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Inside Farmer Mac’s risk management machine

At 25, agency is very different creature than at the start

"We reduced maximum LTV ratios for certain areas without losing business. You won't see institutions looking to win business by doing higher LTV loans or farmers wishing to over-lever operations," says Tim Buzby, president and CEO of Farmer Mac, in an interview. "We reduced maximum LTV ratios for certain areas without losing business. You won't see institutions looking to win business by doing higher LTV loans or farmers wishing to over-lever operations," says Tim Buzby, president and CEO of Farmer Mac, in an interview.

Tim Buzby would be first to admit that he’s not farm-raised. “I grew up in a little town in south New Jersey that does have a lot of farming, but I never actually worked on a farm,” says the president and CEO of Farmer Mac. “Having been here for 13 years now, it’s amazing how it rubs off on you.”

But Buzby, the agency’s CFO prior to stepping up to the top staff post a year ago, hasn’t been satisfied with merely learning from the numbers (which he can quote from memory). He often joins Farmer Mac’s outreach staff when they visit with the bankers and Farm Credit System institutions that use, or could use, the company’s services. He’s also visited farms, interested in learning more about the people whom he sees as the ultimate customers of Farmer Mac’s services.

“Outreach is important,” says Buzby. “We find that a lot of people are aware of Farmer Mac, but they don’t fully understand what we do. But I like to say that the best meetings I go to are the ones where somebody else does most of the talking, so we can figure out ways to help.”

Farmer Mac has passed the 25-year milestone, having come into being with significant participation by ABA. (The association continues as a partner today, through which members qualify for special pricing.) The first of four significant revisions of its charter came in 1990, each step building on the original model. Buzby notes that amendments made in 1996 helped business really take off.

Beyond mere longevity, Farmer Mac has passed two financial milestones. In 2012, it purchased $1.1 billion of farm and ranch loans and U.S. Department of Agriculture guaranteed securities in a single calendar year—more than double the volume seen in 2008. The corporation’s outstanding business volume came to $13 billion.

Buzby says Farmer Mac is poised to exceed 2012’s volume by “quite a bit. And I think that we will likely exceed that again next year.”

He adds that “if you had told me five years ago that we were going to purchase $1 billion in loans in 2012, I would have said, ‘You need to explain to me how we’re going to do that.’ Now, if you told me that we’re not going to do $2 billion annually five years from now, I’d ask you to explain to me why not.”

Sources of volume vary from year to year. Over the last couple of years, the business from Farm Credit System institutions has been down and that from banks has been on the upswing, says Buzby. Putting aside activity in rural utility credit and USDA loans, he says, banks account for about 75% of agency volume currently.

Part of the driving force behind the growth is today’s interest rate challenge.

“Long-term fixed rates are the primary driver of much of the business that comes to us,” says Buzby. Bankers see this as a time to investigate ways to give farmers the fixed rates they want to lock in without putting the bank into a bind as market rates rise.

In addition, many small banks have customers who may be outgrowing the bank. “There’s the constant need to keep customers you have and to gain new ones,” says Buzby. “They are looking to lay off risk, and we like to be there for them to do that with us.”

We spoke with Buzby at Farmer Mac headquarters in Washington, D.C. Here are additional highlights of the interview, edited for clarity.

ABABJ: Enterprise risk management is a challenge facing banks of all sizes. Farmer Mac’s services address liquidity, credit, rate, market, and concentration risks. Is that an angle that brings more banks into your customer base?

Buzby: We don’t directly offer tools like stress-testing models, though we can provide industry statistics to bankers for their risk-management planning. But part of our overall understanding of our market—how we decide where we’re going to get the most bang for our buck—is through looking at banks’ call reports and seeing who is concentrated in ag. We see what their capital positions are and who has had strong growth, so we can target market and offer financing to institutions that may be facing risk-management issues.

