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Frequently Asked Questions and Commentary
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Congressional
Statements of Policy
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V
=
|
(1
+ g) yo
|
|
r
- g
|
In this case V, is the value of the bank, y0 is its current income or free cash flow, r is the real return to capital from similar investments and g is the real growth rate in earnings. Our formula also assumes that the lifetime of the bank is long – a reasonable choice for a cooperative or a corporation. And we assume that the return to capital and the growth rate are constant over time.
For simplicity, let’s assume that the real growth rate in earnings is zero – earnings will keep up with inflation but that is all. Now the formula becomes:
|
V
=
|
yo
|
|
r
|
To see how this works, suppose that the bank we are selling generates
about $115 million a year in net income – roughly what FCSA
has averaged over the past three years. Also we’ll assume
that the nominal return to capital is 12 percent – approximately
what commercial U.S. agricultural banks have earned on equity over
the past decade.(1) With an expected inflation
rate of 3 percent this gives us a real return to bank capital of
8.7 percent. Our value estimate looks like this:
|
V
=
|
$115
million
|
=
$1,322 million
|
|
.087
|
What does this say? If you want to make a long term investment in a bank that generates after-tax free cash flows of $115 million per year, that earnings will keep pace with inflation of 3 percent and you want at least a 12 percent after-tax rate of return, you can pay up to $1.32 billion for the bank.
Here
is a sensitivity table to show how value, earnings and capital costs
interact:
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Bank
Value ($ million)
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||||
|
Cost
of Capital
|
Income,
$ million
|
|||
|
Nominal
|
Real
|
110
|
115
|
120
|
|
9
|
5.8
|
1,897
|
1,983
|
2,069
|
|
12
|
8.7
|
1,264
|
1,322
|
1,379
|
|
15
|
11.6
|
948
|
991
|
1,034
|
Remember, this is a highly simplified example. But it does give some ballpark numbers for you to consider.
One final point. The bank’s capital as shown on its balance sheet – its “book value” usually exists in the form of stock and retained earnings or surplus. The amount of bank capital on the balance sheet reflects accounting rules, economic conditions, legal or reserve requirements and business strategy. There may be a gap (greater or smaller) between value, reflecting long term earning potential, and the owners’ or members’ equity as shown on the balance sheet. In other words, the value of the bank is not necessarily equal to the book value of equity shown on the balance sheet. Further, if the bank were actually liquidated, contingent liabilities such as taxes and other fees would also reduce the net capital value.
What is a Reasonable Price?
The sale of a Farm Credit System unit to a private bank is unprecedented. Consequently, there are no “comparables” that might be used to test or benchmark Rabobank’s offer. Careful analysis coupled with a clear understanding of the benefits received from government preferences and the contributions of members is the best option in determining the value of a cooperative bank.
(1) An alternative approach is to use the capital asset pricing (CAPM) model to determine a discount rate. The National Agricultural Mortgage Corporation (FarmerMac) has a reported beta of 1.05 (NYSE). U.S. Bank, the second largest agricultural lender in the U.S. has a beta of 1.11 (NYSE). If we assume a risk free rate of 3.5 percent and a market risk premium of 8 percent, for example, the nominal cost of capital would be 11.9-12.4 percent.
Prepared by: Robert W. Jolly (9/2/04)
Rabobank
General
Rabobank is a major player in agribusiness lending in 35 countries. On the basis of assets, Rabobank is the 15th largest banking organization globally, headquartered in the Netherlands. Rabobank is owned by 328 local banks providing financial services and products to the Dutch retail and business markets. The organization has 9,000,000 business and private customers and admits to being a market leader in virtually every area of financial services. Outside the Netherlands, the Rabobank Group, as it is called, has 222 offices in 34 countries. The firm has a particularly large market share in Australia.
Although Rabobank is organized as a cooperative, it does not pay patronage dividends, has no mechanism for paying out profits and does not follow traditional cooperative principles.
In the United States, Rabobank is regulated by the Federal Reserve System.
