oversight

Farmers Home Administration: Changes Needed in Loan Servicing Under the Agricultural Credit Act

Published by the Government Accountability Office on 1990-08-02.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                                                  c
                United   States   General   Accounting   Office

                 Report to the Chairman, Committee on
GAO             ‘Agriculture, Nutrition, and Forestry,
                 U.S. Senate


qugust   1990
                FARMERS HOME
                ADMINISTIZATION
                ChangesNeeded in
                Loan Servicing Under
                the Agricultural Credit
                Act
Resources, Community, and
Economic Development Division

B-239540

August 2,199O

The Honorable Patrick .J. Leahy
Chairman, Committee on Agriculture,
   Nutrition, and Forestry
IJnited States Senate

Dear Mr. Chairman:

This report responds to your September 22, 1988, request for a review of the Farmers Home
Administration’s (FmEIA) implementation of the debt servicing requirements as set forth by
the Agricultural Credit Act of 1987. We are recommending a variety of legislative changes to
improve the results of FIIIHA'S implementation of the act. In addition, we recommend that the
Secretary of Agriculture take action to improve borrowers’ financial situations after
restructuring.

As arranged with your office, we are sending copies of this report to appropriate Senate and
House committees; interested members of the Congress; the Secretary of Agriculture; the
Administrator, FmIIA; the Director, Office of Management and Budget; and to other interested
parties. We will also make copies available to others upon request,

This work was performed under the direction of .John W. Harman, Director, Food and
Agriculture Issues, (202) 275-5138. Other ma,jor contributors are listed in appendix IV.

Sincerely,




J. Dexter Peach
Assistant Comptroller General
                            Several changes need to be made to the act. First, legislative action
                            needs to be taken to ensure that bad faith borrowers-those     whose
                            delinquency was due to circumstances within their control or who did
                            not act in good faith in connection with the terms of their F~HA loans-
                            do not unduly benefit from the act. Second, amendments need to be
                            made to allow F~HA to consider unsecured assets in its loan servicing
                            decisions. Such a change would reduce the debt relief for those delin-
                            quent borrowers who have sufficient assets to satisfy some or all of
                            their delinquency.

                            Furthermore, the act may have created an incentive for nondelinquent
                            borrowers to intentionally become delinquent since the debt reduction
                            provisions apply only to borrowers who default on their loan payments.
                            Although borrowers who intentionally become delinquent are not to
                            receive the act’s benefits, FTIIHA may be unable to deny servicing to them
                            because concluding that they caused their delinquency is difficult.



Principal Findings

Borrower Participation in   At the county offices GAO reviewed, 63 percent of the borrowers were
Debt Servicing              offered net recovery value buy-out, producing debt write-offs of $78
                            million; 18 percent were offered restructuring, producing debt write-
                            downs of $13 million; and 19 percent were offered restructuring,
                            involving no debt write-downs. Forty percent of the borrowers had FIIIHA
                            debt in the $250,000 to $999,999 range. For example, one borrower, who
                            had not made any loan payments since 1985, was offered a write-off of
                            $738,928 through net recovery value buy-out,


Restructured Borrowers      After restructuring, 91 percent of the borrowers analyzed by GAO at the
                            FmHA county offices had such high debt-to-asset ratios and/or low cash
Financially Weak After
                            flow margins for the upcoming year that their potential for successful
Servicing                   farming operations appeared limited. Almost 50 percent of the bor-
                            rowers had debts which exceeded their assets and about 59 percent had
                            a cash flow margin of less than $100 after projecting income and
                            expenses for the upcoming year. F~HA does not have a cash flow reserve
                            requirement for its restructured borrowers. One restructured borrower,
                            for example, had a $2 positive cash flow for the upcoming year, a 222
                            percent debt-to-asset ratio, and a $246,000 negative net worth. Further-
                            more, some of the restructured borrowers interviewed by GAO doubted


                            Page3                         GAO/RCED-90.169A@culturalCreditActDebtServicing
                  Executive Summary




                  are contained in the proposed 1990 Farm Bill, which passed the Senate
                  Committee on Agriculture, Nutrition, and Forestry on May 17, 1990.


                  GAO  recommends that the Secretary of Agriculture direct the F~HA
Recommendations   Administrator to (1) revise regulations implementing the Agricultural
                  Credit Act to provide restructured borrowers with a lo-percent cash
                  flow margin after servicing, (2) alert county offices that borrowers may
                  attempt to intentionally become delinquent to qualify for debt relief,
                  and (3) notify farmer program borrowers that intentionally causing
                  delinquencies could disqualify them from obtaining debt relief.

