Statement of Policy on System Institution Activities Involving the Potential for Nonexclusive Territories

FARM CREDIT ADMINISTRATION

Statement of Policy on System Institution Activities Involving

the Potential for Nonexclusive Territories

AGENCY: Farm Credit Administration.

ACTION: Statement of policy; request for comments.

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SUMMARY: The Farm Credit Act of 1971 (1971 Act) gives the Farm Credit

Administration (FCA) broad powers to issue and amend the charters of

Farm Credit System (System) institutions and regulate the exercise of

their powers. In most instances since 1933 the FCA has issued charters

and regulations that authorize institutions to provide their services

in exclusive territories. The FCA Board has determined that since the

agency may be requested to issue nonexclusive charters in the future or

to modify the regulations governing out-of-territory activities, the

FCA Board should adopt a policy statement setting forth its views on

nonexclusive territories. The FCA Board is requesting comments on its

views.

DATES: Comments must be submitted on or before [June 13, 1994.

ADDRESSES: Comments should be mailed or delivered (in triplicate) to

Kenneth D. Smith, Executive Assistant to FCA Board Member Gary C.

Byrne, Farm Credit Administration, 1501 Farm Credit Drive, McLean,

Virginia 22102-5090. Copies of all comments received will be available

for examination by interested parties in the offices of the Farm Credit

Administration, 1501 Farm Credit Drive, McLean, Virginia.

FOR FURTHER INFORMATION CONTACT: Kenneth D. Smith, Executive Assistant

to Board Member Gary C. Byrne, Farm Credit Administration, 1501 Farm

Credit Drive, McLean, Virginia 22102-5090, (703) 883-4010, TDD (703)

883-4444.

SUPPLEMENTARY INFORMATION: The 1971 Act authorizes the FCA to issue and

amend the charters of System institutions and regulate the exercise of

their powers. Included in this authority is the ability for the FCA to

issue or amend charters or promulgate regulations that would result in

increased competition among System institutions. The issue of

competition among System institutions arises, typically, in two types

of situations. First, charters could be issued authorizing two or more

System institutions to extend the same types of credit services to the

same types of customers in the same geographic territories; such

charters have typically been issued as a result of mergers or other

chartering actions requested by institutions. Second, institutions

could be authorized by regulation to engage in certain activities

outside of their chartered territories.

Background

Although the FCA has broad authority to issue charters that

authorize two or more institutions to serve the same territory,

exclusive charters have been the general practice since 1933.1 The

exceptions to this general practice are worth noting. Prior to the

Agricultural Credit Act of 1987 (1987 Act), at least four types of

competition existed at various times as follows:

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\1\The Emergency Farm Mortgage Act of 1933 (1933 Act) authorized

the chartering of production credit associations (PCAs) and other

institutions. FCA, generally, has issued PCA charters with exclusive

territories.

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(1) Nonexclusive Charters

The 1916 Federal Farm Loan Act (1916 Act) authorized the creation

of numerous National Farm Loan Associations, predecessors to the

Federal land bank associations (FLBAs). Few, if any, of these

associations had exclusive territories. Most of the charters involving

nonexclusive territories were issued prior to 1933. At one time, there

were about 5,000 FLBAs. As a result of mergers and territorial

realignments, only a few FLBA charters with nonexclusive territories

remain, all in the Texas District.

(2) Competition Between Short- and Long-Term Lenders

The potential for intra-System competition has always existed

between the long-term lender (Federal land bank/FLBA) and the short-

and intermediate-term lender (Federal intermediate credit bank/

production credit association/agricultural credit association) (FICB/

PCA/ACA) serving the same territory because of overlapping lending

authorities.

(3) Specialized Association Charters

In the early days of the System, FCA granted certain associations

authority to finance specific commodities over wide geographical areas

(often statewide) resulting in the issuance of charters with the same

territory as other associations in the area. Only two of these

specialized lending charters remain: two ACAs on the east coast have

full authority in an exclusively chartered area and very limited

authority in broader areas.