Recent acquisitions
In 2002, Rabobank International acquired Valley Independent Bank which involves a retail network in Southern and Central California. In 2003, Rabobank International gained an agricultural mortgage lender with a nationwide distribution network through the acquisition of Land Lease Agribusiness (Rabo AgriFinance). Also in 2003, Rabobank acquired Cedar Falls, Iowa-based AgServices of America, a crop input lender with an extensive delivery network.
Prepared by: Neil E. Harl
How Has FCSA Performed Compared With Other Banks?
One of the reasons -- stated or implied --for the sale of FCSA to Rabobank is that FCSA has underperformed financially and in terms of services provided to members. Table 1 presents several common financial performance measures for three Farm Credit Banks averaged over 2001-2003. This information was obtained from annual reports, issued for this period.
FCSA and MidAmerica FCS (MAFCS) are quite similar in size and capital. MAFCS shows higher returns and lower non-interest costs. AgStar is a significantly smaller bank. The returns to assets and capital for AgStar are greater than the two larger banks. AgStar carries lower surplus levels – but they are well within standards.
Table 1. Average Financial Ratios, 2001-2003 Selected Farm Credit Banks
|
FCS
America
|
Mid
America FCS
|
AgStar
|
|
| Average Assets ($ billion) | $6.99 | $7.26 | $2.23 |
| Profitability | |||
| Return on Average Assets | 1.77% | 2.07% | 2.20% |
| Return on Average Total Capital | 10.78% | 12.78% | 16.30% |
| Net Interest Income/Earning Assets | 2.83% | 2.27% | 3.07% |
| Solvency | |||
| Capital/Assets | 16.79% | 15.80% | 13.60% |
| Liabilities/Capital
|
495.67% | 531.16% | 637.16% |
| Lending | |||
| Net Charge-offs/ Average Loans | 0.09% | 0.20% | 0.17% |
| Allowance for Loan Losses/ Total Loans | 3.16% | 1.65% | 2.00% |
| Average Loan Interest Rate | 6.06% | 6.28% | 6.25% |
| Operating | |||
| Permanent Capital Ratio | 14.23% | 14.90% | 12.63% |
| Total Surplus Ratio | 13.77% | 14.10% | 12.10% |
| Core Surplus Ratio | 12.46% | 12.30% | 10.23% |
| Non Interest Income/Assets | 0.74% | 0.47% | 0.47% |
| Non-Interest Expense/Assets | 1.60% | 0.62% | 1.06% |
| Retained Earnings/Assets | 16.10% | 15.08% | 10.68% |
| Wages/Assets | 0.85% | 0.39% | 1.14% |
Source:
AgStar: Serves 69 counties in southern and eastern Minnesota and
16 in western Wisconsin.
Annual Report: http://www.agstar.com/uploads/2003annualreport.pdf
[700K .pdf file, 30 pages]
Farm
Credit Services of America serves Iowa, Nebraska, South Dakota,
and Wyoming.
Annual Report. http://www.fcsamerica.com/company/AR99FCSA.pdf
[300K .pdf file, 40 pages]
MidAmerica
Farm Credit Services serves Indiana, Ohio, Tennessee, and Kentucky.
Annual Report: http://65.219.107.42/images/2003AnnualReportFinancials.pdf
[1.1 MB .pdf file, 27 pages]
Prepared by: Robert W. Jolly (9/3/04)
Who
Owns the Surplus?
Most of the earnings in FCSA over the past 20 years were placed in the unallocated retained earnings category on the balance sheet. Stated differently these earnings were not placed on the balance sheet with an individual member's name attached to them and an obligation to eventually redeem them for cash. Instead corporate income taxes were paid on those generated from non-Land Bank activities. No tax was paid on the income from Land Bank activities under a long-standing provision exempting Land Bank sourced earnings from federal income tax.
So long as the cooperative continued to operate, these unallocated earnings served as "permanent" (in that they do not need to be redeemed) equity capital. However upon liquidation, the question arises:
Who owns the unallocated retained earnings?
- Is it the current stockholders?
- Is it the past stockholders who contributed to building the surplus?
- Is it the future stockholders who will do business going forward?
- Should the remaining parts of the Farm Credit System get the surplus?