                  Further, GAO recommends that the Congress amend the Agricultural
                  Credit Act to address several issues including making it clear that bad
                  faith borrowers are prevented from receiving debt relief benefits and
                  authorizing E-I~IHAto consider all assets of delinquent borrowers who are
                  being considered for debt relief.


                  USDA   agreed with two of GAO'S recommendations addressed to the Secre-
Agency Comments   tary. However, although agreeing with the recommendation that the
                  cash flow margin should be increased, USDA commented that it supports
                  a S-percent, rather than a lo-percent, margin. GAO believes that a lo-
                  percent margin, which is consistent with FITIHA'S guaranteed farm loans,
                  is needed to provide restructured borrowers with the ability to cover
                  unforeseen expenses. IISDA also offered some technical comments, which
                  GAO considered in finalizing this report. IJSDA did not comment on the
                  recommendations addressed to the Congress. USDA disagreed with GAO'S
                  view that the net recovery value buy-out option is available only to good
                  faith borrowers. IJSDA'S position is that the net recovery value buy-out
                  authority of the act is separate from the restructuring authority and
                  therefore net recovery value buy-out is not subject to the eligibility pro-
                  visions of the act. GAO has not, modified its position. GAO questions USDA'S
                   interpretation because the net recovery value buy-out authority is an
                   integral part of the overall statutory scheme to provide benefits only to
                   good faith borrowers and, in GAO'S view, it is not a separate and distinct
                   authority. Nevertheless, as stated in the report, GAO supports legislative
                   action to ensure that borrowers who act in bad faith do not receive the
                   act’s benefits. IJSDA'S comments and GAO'S evaluation are discussed in
                   chapters 3,4, and 5.




                   Page 6                       GAO/RCED90-169 Agricultural   Credit Act Debt Servicing
                      Contents




Chapter 5                                                                                           59
Agricultural Credit   Cost of Farming Reduced for Serviced Borrowers                                59
                      FmHA Nondelinquent Borrowers Question Equity of the                           61
Act May Encourage         Agricultural Credit Act
Loan Defaults by      Conclusions                                                                   63
                      Recommendations to the Secretary of Agriculture                               64
Solvent Borrowers     Agency Comments and Our Evaluation                                            64

Appendixes            Appendix I: Agricultural Credit Act’s Implementation                          66
                          Schedule
                      Appendix II: FmHA County Offices Reviewed by GAO                              67
                      Appendix III: Comments From the Under Secretary for                           68
                          Small Community and Rural Development, USDA
                      Appendix IV: Major Contributors to This Report                                71

Tables                Table 2.1: Notified Borrowers Who Applied for Servicing                       22
                          in 10 FmHA County Offices
                      Table 2.2: Borrowers Offered Loan Servicing Within 60                         25
                          Days of Application in 10 FmHA County Offices
                      Table 2.3: Borrowers Who Had Debt Servicing Offered                           28
                           and Completed in 10 FmHA County Offices as of
                          June 30,1989
                      Table 2.4: Borrowers by Range of Debt Prior to Loan                           29
                           Servicing in 10 FmHA County Offices
                      Table 2.5: Borrowers by Type of Loans in 10 FmHA                              31
                           County Offices
                      Table 2.6: Borrowers, Debt Amount, and Debt Reduction,                        32
                           by Servicing Category in 10 FmHA County Offices
                      Table 2.7: Borrowers by Range of Write-Downs and                              33
                           Write-Offs in 10 FmHA County Offices
                      Table 3.1: Borrowers by Farm Income/ Solvency                                 38
                           Categories After Restructuring in 10 FmHA County
                           Offices
                      Table 3.2: Average Financial Data for Restructured                            39
                           Borrowers by Income/Solvency Category in 10 FmHA
                           County Offices
                      Table 3.3: Borrowers by Cash Flow Margin After                                40
                           Restructuring in 10 FmHA County Offices




                       Page 7                    GAO/RCED-96-169 A@icultur.al Credit Act Debt Servicing
Page 9   GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
                                        chapter 1
                                        Introduction




                                        Figure 1.1 shows that           FmHA    past due loan payments grew steadily
                                        during the 1980s.’


