996 and 1995, respectively. Appendix I provides information on the five states with the most delinquent debt in each of these 3 fiscal years. FSA incurs losses when it writes off the direct farm loans of delinquent borrowers through its debt settlement process, which essentially represents the agency’s final resolution of unpaid loans and generally occurs after loan-security property has been liquidated. In fiscal year 1997, FSA wrote off about $380 million through debt settlements, which is down from the more than $860 million written off in fiscal year 1996 and $780 million written off in fiscal year 1995. In total, about 7,600 borrowers had slightly more than $2 billion written off during this 3-year period. FSA has the following four options for resolving debts in its debt settlement process: Adjustment. A borrower agrees to make, at some time in the future, one payment, or a series of payments, that is less than the amount owed. Compromise. The debt is satisfied when a borrower makes an immediate single lump-sum payment that is less than the amount owed. Cancellation. The debt is written off without any payment made, and the borrower is released from further liability because FSA believes that the borrower has insufficient potential to make additional payments. Charge-off. The debt is written off without any payment made, and FSA ends collection activity, but the borrower is not released from liability for the amount owed. Table 2 summarizes the amount of debt written off during the fiscal year 1995-97 period through each of the four debt settlement options. As the table shows, a comparatively small number of borrowers who had a large amount of debt written off accounted for a substantial portion of the write-offs. In 1997, for example, 182 borrowers, or about 9 percent of those whose debts were written off, had $500,000 or more forgiven; these borrowers received about 48 percent of the total debt forgiveness. Borrowers in a small number of states accounted for a disproportionate share of the write-offs. Specifically, borrowers in the five states with the most write-offs each year received about 48 percent of the total write-offs during this 3-year period. Appendix II provides information on the five states with the most write-offs during each of these 3 fiscal years. Three statutory provisions were enacted in the mid-1990s that provide FSA with discretionary authority to contract for loan-servicing assistance. These provisions authorize, but do not require, contracting with (1) private attorneys to obtain legal assistance in resolving delinquent farm loan accounts, (2) private lenders to obtain assistance in servicing farm loan borrowers’ accounts, and (3) private collection agencies to obtain assistance in collecting delinquent farm loans. FSA has made little use of these authorities: It has contracted with private attorneys in only two states; it has not contracted with private lenders or with private collection agencies and is not actively considering doing so. The Farmers Home Administration Improvement Act of 1994 (P.L. 103-248, May 11, 1994) gave FSA discretionary authority to contract with private attorneys to assist in resolving delinquent farm loan accounts. The process for using the new contracting authority generally starts with a request for legal assistance from an FSA state office to FSA’s Farm Credit Programs at headquarters. Farm Credit Programs then refers the request to USDA’s Office of General Counsel (OGC), which after its review may refer the matter to the Department of Justice. Justice, in consultation with FSA and USDA’s OGC, reviews the situation to see if (1) the farm loan cases can be handled by the U.S. Attorney’s office that has jurisdiction for the area, (2) the cases can be referred to a private attorney under contract with Justice, or (3) FSA should use its authority to contract with a private attorney. FSA is required to obtain the approval of both OGC and Justice before it can enter into a contract with a private attorney. Once OGC and Justice have approved FSA’s request for contracting, FSA’s state office solicits bids and subsequently enters into contracts, with OGC providing legal advice to the contracting office. To date, FSA has contracted with private attorneys to obtain assistance in resolving delinquent farm loan accounts in only two states—Louisiana and New Jersey—and has no plans to expand its use in other states. Specifically, following the process described above, FSA’s Louisiana state office entered into contracts with nine law firms to handle foreclosure cases in October 1995. As of February 1998, two of the nine firms were no longer under contract. According to FSA’s state officials, the agency canceled one contract at the law firm’s request and the other because of noncompliance with the terms of the contract. Through February 10, 1998, FSA had referred a total of 156 foreclosure cases to the law firms. Sixty-four of these cases had been settled, with collections totaling $2.2 million; borrowers in another nine cases had filed for bankruptcy; and the remaining cases were ongoing. The cost of legal services was about $58,000, excluding the attorneys’ reimbursable expenses, such as court filing fees. Concerning New Jersey, USDA officials told us that FSA’s New Jersey state office contracted with a law firm after approval by the U.S. Attorney’s office with jurisdiction there. No farm loan cases in New Jersey had been referred to the private law firm, and the USDA officials said they anticipate