- Should
the government have a claim since it provided the initial risk
capital
to the system?
The answer for an investor-owned corporation (which pays its stockholders based on the amount of equity they hold) is straightforward. It belongs to the current stockholders. Those who have sold their stock and are not currently shareholders have no claims. Presumably the value of retained earnings was capitalized into the stock price when they sold. Prior stockholders received fair market value at the specific time of the sale.
In the case of FCSA (which is a cooperative) the answer is not so simple. Several key differences between cooperatives and ordinary investor-oriented corporations complicate things. (1) Unlike the ordinary corporation, earnings in the cooperative are issued to stockholders based on their use of the cooperative rather than on the amount of capital provided. (2) The decision to invest is not solely based on generating a return on investment. It is also coupled with obtaining the right to use the cooperative. In the case of FCSA the borrower had to be a stockholder in order to use the cooperative. (3) Third, the equity in FCSA is purchased and redeemed at face value. Unlike an ordinary public corporation the level of unallocated retained earnings is not reflected in the share value.
In many ways the unallocated surplus in FCSA represents an endowment generated by past members for current (and future members) to use in capitalizing the lending cooperative. It was not generated exclusively by the current stockholders. Nor was the investment cost for current stockholders adjusted to reflect the level of unallocated retained earnings. Finally, the decision of individual stockholders to buy or sell was based on their need for credit rather than the level of unallocated returns.
So who owns the surplus? Is it those past member stockholders who generated it by forgoing the option to receive a patronage refund on their interest bill? Is it the current member stockholders who now own and use the cooperative and will make the decision of whether or not to liquidate? Or is it the future member stockholders who will find it possible to join a well-capitalized FCSA.
One possible answer is: It belongs to those who generated the surplus over the past 20 years or so. It could be argued that those who owned and used FCSA during the critical period when FCSA was being recapitalized in the mid-1980s have the most legitimate claims. But 20 years is a long time and there are numerous difficulties in looking back that far. More than a few of those members are now deceased and their estates long ago settled.
Another possible answer is that those who have the most legitimate claims are the members who used the cooperative over some more recent (albeit still somewhat arbitrary) period when much of the retained earnings were generated. This has in some cases been formalized in cooperative statutes. Some state statutes designate unallocated retained earnings must be distributed to current and former patrons based on the amount of unredeemed allocated equity they hold.
This provision allows those who did business with the cooperative in the past, and contributed to building the surplus to share in the distribution -- even though some of them may no longer be active members. But in the case of FSCA virtually all the earnings were put into surplus and there is no allocated equity to use as a basis for determining how much each patron should receive. It would be necessary to pick some arbitrary period, look back and calculate what the claims would have been if the equity actually had been allocated rather than put into surplus.
A third possible answer is that people who are currently owners and users have the most legitimate claim. They, after all, have undertaken the current fiduciary responsibility for the assets of FCSA and they are the ones who have the voting rights. But should the entire endowment be distributed to them simply because they happen to be members at this time? Was it the intent of prior members (who built the surplus) to create a windfall for the voting members at some future moment in time?
A fourth possible answer is that the surplus is truly an endowment from past and current users for use in capitalizing a user-owned and controlled cooperative for current and future users. Upon liquidation, should at least the majority of the endowment be kept and used toward that end rather than distributed in its entirety as a windfall gain to current members?
Some would argue that the remaining parts of the system should get at least some of the surplus. All parts of the system assume joint and several liability for the other parts. If FCSA benefited from this assurance during the period when the surplus was built does it not have a legitimate claim to at least some of the surplus?
Finally some might argue that the U. S. taxpayers have a legitimate claim to at least part of the unallocated reserves. Since the system was conceived and started by the U.S. government and the majority of the capitalization through the most risky periods of its life came from the government, it could be argued that the taxpayers have a claim. Is it reasonable that some of the unallocated reserves should be returned to the taxpayers as a return for taking on the role of entrepreneur and venture capitalist during start up and the most perilous times FCSA has survived?