Figure 1.1: FmHA Past Due Payments as
of June 30,1990-89
                                        10      Dollan In Bllllons




                                         1950          1981      1962    1693      1094       1955      1695       1987      1680       1609

                                        Source FmHA’s Active Borrowers Delmquent Report (Report code 616) for each year


                                        The increase in FIIIHA’S delinquent loans can be attributed partly to
                                        the high risk farmers to whom FmHA loans money and to the stressed
                                        financial condition of agriculture during the 1980s. When the farm
                                        economy experienced a downturn in the early 198Os, FIIIHA continued
                                        to carry delinquent borrowers by using existing loan servicing poli-
                                        cies, including subordination of FmHA loan security, debt set-asides
                                        and deferrals, and rescheduling loans at reduced or limited resource
                                        interest rates.

                                                loan-making policies, congressional directives, and judicial deci-
                                         FITIHA’S
                                         sions during the 1980s also contributed to the increase in delinquencies,
                                         For example, F~HA’S continuation policy between 1983 and 1985 kept
                                         farmers in business by extending additional credit to those who were
                                         unable to repay existing debt. F~HA rescinded the continuation policy in


                                         ’ FmHA reports loan delinquencies as only the total payments (principal and m&rest) that are pwt
                                         due rather than the total principal on which the payments are past due. The latter defimtmn is used
                                         by other mryor institutional lenders to the nation’s farmers.



                                         Page 11                                 GAO/RCED-96.169 Agricultural     Credit Act Debt servicing
Chapter 1
Introduction




for delinquent borrowersz If a delinquent borrower does not qualify for
restructuring, the act also provides for a mediation meeting between the
borrower, FmHA, and the borrower’s other creditors in a further attempt
to develop a feasible restructuring plan.

Good faith borrowers who are unable to develop a feasible restructuring
plan may be eligible to pay F~HA an amount equal to the net recovery
value of collateral securing their loans, thereby ending their debt obliga-
tion to F~HA. FIIMA takes into account the estimated costs of foreclosing,
holding, and disposing of security property in determining net recovery
value. The payment in many cases is substantially less than (1) the
market value of property securing the F~HA debt or (2) the amount of
total outstanding debt a borrower owes FmHA. The term “net recovery
value buy-out” is used to describe this payment. F~HA writes off the dif-
ference between a borrower’s total outstanding debt and the buy-out
amount when a borrower makes this payment.

The act provides that FmHA recover part of a write-down or write-off
under some circumstances. For example, under a shared appreciation
agreement F~HA will recover part of a write-down from borrowers
whose debt is restructured if within 10 years borrowers sell or other-
wise convey the real property securing their loans, cease farming, or
repay the debt. Likewise, under a recapture agreement F~HA will
recover part of a write-off from borrowers who buy out their debt if
within 2 years they sell their real property. However, the act does not
provide for recovery when a borrower’s loan security is chattel
property. I

Borrowers whose loans are not restructured and those who do not buy
out their debt at net recovery value are subject to foreclosure by F~HA
on the collateral securing their loans. The Agricultural Credit Act and
the Food Security Act of 1985 (P.L. 99-198, Dec. 23, 1985) provide that
borrowers whose real property is foreclosed have an option of leasing or
purchasing the property back from F~HA (referred to as leaseback/
buyback). Also, borrowers are permitted to purchase their farm home-
steads, including farm buildings and up to 10 acres of land (referred to


‘It is also possible for a nondelmqucnt borrower experiencing financial stress to be eligible for all
primary loan service programs. except debt write-down. Such borrowers, however, must be unable to
pay their debt as scheduled brforc FmHA will use a primary loan service program.

‘Chattel property, as opposed to real estate, is personal property used in farming operations for the
production of incomr, including property such as trucks, tractors, and other major equipment.



Page 13                                 GAO/RCED-99.169 Agricultural       Credit Act   Debt   Servicing
                             Chapter 1
                             Introduction




                             instructions on how to apply for loan servicing. FIIIHA required bor-
                             rowers to apply for servicing in writing within 45 days after receiving
                             their notices. FIIIHA was to determine whether each borrower who
                             returned a completed application qualified for servicing and to provide
                             a written servicing offer within 60 days after receiving an application to
                             each qualifying borrower.

                             FmtIA designed its DALK$ computer program to assist county offices in
                             determining how borrowers could be serviced. The computer program
                             compared the present value of borrowers’ restructured loans with the
                             net recovery value of the collateral securing the loans and determined
                             the servicing option to be offered.