We try to get to either the people who lend or the people who handle risk management. Often the ag lending group is trying to grow the portfolio. So they are not incented to sell loans, necessarily. On the other hand, the treasurer’s office or the CFO within that same bank might be looking at their loan-to-deposit ratio and determining that, in fact, they would love to have an outlet to sell loans, but they might not be familiar with Farmer Mac. If we can get the ag folks talking to the finance folks, together we can come up with something that works.

ABABJ: Risk management is something Farmer Mac itself must be concerned with, too.

Buzby: Internally, we do a lot of stress testing, capital-adequacy management. We have a regulator [Farm Credit Administration’s Office of Secondary Market Oversight] that is solely focused on us. They look at us as a financial institution that has credit risk, interest rate risk, capital risk, liquidity risk. We have our own internal policies and procedures. They look very closely at how those have been developed and how they’ve evolved.

ABABJ: One of the major points of Dodd-Frank, regarding the residential mortgage secondary market, is the concept of “skin in the game.” But that element of the original Farmer Mac schematic was eliminated in 1996, so that you can now buy 100% of loans.

Buzby: Before the change, the skin-in-the-game requirement was causing institutions to feel if they kept the first 10% of risk on an ag real estate portfolio, that they hadn’t really put off any risk. And the banks’ regulators didn’t feel that Farmer Mac was absorbing any risk, and the banks weren’t getting any capital benefit then.

So, typically, now we take all the risk in a portfolio. However, in order to provide a pricing advantage for some institutions, we’ll let them keep a first-loss position—1%, 2%, 3%, say—in exchange for a lower fee. If we’re talking to a lender about selling us a pool of loans or entering into a long-term standby purchase agreement, and they think the price is too high, we’ll try to lower the price that way, or we’ll encourage them to give us better loans.

They might want to shed, say, $50 million worth of risk on these types of loans. What are they willing to pay to shed that risk? They could just sell those loans and that risk would be gone. But then their portfolio shrinks, so they may not want to do that.

They may be willing to pay 30 basis points a year for that, but not 50. We may be charging 45. We try, in those discussions, to be a completely open book. We tell them what our costs are, and we try to run a very efficient operation, so people don’t see their bank as paying for our operation.

ABABJ: Where do you see ag land prices going?

Buzby: I don’t think we’re in the midst of a bubble that’s going to crash. Land values get talked about in the aggregate, generally, but there are certainly many pockets around the country where the trajectories are different. Often, individual transactions get talked about that are not representative of agriculture for that broad a region.

I think there’s a healthy balance right now in terms of people who are buying the land to farm over the long term, not to buy and sell in three years at a profit. So I try not to focus on land values and what that means for a specific farmer. I look more at the overall health of agriculture.

If commodity prices remain reasonable or strong, that should bode well for the farmer overall. You know, when corn prices are at $7, that’s great for corn farmers, but it’s not necessarily good for those farmers who use corn as an input. Most of the farmers producing crops will make money this year. And those who are using those crops for inputs are much better off than they were a year or so ago.

ABABJ: Farmer Mac has exposure in deals involving over 100 different commodities. Are there any of concern to you?

Buzby: Within the past year, we reduced our maximum LTV ratios for certain areas of the country. I don’t think that has, in any way, caused us to lose any business. It’s just a precaution. I don’t think we’ll see institutions looking to win business by doing higher LTV loans. I don’t think you see many farmers wishing to over-lever their operations.

Specifically, 60% LTV is our maximum in those areas that I mentioned. It’s not like every loan we’re doing there is at 60%. The average in our portfolio is in the low 50s and that’s original LTV. So over the past decade, we’ve done a lot of loans with an original LTV average in the 50s, and since then, for all of those loans, you’ve had the principle balances paid down, and generally you’ve seen land prices come up. So I think we’re in a pretty good position.

ABABJ: When you do deals for loans, how long are they typically under your roof?

Buzby: Until they’re gone. So generally, whether it is a loan that we’ve purchased or a long-term standby purchase commitment, generally, once a loan is put into the program, it’s there for its life—on average, seven-plus years on a weighted-average term.