While it is interesting and perhaps helpful to consider who has the most just or legitimate claim, it is the legal claims that count in the end. Provisions in FCSA Articles of Incorporation and provisions in the FCSA By-Laws along with FCA regulatory decisions, board resolutions, and provisions of the Farm Credit Legislation will ultimately determine how it is distributed. That said, it seems reasonable to expect that the difference between what is just and what is legal would not be a huge one.
Prepared by: Roger Ginder, October 2004.
Why
Sell the Bank? Options for FCSA Members
The reasons given by FCSA directors for the sale to Rabobank -- at least those reported in the press --include:
a) increase the number and quality of financial products and services available to members,
b) improve lending efficiency and bank performance,
c) return accumulated surplus to members,
d) sidestep the lending restrictions placed on FCSA by the Farm Credit Administration.
If these are, in fact, the major motivations for the sale of FCSA, then there are several options available to members for achieving them.
If members are concerned primarily about the first three reasons, a-c, the simplest approach would be to change the way the bank is being managed. The FCSA is, after all, a farmer-owned cooperative. If members think the bank is not performing well or is sitting on a pile of cash, then they can demand that their elected directors, and through them, the hired managers, take steps to rectify the problem. If you aren’t happy with the way the bank is being managed, you don’t have to sell it to fix it.
If the directors are not sufficiently responsive, articles and by-laws usually contain provisions for members to exert their influence. These might include:
- Provisions for petition of the board of directors by dissident stockholders
- Provisions for calling a special member meeting to deal with important issues
- Provisions for recalling directors
Beyond that there may be statutory provisions that spell out other procedures. A final option that could be excercised by disgruntled stockholders would be a class action lawsuit that might allege breach of fiduciary duty on the part of the FCSA board.
A more drastic action, again focusing on items a-c, would be to seek out a merger with a Farm Credit Bank with stronger financials or a board more aligned with members’ interests.
If, however, item d is a key driver, then exiting the Farm Credit System with a sale to an outside firm is the only option -- at least in the short run. Longer term it might be possible to ease some of the restrictions placed on the Farm Credit System through congressional action.
There are benefits and costs with each of these options. FCSA members need to carefully consider what they might gain and what they might lose -- today and in future years.
Prepared by: Robert W. Jolly (9/3/04)
The "Exit" Fee
The payment of the exit fee is of importance because (1) much of the capital involved, which is now held as unallocated earnings, will flow out of FCSA and, in large measure, outside the four-state area to benefit other FCS borrowers in other states; (2) payment of the fee diminishes the amount to which stockholders would be entitled; and (3) the expected income tax consequences mean that the U.S. Government and the respective states would be major beneficiaries of the payment of the exit fee.
Payment of the "exit fee," estimated to exceed $800,000,000 is to be paid by FCSAmerica out of unallocated surplus, not by Rabobank.
The exit fee is based on the average daily balances of assets and liabilities for the 12-month period preceding the termination date with adjustments. 12 C.F.R. §§ 611.1250, 611.1255. To calculate the fee, assets are multiplied by six percent and that amount is subtracted from total capital. 12 C.F.R. § 611.1255(a)(6). Thus, the exit fee is all capital above six percent of assets.
The exit fee is paid to the Farm Credit Insurance Fund. 12 C.F.R. § 1255(d)(1). Thus, the benefits from the exit fee will largely be enjoyed outside the four state area in the form of reduced loan costs for FCS borrowers in other states.
Because the unallocated surplus comes in part from earnings that have not been subjected to income tax (the Federal Land Bank earnings have been exempt from income tax), payment of the exit fee (to the extent the payment is from unallocated surplus) is expected to trigger income tax liability to FCSAmerica as discussed more fully under Income Tax Implications.
The exit fee could be avoided if a buyout or merger were to occur with another Farm Credit System unit with the full amount of the fee retained within the System.
Prepared
by: Neil E. Harl
Income Tax Implications
The income tax implications are important because of (1) the impact on the purchase price (the greater the negative income tax consequences the lower the purchase price) and (2) the potential effect on the amount available for distribution to stockholders.