that none will be. Little consideration has been given within USDA for additional contracting by FSA because its needs for legal assistance are being satisfied by Justice. In two states, Justice has been referring problem farm loan cases to private attorneys that it has under contract. Specifically, according to a Justice official, the Department has referred such cases in the middle district of Florida since March 1993 and the southern district since January 1994—both before FSA received its contracting authority. The Justice official also told us that farm loan foreclosure cases in the northern district of New York are being handled by private attorneys under contract with Justice. FSA and OGC officials said that FSA has additional legal needs in New York, which will probably also be met by referring cases to private attorneys under contract with Justice. The OGC official also said that USDA discussed FSA’s legal needs in Idaho with Justice, and, as a result, the U.S. Attorney’s office has increased legal action on farm loan cases in that state. Finally, state law can have a considerable bearing on FSA’s legal needs involving problem farm loan cases. Specifically, when state law provides for nonjudicial foreclosure—that is, when judicial process is not needed for a lender to foreclose the loan-security property of a delinquent borrower—FSA has less need for legal assistance than when state law requires judicial process in foreclosure cases. According to USDA officials, about half of all states allow nonjudicial foreclosure. The Federal Agriculture Improvement and Reform (FAIR) Act of 1996 (P.L. 104-127, Apr. 4, 1996) gave FSA discretionary authority to contract with private lenders to assist in servicing outstanding loans, including contracting for one or more pilot projects to test the concept. To date, FSA has not used this authority and is not actively considering its use. Agency officials told us that the new contracting authority is not needed for three reasons. First, they stated that USDA’s recent reorganization of various farm program functions and offices has resulted in an increased number of field staff available to service farm loan borrowers. While this may be true, we note that FSA continues to have problems in servicing farm loans. Specifically, our review of FSA’s internal control reviews during fiscal year 1997 found that the agency’s field officials do not always follow FSA’s own loan-servicing standards. For example, as table 3 shows, FSA’s rates of noncompliance on four key loan-servicing standards ranged from about 17 to 29 percent. The problems identified in FSA’s fiscal year 1997 internal control reviews were not unique. For example, FSA’s internal control reviews in fiscal years 1995 and 1996 showed a total 20.6-percent rate of noncompliance with the requirement that field staff analyze borrowers’ operations and assist in planning, a 20.3-percent rate of noncompliance with the requirement that annual chattel inspections be performed to ensure that security property is being maintained, and a 16.8-percent rate of noncompliance with the requirement that office and field visits with borrowers be documented to reflect adequate supervision. FSA’s officials acknowledged that the agency has a problem with loan servicing. They said that the agency’s field staffs, which now include people who had previously worked on USDA’s farm payment programs but not on the farm loan programs, need to be specifically assigned to work on farm loans and trained in credit matters. They anticipate that these actions will be taken in the future. The second reason cited by FSA’s farm loan officials for not contracting with private lenders is because they use other discretionary authority to contract with entities besides lenders for some servicing of farm loans, such as with local management consulting firms and accounting firms to review borrowers’ operations and financial reports and with local appraisal companies to appraise property used as security for loans. We confirmed that FSA has employed such contractors for some loan-servicing activities. Finally, FSA’s farm loan officials said they have not contracted with private lenders because such contracting would increase their cost of operating the farm loan programs. FSA has not, however, estimated either the cost or potential benefits of loan-servicing assistance. The statutory provision authorizing contracting with private lenders required USDA to report to the Congress by September 30, 1997, on its experience in using contracts. USDA did not file this report because it did not contract with any private lenders for loan-servicing assistance. The FAIR Act also gave FSA discretionary authority to contract with private collection agencies to assist in collecting on unpaid accounts. However, as of March 1998, FSA had not contracted with private collection agencies for assistance, and FSA’s officials are not actively considering such contracting. The officials said they are not using this authority because, before FSA can contract with private collection agencies, it must complete the Con Act’s servicing requirements, as discussed below, that apply to borrowers with delinquent loans. However, because this process often takes more than 180 days, FSA is required to transfer delinquent accounts to the Department of the Treasury for collection action, which precludes FSA from contracting for the services itself. This transfer is in accordance with the Debt Collection Improvement Act of 1996 (DCIA)—section 31001 of P.L. 104-134, Apr. 26, 1996—which was enacted shortly after FSA was given its authority to contract with private collection agencies. When a borrower misses a loan payment, the Con Act’s requirements and FSA’s implementing regulations provide the following process for servicing the delinquent loan. Specifically, when a borrower is 90 days past due on a scheduled payment, FSA is to formally notify the borrower of its available loan-servicing options, such as the possibility of restructuring the outstanding loans. Generally, the delinquent borrower has 60 days to apply for servicing. If the borrower applies for restructuring, FSA has 90 days to process the application and to notify the borrower if he or she qualifies for restructuring. After notification, FSA has 45 days to offer to restructure the borrower’s debts. If the borrower did not qualify for restructuring, the borrower has 90 days to make a buyout payment to FSA that is based on the value of property used as security for the loan. When the borrower does not apply for servicing or when the borrower does apply but restructuring or a buyout does not occur, FSA will demand full repayment of the debt. If the payment is not made, FSA starts the liquidation phase of its servicing, which may include foreclosure action, and then debt settlement. FSA’s farm loan officials told us that the agency needs to complete its loan servicing for borrowers, including debt settlement, before it could consider private collection services. Furthermore, in debt settlement, only delinquent borrowers whose debts are charged off by FSA remain liable for the unpaid amounts of their loans and would be subject to debt collection action. However, because of the time required for servicing delinquent accounts, most of these borrowers have been delinquent for at least 180 days. As a result, under the DCIA, FSA is required to transfer the accounts to Treasury for collection action. Once the accounts are transferred, Treasury may refer these borrowers to one of the private collection agencies that it has contracted with for collection action. USDA officials also said that Treasury officials have told them to forward any accounts that are less than 180 days delinquent, after the loan security has been liquidated, for referral to one of Treasury’s collection contractors. At the time of our review, none of FSA’s farm loan accounts had been or were ready to be transferred to Treasury, nor was Treasury ready to receive delinquent accounts. FSA officials told us that the agency has to complete two tasks before any accounts can be transferred. First, FSA has to modify the format of its automated farm loan record system because the current format does not meet Treasury’s requirements. Second, each borrower whose debt was charged off has to be reviewed by FSA’s field offices to ensure that the account qualifies to be transferred—for example, the borrower is not in litigation, foreclosure, or bankruptcy, and the statute of limitations on pursing collections has not expired. FSA officials estimated that both the modification of their automated system and the review of the borrowers would be completed by September 1998. We provided a draft of this report to USDA and met with Department officials to obtain their comments. These officials included the Farm Service Agency’s Deputy Administrator for Farm Credit Programs and the Director of the Loan Servicing and Property Management Division and the Office of General Counsel’s Associate General Counsel for Rural Development. The USDA officials generally agreed with the material contained in the report and offered technical corrections and suggestions for clarifying the report. We made these corrections and incorporated their suggestions as appropriate. We performed our work from January through April 1998 in accordance with generally accepted government auditing standards. Our scope and methodology are discussed in appendix III. As agreed, unless you publicly announce its contents earlier, we plan no further distribution of this report until 14 days from the date of this letter. At that time, we will send copies of this report to the appropriate Senate and House committees; interested Members of Congress; the Secretary of Agriculture; the Administrator of FSA; the Director, Office of Management and Budget; and other interested parties. We will also make copies available to others upon request. Please call me at (202) 512-5138 if you or your staff have any questions. Major contributors to this report are listed in appendix IV. This appendix provides information on the Farm Service Agency’s (FSA) active direct farm loans in the five states with the highest amounts of delinquent debt. Tables I.1, I.2, and I.3 show the total amount of outstanding principal and the portion owed by delinquent borrowers at the end of fiscal years 1997, 1996, and 1995, respectively. The tables also provide this information for borrowers in two ranges of outstanding principal—those owing less than $500,000 and those who owe $500,000 or more. This appendix provides information on write-offs of direct farm loans by FSA in settling delinquent borrowers’ debts through the debt settlement process in the five states with the highest amounts of write-offs. Tables II.1, II.2, and II.3 show the total amount of debt written off for borrowers who have undergone debt settlements during fiscal years 1997, 1996, and 1995, respectively. The tables also provide this information for borrowers by two ranges of