In addition, a small number of other nonexclusive charters were

granted. Very few of the other nonexclusive charters granted during

this early period still exist, and they are primarily located in New

Mexico, a small area of California, and Nevada.

(4) Competition Created By Statute

The 1916 Act created parallel long-term mortgage credit systems to

serve both commercial banks and direct retail customers: A system of

cooperative mortgage banks and a system of joint stock land banks owned

by investors. The former evolved into the Federal land banks (now the

farm credit banks or agricultural credit banks) and the latter no

longer exist.2

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\2\In 1993, similar systems were created to serve cooperative

borrowers (the banks for cooperatives) and short-term production

credit users. The production credit system consisted of the PCAs,

FICBs, (now the farm credit or agricultural credit banks), and a

system of production credit corporations (which no longer exist).

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In addition to these existing forms of competition, the 1987 Act

contained several provisions that have resulted in competition among

System institutions:

(1) Section 411

This section provided that PCAs and FLBAs sharing substantially the

same territory were required to vote on whether to merge. These mergers

led to five ACAs with nonexclusive charters in areas where the parties

merging did not have identical territories. The FCA Board also provided

any association that no longer had exclusive territory as a result of

such mergers an opportunity to become an ACA. Several of the

associations affected by these ``411 mergers'' subsequently became

ACAs.

(2) Section 413

This section required a merger vote by the 13 banks for

cooperatives (BCs). Eleven of the 13 banks voted to merge, resulting in

the creation of three BCs with the same territory.

(3) Section 433

This section authorized certain associations to change their

affiliation from one Farm Credit Bank (FCB) to another. The district

FCB from which the association shifted retained its chartered authority

to continue to serve the area through other existing or newly created

associations. However, competitive charters cannot be issued in these

areas unless the affected parties give their consent. So far, no

competitive association charters have resulted from this provision.

In addition to these statutory authorities, there are certain

restraints on the FCA's authority to issue competitive charters.

First, following passage of the 1987 Act, the FCA Board granted

charters to institutions serving the same territory in those situations

arising from mergers that were specifically required to be voted on by

the 1987 Act or as necessary to provide for a level playing field as a

result of those mergers. However, because of concerns surrounding the

potential for competitive situations arising from the 1987 Act, the FCA

Board determined it would not issue competitive charters, other than as

required by statute, until it had thoroughly reviewed the issue.

Second, the law specifies certain circumstances in which the FCA

may only grant competitive charters if all of the institutions affected

by the proposed charter grant their approval. Those circumstances

involve:

(1) The territories where associations changed their affiliation

from one FCB to another in accordance with section 433 of the 1987 Act;

and

(2) The States of Mississippi, Alabama, and all of Louisiana except

the territory served by the Northwest Louisiana PCA.

With the exception of those situations discussed above where an

institution must obtain the consent of another institution, the law

does not prohibit institutions from requesting ``competitive

charters.'' Indeed, the 1971 Act does not directly address the issue of

competition among System institutions. Instead, the Act concerns itself

with the purposes, operating objectives, and authorities of the System

and its regulator. When the agency receives these requests it must act

on them, based on an analysis of all relevant facts, and arrive at a

reasonable conclusion that is consistent with the purposes of the Act.

In the first few years after passage of the 1987 Act, most of the FCA's

decisions involving competitive issues were associated with the merger

of unlike associations to become ACAs. In the last few years, the

competitive issues coming before the FCA have involved banks as well as

associations. In addition to matters involving charters, competition

issues have arisen in the context of out-of-territory authorities

provided for by regulations. By this policy statement, the FCA Board

now expresses its views on how the agency will approach decisions that

may involve competition among System institutions.