History of exemptions from income tax
Federal Land Banks. Income earned by the Federal Land Banks and the Federal Land Bank Associations is exempt from federal, state, municipal and local taxation. The exempt status was provided for in the original act creating the Federal Land Banks in 1916 (the Federal Farm Loan Act) and has been continued in subsequent legislation. See 12 U.S.C. § 2023 (2000). A 1988 amendment, which is reflected in 12 U.S.C. § 2023 (2000), specifies that the income of "Farm Credit Banks" is exempt from all federal, state, municipal and local taxation. The term "Farm Credit Bank" is defined to include Federal Intermediate Credit Banks and Federal Land Banks but not production credit associations or banks for cooperatives.
The provision states:
"The Farm Credit Banks and the capital, reserves, and surplus thereof, and the income derived therefrom, shall be exempt from Federal, State, municipal, and local taxation, except taxes on real estate held by a Farm Credit Bank to the same extent, according to its value, as other similar property held by other persons is taxed. The mortgages held by the Farm Credit Banks and the notes, bonds, debentures, and other obligations issued by the banks shall be considered and held to be instrumentalities of the United States and, as such, they and the income therefrom shall be exempt from all Federal, State, municipal, and local taxation, other than Federal income tax liability of the holder thereof under the Public Debt Act of 1941 (31 U.S.C. 3124).
Bonds, debentures and other obligations issued by Federal Land Banks are exempt from all taxes other than federal income tax. This makes Federal Land Bank bonds more attractive to the investing public. The exemption benefits security holders and also allows securities to be priced more favorably.
Although no provision exists for Federal Land Bank Associations to distribute patronage refunds, distributions can be in the form of dividends.
The FLB and FLBA exemptions were similar to the exemptions for federal instrumentalities. See I.R.C. § 501(e)(1). As a result of the exemptions, a substantial amount of FCSA earnings has not been subject to federal or state income tax. The Federal Land Bank exemption, continued to the present, represents the vast majority of earnings, estimated to be as high as 70 percent of the total. The substantial amount of exempt earnings poses a question about the income tax consequences of a take-over of FCSA funds inasmuch as the proposed buyout involves the purchase by Rabobank of the FCSA stockholders' stock.
Production Credit Associations and Banks for Cooperatives. With respect to the taxability of production credit associations, the relevant provision, prior to the 1985 amendment, stated as follows:
"Each production credit association and its obligations are instrumentalities of the United States and as such any and all notes, debentures, and other obligations issued by such associations shall be exempt, both as to principal and interest from all taxation (except surtaxes, estate, inheritance, and gift taxes) now or hereafter imposed by the United States or any State, territorial, or local taxing authority. Such associations, their property, their franchises, capital, reserves, surplus, and other funds, and their income shall be exempt from all taxation nor or hereafter imposed by the United States or by any State, territorial, or local taxing authority; except that interest on the obligations of such associations shall be subject only to Federal income taxation in the hands of the holder thereof pursuant to the Public Debt Act of 1941 (section 742(a) of Title 31) and except that any real and tangible personal property of such associations shall be subject to Federal, State, territorial, and local taxation to the same extent as similar property is taxed. The exemption provided in the preceding sentence shall apply only for any year or part thereof in which stock in the production credit association is held by the Governor of the Farm Credit Administration." (emphasis added, footnote omitted).
Accordingly, prior to its amendment in 1985, 12 USC § 2098 (1982) had provided for the tax exemption of production credit associations for any year or portion of a year during which any stock in the entity was held by the Governor of the FCA, even if the stock in the entity was held primarily by other individuals or organizations.
The 1985 amendment, however, amended the provision to read as follows:
"Each production credit association and its obligations are instrumentalities of the United States and as such any and all notes, debentures, and other obligations issued by such associations shall be exempt, both as to principal and interest from all taxation (except surtaxes, estate, inheritance, and gift taxes) now or hereafter imposed by the United States or any State, territorial, or local taxing authority."
Notably, the 1985 amendment eliminated the last two sentences of the provision as it existed previously which eliminated the exemption of income from taxation.