ABABJ: A change was made, too, in the first half of 2012, regarding debt-coverage ratios.

Buzby: That was a similar change in time when we changed the LTV standards. Again, we were taking a look at the overall standards and tightening things up a bit. Not because we were overly concerned or had any specific issues, but just an adjustment that we thought made sense. We don’t want to be in a position where we’re sacrificing quality in order to gain quantity.

ABABJ: You came to Farmer Mac from the residential mortgage world. Securitization, once hot, has been weak to moribund since the crisis. How would you describe Farmer Mac’s current and future use of securitization?

Buzby: Many people make the argument we were created to be like Fannie Mae and Freddie Mac. While that may have been the case, we almost immediately departed from their business model. Our business is very different from the homogenous commodity of home mortgages in which Fannie and Freddie for a period of time securitized very successfully. The concept had been that we could replicate their model. But in actual practicality, it hasn’t come to bear.

Ag mortgages are difficult to securitize because they’re not homogenous. They have different payment characteristics, and you have collateral types that are very different. Prepayment characteristics, therefore, are very difficult for investors to model. And, quite frankly, the ultimate investors demand a higher return than we would to buy the loans and keep them ourselves. We’d rather keep the loans and pass on better savings to the ultimate customer.

We’ve long been largely a buy-and-hold player, as well as providing direct financing to institutions through what we call our AgVantage product, which is a securitized lending function. [Banks sell mortgage-backed bonds to Farmer Mac. The bonds are secured by a pledge of the issuer’s qualified agricultural mortgage loans and by the issuer’s general credit.] And also through our long-term standby purchase commitment program.

We have done securities in the past; in the future, we could. I’ve talked to people on our board of directors about it, and my view was if the board wanted us to do a securitization, we can do a transaction, but that’s not a business. We are here to conduct a business, not a series of individual transactions. The resources necessary are costly. If we can’t replicate that many times over, it wouldn’t be an efficient way for us to do business.

That being said, we continue to be in conversations about securitization with a number of players and how we might be able to bring that to bear. We think, ultimately, there will be the possibility for us—even if it’s only with specific customers, under specific circumstances. That would provide another source of liquidity.

ABABJ: Among the many crops Farmer Mac has been involved with is ethanol production. How is that doing?

Buzby: It’s doing fairly well. We got into ethanol at the beginning of 2006, and our portfolio grew to about $335 million at one point. Now, it’s down to about $130 million. We did take some losses on that portfolio—most notably in 2008 and 2009. But overall, we’ve made money on that industry.

We currently don’t have any delinquent loans in our ethanol portfolio. We expect that with where corn prices are; once we start to see financial statements coming in from the ethanol producers early next year, we’ll see that the producers themselves did pretty well this year. I expect that that portfolio will run off pretty quickly over the course of the next couple of years. It’s always a concern because it’s a volatile industry, and the economics can shift in a heartbeat with changing corn prices and changing gasoline prices.

There’s not a lot of ethanol financing getting done. Nobody’s asking us to do it. I think a lot of lenders are in the same position we are. We’ll certainly be cautious the next time those sorts of opportunities come about.

ABABJ: What do you think has been the chief lesson?

Buzby: Don’t move too far too fast just because you see business opportunity. At the time, we were looking at ethanol as an opportunity to grow and charge higher fees. I wouldn’t say we shouldn’t have gotten into it, but we initially intended to get into it more aggressively than we actually did. Good thing we didn’t.

Steve Cocheo

Steve Cocheo’s career in business journalism has taken him to all 50 states and nearly every corner of banking in institutions of all sizes. He is executive editor of ABA Banking Journal, digital content manager of ababj.com, and editor of ABA Bank Directors Briefing. He coordinates the popular Pass the Aspirin and First Person features and wrote the booklet series Focus On The Bank Director. He is the only journalist to have sat in on three federal banking exams, was a finalist for the Jesse H. Neal national business journalism awards, and a winner of multiple awards from the American Society of Business Publication Editors.

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