                             Borrowers who received restructuring or net recovery value buy-out
                             offers had 45 days to accept the offers. However, borrowers who
                             received buy-out offers could delay their decisions by (1) requesting
                             mediation in a further attempt to develop a plan that would qualify
                             them for restructuring, (2) appealing the FITIHA decision that they did not
                             qualify for restructuring, or (3) requesting an independent appraisal of
                             their collateral.

                             When all efforts to develop a feasible financial plan for an F~HA bor-
                             rower had been exhausted, and when borrowers did not buy out their
                             loans at the net recovery value, FITIHA was to notify them of its intent to
                             “accelerate” the loans and foreclose on the collateral. When a loan is
                             accelerated, it becomes due immediately. Acceleration is, in effect, the
                             last step before foreclosure proceedings. However, prior to acceleration,
                             borrowers could request :

                         l a meeting with FIIIHA to provide additional information concerning the
                           servicing decision,
                         . an appeals hearing,
                         l an independent appraisal of the property securing the F~HA debt,
                         . a consideration for preservation loan service options, or
                         . the voluntary conveyance of their securit.y property to FmHA and a debt
                           settlement agreement.


                             On September 22. 1988, the Chairman, Senate Committee on Agricul-
Objectives, Scope, and       ture, Nutrition, and Forestry requested that we review F~HA'S imple-
Methodology                  mentation of the debt servicing provisions of the Agricultural Credit Act
                             of 1987. In doing so, WC



                              Page 15                      GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
                                     -
Chapter 1
Introduction




office records and discussed with county office officials the status of an
additional 627 borrowers in an attempt to determine these borrowers’
reasons for not applying. We did not analyze records for 41 borrowers
who had not completed the application process.

At the time of our review, county office staffs had determined that of
the 569 applicants, 474 qualified and 87 did not qualify for servicing.
Additionally, eligibility decisions and offers were pending for eight bor-
rowers. To determine various financial characteristics of delinquent bor-
rowers who were offered servicing, we reviewed county office records
for 434 of the 474 qualified borrowers. In two county offices we did not
analyze 40 qualified borrowers because they were in mediation or had
declined FmHA’S servicing offer. We included such borrowers in our anal-
ysis of debt servicing for the other eight county offices. For the 434 bor-
rowers analyzed, we determined the amount of debt that was
restructured without write-down, restructured with write-down, and
written off with net recovery value buy-outs. We also determined the
types and sizes of loans held by delinquent borrowers who qualified for
servicing.

In analyzing FmHA’S implementation of the act and the act’s impact on
borrowers, we determined (1) who was and who was not sent a servicing
notification and application package, (2) whether application packages
were received, (3) whether borrowers responded to the packages, (4)
why borrowers did not respond, (5) which and how many borrowers
requested servicing, (6) why borrowers did not request servicing, (7)
whether FmHA’S process or eligibility rules restricted borrower participa-
tion, (8) whether F~IIA denied servicing to some borrowers and why, and
(9) the type of servicing FmIIA offered borrowers.

We made three other analyses in response to the Chairman’s request for
an assessment of the act’s impact on FmHA borrowers. First, regarding
delinquent borrowers to whom FmHA offered restructuring, we assessed
whether the act restored their financial strength to a point at which
they could potentially operate successful farms or ranches. Specifically,
we compared projected annual cash flows and debt-to-asset ratios for
restructured borrowers to financial indicators for successful farming
operations used by I%DA and FmHA. Further, we analyzed other data that
could indicate ability to operate successful farms, including F~HA’S loan
restructuring and lending practices, and the opinions of FmHA borrowers
and county and state office staffs.




 Page 17                      GAO/RCED-90.169 Agricultural   Credit Act Debt servicing
Chapter 1
Introduction




In November 1989, we issued a fact sheet to the Chairman, Subcom-
mittee on Agricultural (?edit, Senate Committee on Agriculture, Nutri-
tion, and Forestry, entitled Farmers IIome Administration: Loan
Servicing Benefits for Had Faith Borrowers (G.~o/K(‘t:r)-!lo-77~~,Kov. 29,
 1989). The fact sheet provided information on delinquent borrowers
who acted in bad faith and who had received benefits, or were consid-
ered eligible to receive benefits, under the provisions of the Agricultural
Credit Act. The fact. sheet was based on some of the information con-
tained in chapter 4 of this report.. In addition, we testified in March 1990
before the Subcommittee on Agricultural Credit, Senate Committee on
Agriculture, Nutrition, and Forestry on the preliminary results of oui
work on this review. I