write-offs—those who received less than $500,000 and those who received $500,000 or more in debt forgiveness. As requested, our objectives were to assess (1) the levels of outstanding principal on active direct farm loans at the end of fiscal years 1995 through 1997, including the amounts owed by delinquent borrowers; (2) the amount of debt written off by FSA through the debt settlement process in fiscal years 1995 through 1997; and (3) FSA’s use of three statutory provisions enacted in the mid-1990s that authorize FSA to contract with private attorneys for legal assistance in resolving delinquent farm loan accounts, private lenders for assistance in servicing farm loan borrowers’ accounts, and private collection agencies for assistance in collecting delinquent farm loans. To address the first two objectives, we obtained and analyzed information in the computerized databases in FSA’s St. Louis Finance Office and in the agency’s various financial reports on the farm loan portfolio. As requested, this effort included compiling information on borrowers who owe less than $500,000 and those who owe $500,000 or more, the five states with the highest amounts of delinquent debt, borrowers who received write-offs of less than $500,000 and those who received write-offs of $500,000 or more, and the five states with the highest amounts of write-offs. We did not verify the accuracy of the information contained in these databases or reports. To address the third objective, we reviewed the three statutory provisions and their legislative histories. We interviewed FSA’s officials, including the Deputy Administrator for Farm Credit Programs, the Director of the Loan Servicing and Property Management Division, and the Director of the Financial Management Division; and the U.S. Department of Agriculture’s (USDA) Associate General Counsel for Rural Development. Additionally, concerning the authority to contract with private attorneys, we discussed contracting by the Department of Justice with its Director of Debt Collection Management; and we reviewed the executive memorandum for USDA and Justice on FSA’s contracting, USDA’s and FSA’s operating documentation, and statistical information we obtained from FSA’s Louisiana state office. On contracting with private collection agencies, we reviewed the requirements of the Debt Collection Improvement Act of 1996 concerning the transfer of delinquent accounts to the Department of the Treasury and guidance issued by Treasury on using the private collection agencies that it has under contract. Our work was performed from January through April 1998 in accordance with generally accepted government auditing standards. Charles M. Adams, Assistant Director Oliver H. Easterwood Jerry D. Hall Patrick J. Sweeney Larry D. Van Sickle The first copy of each GAO report and testimony is free. 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Summary: Pursuant to a congressional request, GAO provided information on: (1) the levels of outstanding principal on active direct farm loans at the end of fiscal years (FY) 1995 through 1997, including the amounts owed by delinquent borrowers and the amount of debt written off by the Farm Service Agency (FSA) through the debt settlement process in each of these fiscal years; and (2) FSA's use of three statutory provisions enacted in the mid-1990s that authorize FSA to contract with the private sector to resolve delinquent loans. GAO noted that: (1) the size of the Farm Service Agency's direct farm loan portfolio has decreased in recent years; (2) the outstanding principal on active farm loans totalled about $11.4 billion in September 1995, $10.5 billion in September 1996, and $9.7 billion in September 1997; (3) the percentage of the portfolio held by delinquent borrowers--those who were at least 30 days past due on loan repayment--also decreased; (4) in September 1995, delinquent borrowers held 40.7 percent of the outstanding principal on direct farm loans; the delinquency rates for 1996 and 1997 were 34.2 percent and 28.2 percent, respectively; (5) FSA wrote off about $380 million for almost 2,000 borrowers in fiscal year (FY) 1997 through its debt settlement process, which essentially represents the agency's final resolution of unpaid loans and generally occurs after loan-security property has been liquidated; (6) previously, the agency has written off about $860 million and $780 million in (FY) 1996 and 1995, respectively; (7) of the more than $2 billion that was written off during the 1995-1997 period, most--81.5 percent--was written off with no payments to the agency by the borrowers at the time of debt settlement; (8) the extent of these write-offs underscores the high risks associated with the agency's farm loans; (9) to date, FSA has made only limited use of one of the three new loan-servicing authorities it was given in the mid-1990s; (10) specifically, it has contracted with private attorneys to obtain legal assistance in resolving delinquent farm loan accounts in two states and has no plans to expand its use in other states; (11) in regard to the other two authorities, FSA has not contracted with private lenders or with private collection agencies and is not actively considering such contracting; and (12) agency officials said they have not used these new contracting authorities more extensively because, among other things, they can obtain assistance from the Department of Justice and the Department of the Treasury or they can perform the servicing functions with their own personnel.