The current provision on the exempt status of production credit associations appears in 12 U.S.C. § 2077:
"Each production credit association and its obligations are instrumentalities of the United States and as such any and all notes, debentures and other obligations issued by such associations shall be exempt, both as to principal and interest, from all taxation (except surtaxes, estate, inheritance, and gift taxes) now or hereafter imposed by the United States or any state, territorial, or local taxing authority, except that interest on such obligations shall be subject to Federal income taxation in the hands of the holder."
Note that the income of production credit associations is not exempt.
An almost identical provision applies to banks for cooperatives. 12 U.S.C. § 2134 (2000).
A 1988 IRS General Counsel's Memorandum concluded:
"…for periods prior to January 22, 1986, during which no stock in the production credit association or bank for cooperatives is held by the Governor of the FCA, such entities are subject to federal income tax, presumably in the same manner as other nonexempt corporate lending financial institutions. For periods after January 21, 1986, production credit associations and banks for cooperatives are subject to federal income tax, presumably in the same manner as other nonexempt corporate lending financial institutions." (footnote omitted). GCM 39,719, March 30, 1988.
It is noted that no production credit association stock or bank for cooperatives stock had been held by the Governor of the FCA since 1968.
Effect of the Agricultural Credit Act of 1987 on FLB
The FLB and FLBA exemptions were called into question by IRS following the enactment of authority in the Agricultural Credit Act of 1987 allowing the merger of Federal Land Banks into an Agricultural Credit Association (ACA). It should be noted that the Internal Revenue Service ruled on three occasions (Ltr. Rul. 9641006, July 18, 1996; Ltr. Rul. 9652001, July 17, 1996; Ltr. Rul. 9652002, July 17, 1996) that Agricultural Credit Associations (created upon the merger of Federal Land Banks and Production Credit Associations under the Agricultural Credit Act of 1987) are not exempt from income tax from long-term lending activities previously carried on by a predecessor Federal Land Bank or Federal Land Bank Association.
In the private letter rulings, IRS concluded that:
"…the Farm Credit statutes do not exempt an ACA's long-term mortgage income from federal income taxation. Our conclusion is based on rules set forth by the Supreme Court for determining whether a new corporation is entitled to special statutory exemptions of a predecessor corporation, as well as on more general rules…that have been set forth by the courts for determining whether a taxpayer is entitled to an exemption from federal income taxes." Ltr. Rul. 9652001, July 17, 1996.
FCSA is listed as an Agricultural Credit Association. However, a federal district court, in United States v. Farm Credit Services of Fargo, ACA, 89 AFTR 2d 2002-334 (D. N.D. 1998), has confirmed that the Federal Land Bank exemption for income could continue after 1987. In that case, an ACA was formed by the merger of an exempt FLBA (offering long-term land loans) and a non-exempt production credit association (PCA) offering short- and intermediate-term loans. The income from the ACA's long-term land loans was held to be exempt. The court said that to conclude that Congress intended to deny the continuance of the exemption would be "illogical and absurd." The court said that no specific language was needed for the long-term land loan income exemption because it already existed and was incorporated by reference. Thus, FCSA has continued to enjoy an exemption of income from long-term land lending.
Taxation of other units of FCSA
The production credit lending of FCSA has continued to be subject to cooperative taxation rules.
The special tax status of cooperatives involves patronage refunds whereby a percentage of the patronage earnings (80 percent) is retained by the cooperative with 20 percent of the earnings paid out to the member as patronage. The income tax on the entire amount is paid by the patron. For earnings not classified as patronage, the cooperative (other than those earning exempt income) pays income tax on the earnings at the corporate rate.
Treatment of the exit fee
The proposed buyout of FCSA by Rabobank also raises a question about the income tax consequences of payment by FCSA of the exit fee which is expected to exceed $800,000,000. Inasmuch as earnings from the Federal Land Bank (and Federal Land Bank Associations) are exempt from income taxes, payment of the exit fee out of tax-exempt funds raises a question of whether the payment would be subject to federal (and state) income tax. That would be the case under well-established tax principles.
The key question is the deductibility of the exit fee as an "ordinary and necessary business expense" under I.R.C. § 162. See National Starch & Chemical Corp. v. Commissioner, 918 F.2d 426 (3d Cir. 1990), aff‚d sub. nom., INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992) (merger expenses including SEC fees and $2,200,000 of underwriting fees conferred long-term benefits related to the "permanent betterment" of the corporation and its shareholders, not expenses in the daily production of income).