Recent Analysis

In 1990, the FCA contracted with consultants to review the issue of

competition within the System and provide the FCA Board with options to

consider. In 1991, as a part of its legislative initiative, the FCA

Board recommended to Congress that the 1971 Act be amended to require

that ACA charters contain exclusive territory. In 1992, the FCA

Chairman appointed FCA Board Member Gary C. Byrne to lead an internal

work group focusing on the issue. This work group analyzed competition

from several perspectives and developed a set of recommendations for

agency action in the absence of legislative changes.

FCA staff identified advantages and disadvantages of various

approaches to the general question of competition within the System and

also considered several challenging situations that may (or have) come

before the agency:

(1) An association not properly serving its territory;

(2) An association wanting to merge, but potential mergers would

involve a charter with nonexclusive territories as a result of an

inability to establish congruent territory; and

(3) An eligible customer with operations in two or more association

territories wishing to choose which association would best serve his/

her needs.

Opinion Interviews

FCA staff interviewed representatives of some of the System

institutions that currently have the authority to compete. The purpose

of the interviews was to gain insight into how competition is working

within the System. Among those interviewed, there was no consensus on

either the benefits or disadvantages of competition.

Some interviewees questioned whether ``competition'' should exist

in the current environment. There was agreement among institution

managers that customer loyalty to the System plays a big part in

maintaining business relationships and, as a result, competing

institutions should not do anything that would damage the System's

reputation. Most respondents wanted to preserve the funding benefits of

the System's Government-sponsored-enterprise (GSE) status. Some

association managers wanted to be able to shop for funding from

different System banks. Several operational problems relating to the

accommodation of competition in the current environment were cited:

joint and several liability; System institution board representation;

size differential; and common funding through a bank jointly owned by

competitors.

In addition to these interviews, FCA staff conducted a limited

survey of System farmer-customers, directors, and managers. The sample

was relatively small, consisting of 51 respondents of 135 randomly

selected, so no definitive conclusions were drawn. The survey was done

to get a sense of the nature and extent of support for, or opposition

to, intra-System competition. Six questions on the survey represented

various positions the agency could take relative to the competition

issue. Additionally, the survey respondents were provided the

opportunity to write in any comments on the issue and include those

comments as part of the survey.

The results of the survey indicated no clear consensus for or

against competition. The farmer-customers surveyed were somewhat more

likely to favor competition than were the managers and directors. Most

System institution managers surveyed were opposed to competition;

however, the directors believed that some form of competition would be

justified if the farmer-customers were not being adequately served. The

only area of consensus was opposition to chartering a new association

within the territory already being served by an existing association.

Competition in the Larger Market

FCA staff also reviewed the economic literature on competition.

System institutions are participants in the agricultural credit market,

which is a part of the broader financial credit market. The financial

credit market, generally, is among the most competitive markets in the

world, in that no one market participant can control price and

availability. While this general competitiveness appears to be true for

the agricultural credit market as a whole, there are exceptions in some

geographical areas and specialty submarkets. Staff concluded that

Government action should not normally be required to ensure that

competitive markets for agricultural credit exist, and that Government

action might be appropriate if the agricultural credit market in a

specific geographical area or agricultural credit submarket were

noncompetitive.

Because System institutions compete in the broader agricultural and

general credit markets, increasing the amount and nature of competition

between and among System institutions could only improve the

availability, terms, and price of credit for eligible customers if the

overall market for agricultural credit in a certain area were

noncompetitive. Therefore, when the local market for agricultural

credit is already competitive, the additional economic benefits of

increased competition, including competition among System institutions,

are likely to be relatively small (although there may be other,

noneconomic reasons for such competition). Conversely, when the local

market for agricultural credit is not competitive, the economic

benefits of increased competition, including competition among System

institutions, are likely to be relatively large (although there may be

other, noneconomic reasons for avoiding such competition).

Finally, the FCA attempted to determine if there were lessons to be

learned or knowledge to be gained by looking at competition between the

Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal

National Mortgage Association (Fannie Mae). These two GSEs carry an

implicit Federal government guarantee. Freddie Mac and Fannie Mae both

serve the same market for secondary housing loans and, although both

have existed for some time, they have only competed directly against

each other since 1990.

Interviews were conducted with representatives from the two GSEs,

the Federal government oversight agency, independent rating agencies,

and those who do business with both companies. Almost all of the

participants believed that competition between the two had yielded

extremely productive results, both in the way of new products for

housing consumers as well as investors.

The interviewees expressed little concern that the newly acquired

ability to compete could force one GSE out of business, thus triggering

some Federal response. However, Freddie Mac and Fannie Mae are a

duopoly for the market they serve. Between the two, they clearly

control the single-family housing, conventional loan secondary market--

an enormous market to begin with--which shows every sign of continued

growth. Because of the nature of the market, its size, its growth, and

the limited number of market participants, vigorous innovation and

competition are not surprising.

After considering the work group's analysis, the FCA Board

concluded that the FCA's current policy of granting exclusive charters,

with limited exceptions, has been generally effective in facilitating

the delivery of agricultural credit and related services to eligible

customers. However, the FCA Board also recognizes that its current

position does not provide for consideration of competitive charters,

even if such charters would provide customers with lower cost or higher

quality agricultural credit. Consequently, the FCA Board proposes to

modify its current policy on competition to authorize the issuance of

competitive charters when doing so would enhance, beyond the status

quo, the availability of the highest quality, lowest cost credit and

credit service, on a safe and sound, financially sustainable basis, to

eligible customers. The FCA Board invites your comments on the

following statement.

Proposed Policy Statement on System Institution Activities Involving

the Potential for Nonexclusive Territories

Competition between Farm Credit System institutions can potentially

occur as a result of the Farm Credit Administration's (FCA) authority

to issue nonexclusive charters and, in some situations, by regulation.

As a general rule, the FCA grants charters and issues regulations which

do not provide for intra-System competition. The FCA Board continues to

endorse this general practice of noncompetitive territories as being

reasonable for a cooperatively owned enterprise that competes with a

variety of other credit suppliers.

Nevertheless, the degree to which the FCA's authority can influence

the level of territorial exclusivity is guided by the overall purposes

and, in some cases, the specific direction of the Farm Credit Act of

1971 (Act). Briefly stated, the Act seeks to provide for a customer-

owned system of cooperative lending institutions that can provide sound

and constructive credit and credit services for agriculture, certain

types of rural housing, and utilities while maintaining high levels of

safety and soundness as measured by sustained financial viability. If a

System institution were to propose a territorial structure or lending

authority different from current practice, the FCA's response would be

based on how the new proposal meets the purposes of the Act. There may

be limited circumstances under which some form of competition would

result in higher quality, lower cost service to customers, on a safe

and sound, financially sustainable basis.

The purpose of this policy statement is to provide a consistent

framework within which the FCA may respond to issues that involve the

potential for competition as a result of either charter, regulation, or

other request submitted by System institutions.

The FCA Board recognizes that System institution boards may

occasionally seek to alter their charters or expand authorities beyond

current boundaries to enhance efficiencies or to provide better service

to customers. Prior to formally submitting requests, the FCA encourages

the adjacent institutions involved to resolve any territorial disputes

that may result from the request in a fair and amicable manner.

Considerable guidance is provided in FCA regulations concerning routine

charter amendments, territorial transfers, and out-of-territory

lending. Additionally, the FCA Board encourages the development of

innovative proposals to address territorial and competitive issues that

are not covered by existing regulation. These may range from one

institution granting permission for the other institution to lend to

its customers, to reciprocal agreements to compete in each other's

territory, to providing some form of compensation for ceded territory,

or to enter into some form of joint venture. The FCA will provide

assistance, upon request, to enable System institutions to reach

agreements on such matters. Naturally, such innovative agreements must

be consistent with the Act and FCA regulations.