Taxation of other exempt earnings
It is also unclear how the remaining tax-exempt earnings in FCSA will be taxed and to whom (FCSA or Rabobank) upon completion of the transaction or at a later time.
The United States Supreme Court has long held to the view that when a new corporation succeeds to the rights and powers of an old corporation, the new corporation is not entitled to the old corporation's special statutory exemptions, including exemptions from taxation, in the absence of an express provision in a statute. People's Gaslight & Coke Co. of Chicago v. Chicago, 194 U.S. 1 (1904). As the court said in Phoenix Fire & Marine Insurance Co. v. Tennessee, 161 U.S. 174 (1895), the court stated that the claim for exemption must be made out "wholly beyond doubt." The court added that "[m]ere silence is the same as a denial of exemption."
Therefore, it would appear that Rabobank would not succeed to the tax exempt status enjoyed by FCSA for long-term land loans.
No guidance requested from IRS
Apparently, a private letter ruling has not been requested from the Internal Revenue Service on the exit fee issue, the issue of tax reporting by stockholders of the $600,000,000 purchase price (which is payment for the interest of the stockholders in FCSAmerica) and the issue of taxation of the remaining tax-exempt earnings inside FCSA.
Potential consequences
The
potential income tax liability, from the portion of retained earnings
which is exempt (from the Federal Land Bank), could total more than
a half billion dollars. This helps to explain what some view as
a below-market offer by Rabobank for the FCSA stock. The deal, as
structured, is potentially costly from a tax perspective. The tax
costs could be avoided for a transfer within the system.
Prepared by: Neil E. Harl
Voting
on the Resolution to
Terminate System Status
The
voting requirements are important to current stockholders because
of the vote needed to approve the proposed buyout and to past borrowers
who did not retain stock in FCSA during the 1999-2004 period.
The FCA regulations (12 C.F.R. §§ 611.1240, 611.330) specify
that the vote required to approve the termination proposal is a
majority vote of those voting in the election. The quorum requirement
is five percent of the stockholders.
The announcement of the buyout stated that the total purchase price
would be "allocated among the FCSAmerica stockholders primarily
on a patronage basis, based on each stockholder's loans outstanding
with FCSAmerica over a specified period." The "specified
period" is the period beginning in 1999. Those who are no longer
stockholders but were borrowers in the 1999-2004 period are not
eligible to participate in the distribution. However, for those
who paid off their loans after 1998 and before the closing date,
and retained their stock, payments can be received. All of this
is subject to FCA approval.
The stockholder meeting to vote on the termination must occur within
60 days of FCA preliminary approval (or, if FCA takes no action,
within 60 days of the end of FCA's approval period). 12 C.F.R. §
611.1240(a). The voting record date may not be more than 70 days
before the stockholder's meeting.
Voting stockholders have the right to reconsider their approval
of the termination if a petition, signed by 15 percent of the stockholders,
is filed with FCA within 35 days after notices are mailed to stockholders
that the termination was approved. 12 C.F.R. § 611.1245(a).
The governing documents and FCA regulations do not require a "super
majority" vote which is often imposed on liquidations, mergers
and other major structural shifts submitted to the stockholders
for vote. A simple majority of those voting is necessary for approval.
Note: "C.F.R." is the Code of Federal Regulations, the
regulations adopted by FCA.
Prepared
by: Neil E. Harl
Dissenter's
Rights
The matter of Dissenter's Rights is important to stockholders because of the confusing nature of the FCA regulations and the early information made available to stockholders. Some stockholders had concluded that those voting "no" on the proposal would be treated less favorably than those voting "yes."
The regulations adopted by the Farm Credit Administration (FCA) govern the subject of dissenter's rights. The regulations are published in 67 Federal Register 17,916 (April 12, 2002). The regulations appear in Title 12, Section 611.1280 of Subpart P, Code of Federal Regulations, Termination of System Institution Status (12 C.F.R. § 611.1280).