In the event agreements are not reached, based on the purposes of

the Act, the standard for addressing each request involving territorial

issues with the potential for intra-System competition is consistent

with what is used in deciding all charter requests, that is:

Determine whether or not the proposal will enhance, beyond the

status quo, the availability of the highest quality, lowest cost,

credit and credit service on a safe and sound, financially

sustainable basis to eligible customers.

In determining whether or not the above standard is met, the FCA

will analyze a range of factors, as each is deemed relevant to the

situation, as outlined in the following categories:

1. Finance and Management

(a) Whether the financial and managerial capacity exists to provide

competitive services and generate sufficient earnings so the new

enterprise can continue on a sustainable basis.

(b) The degree to which it is evident that the proposal could

adversely affect the cost of funds to either the specific institutions

involved or the System as a whole.

(c) Whether the proposal will adversely affect the institutions

involved, thus creating potential liability for the Farm Credit System

Insurance Fund and/or subsequently for banks under joint and several

liability.

2. Market Conditions

(a) Whether there is significant information that the market

involved is being inadequately served by a System institution.

(b) The extent to which the market involved is being served by

other credit sources.

3. Participant Opinion

(a) The views and concerns of the affected System institutions,

including, as appropriate, the views of customer-shareholders,

recognizing that significant disagreement between members of a

cooperative system has the potential for adverse consequences regarding

matters for which they are mutually responsible.

Depending upon the situation, other factors, such as the degree to

which the FCA's discretion is affected by statutory or judicial

considerations or the opinions of outside oversight parties, might also

affect the FCA's decision.

The FCA intends to apply this analysis, on a case-by-case basis, to

requests that involve charters where two institutions would be serving

all or part of the same territory. Similarly, the FCA will apply the

same analysis should future efforts occur to promulgate regulations

that would expand or change the authorities of institutions to engage

in out-of-territory activities.

In the case of charter requests, to ensure that it obtains all of

the necessary information, the FCA will develop procedures, including a

checklist, regarding the submission of materials. The procedures will

include mechanisms that will enable the FCA to solicit and consider the

views of System institutions affected by a proposed request. Consistent

with the procedures provided, the requesting institution will be

expected to make its case that the standard outlined in this policy

will be met. The FCA recognizes that, by their nature, some of the

factors listed would be addressed by the agency rather than the

requesting institution.

While this policy is designed to address the broader issues of the

potential for intra-System competition, several years ago the FCA

determined that it would temporarily avoid acting on requests for

competitive charters until it completed its review of the matter and

issued a policy. This policy is designed to achieve that objective.

Therefore, following the development of these procedures, the FCA Board

will be in a position to entertain charter requests involving the

potential for competition in accordance with the principles contained

in this statement.

The FCA recognizes that System institutions continue to undergo

structural change in their effort to best meet the System's mission.

The agency realizes the importance of these changes and will consider

each request promptly.

Specific Request for Comments

The FCA Board intends to evaluate any matter involving competition

among System institutions that comes before it by balancing all

relevant factors on a case-by-case basis. The FCA Board specifically

invites comments on the factors set forth in the proposed policy

statement and on the appropriate analysis of such factors, and asks for

suggestions for additional factors or analyses that should be

considered by the FCA Board.

No one factor is likely to be dispositive in any given matter, and

the FCA Board has set only one specific criterion or standard that must

be met in each proposal involving increased competition among System

institutions--that the proposal, if approved, would lead to a net

overall improvement in the availability, quality, and price of credit

and credit services to eligible customers. The FCA Board invites

suggestions on the information it should require and the procedures it

should use to determine the ``availability, quality, and price of

credit and credit services'' when it is considering a matter involving

competition among System institutions.

Dated: April 7, 1994.

Curtis M. Anderson,

Secretary, Farm Credit Administration Board.

[FR Doc. 94-8902 Filed 4-12-94; 8:45 am]

BILLING CODE 6705-01-P