A. A dissenting stockholder is an equity holder in a terminating institution on the termination date who either:
1. Was eligible to vote on the termination resolution and voted against termination,
2. Was an equity holder on the voting record date but was not eligible to vote, or
3. Became an equity holder after the voting record date.
B. This has been interpreted by Farm Credit Services of America (see attached letter) as meaning that:
1. A stockholder could vote no on the resolution and still be classified as a non dissenter and be compensated as a non dissenter, in the same manner as those voting yes, or
2. A stockholder could vote no on the resolution and be classified later as a dissenting stockholder (at the stockholder's request), and be compensated as a dissenter.
C. The FCA regulations specify (12 C.F.R. § 611.1280(c)) that if FCA determines "…that the liquidation provision is inequitable to stockholders, we will require you to calculate their share in accordance with another formula that we deem equitable."
The interpretation of the Dissenter's Rights provision by FCSA means that both "yes" and "no" voters will be treated identically unless a "no" voter requests Dissenter's Rights, which is expected to involve a smaller payment.
Note: "C.F.R." is the Code of Federal Regulations which contains the regulations adopted by FCA.
Prepared by: Neil E. Harl
Link to: FCA
Regulations, Part 611-Organization; Subpart P-Termination of System
Institution Status
What is the Competitive Environment for Agricultural Loans in the FCSA Trade Area?
Agricultural credit markets in the FCSA Trade Area (Iowa, Nebraska, South Dakota, and Wyoming) are characterized by slow steady growth in agricultural loan volume and rather dramatic shifts in market share. Here are a few graphs that illustrate these trends.
Figure 1 shows the nominal or current value of farm business assets and liabilities in the FCSA Trade Area. Note that there has been slow steady growth in agricultural loans since the Farm Debt Crisis ended in the late 1980s. Debt secured by real estate and non-real estate assets is nearly equal in absolute amounts and is growing at about the same rate.
The value of farm assets (which is dominated by land) has grown rapidly since bottoming-out in the late mid-1980s. Farm equity or net worth is shown on the graph as the difference between the value of assets and the value of total liabilities. Farmers’ wealth, in current dollars at least, has increased significantly over the past 15 years.
Figure 2 presents market shares for total farm debt by major lenders or credit providers. Commercial banks are the primary source of credit for agriculture in the FCSA Trade Area. Their market share has remained relatively steady at 50 percent for the past decade.
Individuals and others are the second most important credit provider. This is a catchall category but primarily consists of installment land contracts and dealer or supplier credit.
Farm Credit shows a declining market share until about 1998. Their market share has grown rapidly since then.
The
Farm Service Agency (or FmHA as it used to be known) shows a steady
decline in its direct lending market share since the late 1980s.
This is the result of generally improving economic conditions for
agriculture and the deliberate policy shift of FSA from a direct
lender to a guarantor of commercial loans.
Finally, the market share of insurance companies, primarily land
lenders, has been relatively steady over this 20-year period.
Figure 3 gives market shares for the non-real estate credit market. This category includes operating loans as well as loans for machinery, breeding stock and other intermediate assets. Commercial banks hold the dominant market share in this segment. Individuals and others – primarily captive finance companies – hold the second largest market share. Farm Credit’s short term credit market share has been growing since the late 1980s but remains small.
Figure 4 gives market shares for loans secured by real estate. Credit in this market segment may be used to purchase land. But it might also be used to refinance debt or finance livestock facilities, for example, using land as collateral. The most striking change occurring in this market is the rapid growth in commercial banks’ market-share from the bottom to the top in approximately 15 years.
Farm Credit has recently recaptured its second-place position largely at the expense of installment land contract providers.
The agricultural credit market in the FCSA Trade Area is representative of a mature industry – slow growth in demand coupled with strong competition for market share. This type of market is like a zero-sum game – in order to grow loan volume, a lender must take business away from other lenders or loan outside the area. In order to do this, some lenders will pursue a cost strategy -- offering simple financial products with low interest rates. Others will focus their strategy on the benefits of a lending relationship and customized financial products.
Prepared by: Robert W. Jolly (9/1/04)