On March 6, 1990, ILK. 4077, a bill to amend certain aspects of the Agri-
cultural Credit Act, passed the IIouse of Representatives and was
referred to the Senate. This bill addresses various issues that are dis-
cussed in this report including limits on the mimber of times a borrower
may have debt written down or written off, a good faith requirement to
bc eligible for net rec~n~~ry value buy-out and preservation servicing,
and consideration of unsccrired assets in servicing decisions. As of June
28, 1990, the Scnatc had not passed a similar bill. However, various
changes to the act arc c~ontaincd in the proposed 1990 Farm Bill which
passed the Senate Committee on Agriculture, Nutrition, and Forestry on
May 17, 1990.

IWA’S written comments on the results of our work are contained in
appendix III. Various technical changes to the report were made on the
basis of those comments.




 Page 19                      GAO/RCED-90-169 Agricultural   Credit Act Debt Swvicing
                         Chapter2
                         Implementing the Agricultural Credit Act
                         Resulted in Many Delinquent Borrowers’ Not
                         Fkinn Serviced and Substantial Costs for




                         because of uncertainty about whether or not borrowers who had filed
                         for Chapter 7 bankruptcy were eligible to apply. F~HA amended the gui-
                         dance for bankrupt borrowers after county supervisors mailed notifica-
                         tion packages in November 1988. However, county office staff told us
                         they are still unclear about sending notification packages to borrowers
                         in bankruptcy. Excluding the seven bankruptcy cases, the other bor-
                         rowers who had been overlooked were furnished notification packages
                         subsequent to our review.

                         In addition, an error in record keeping resulted in one of the county
                         offices we reviewed offering debt restructuring with a substantial write-
                         down to a borrower who was ineligible. In this instance, the county
                         supervisor notified the borrower, who was not delinquent, of the act’s
                         servicing benefits, and the borrower applied for restructuring. The
                         county office staff processed the borrower’s application and offered to
                         restructure his FmIIA loans, including writing down $201,181 of his
                         $329,026 FrnIu debt. After we briefed the county supervisor on the
                         error. he rescinded the offer before the borrower’s debt was rewritten,


                         Nationally, about 50 percent of the 66,400 notified delinquent borrowers
About Half of Notified   applied for loan servicing. At the county offices we reviewed, 45 percent
Borrowers Applied        of the 1,272 notified borrowers applied for servicing. Table 2.1 shows
                         that 49 percent to 65 percent of the delinquent borrowers in nine of the
                         county offices applied for servicing. In the tenth office, only 14 percent
                         of the delinquent borrowers applied for servicing. Most of the 86 percent
                         in this office who did not apply chose to negotiate a settlement of their
                         F~HA debt or were inactive farmers with little or no remaining collateral.




                          Page 21                            GAO/RCED-SO169 Agricultural   Credit Act Debt Servicing
                           Chapter 2
                           Implementing the Agricultural Credit Act
                           Resulted in Many Delinquent Borrowers’ Not
                           Being Serviced and Substantial Coats for
                           the Government




Borrowers Chose Debt       Some borrowers chose to apply for settlement of their F~HA debts rather
                           than Agricultural Credit Act servicing. In the county offices we
Settlement Rather Than     reviewed, 155 delinquent borrowers, or 22 percent of those who did not
Servicing                  apply, requested debt settlement. Debt settlement is a negotiated agree-
                           ment between a borrower and FI~IHA in which the borrower agrees to
                           repay FmHA a specified amount to settle the outstanding debt.

                           F~HA  state and county office officials told us that borrowers who
                           requested debt settlement usually were no longer farming. According to
                           one county supervisor, borrowers requested debt settlement because it
                           eliminated the need to complete F~HA'S application package. Also, he
                           said debt settlement results were frequently comparable to servicing
                           under the act.


Borrowers Chose to Pay     Some borrowers chose to pay their FmHA loans current or to pay them
Debts Current or in Full   off after receiving FmHA'S notification package. In the county offices we
                           reviewed, 67 delinquent borrowers, or about 10 percent of those who did
                           not apply, chose to make a payment to F~HA rather than request ser-
                           vicing. We did not tabulate the total amount paid by these 67 borrowers.

                           Borrowers chose to pay their FmHA debts current or to pay them off for a
                           variety of reasons. For example, one borrower told us she paid her debt
                           current because F~HA'S notification package reminded her that she was
                           delinquent. Another borrower paid current because she had the money
                           and was uncertain how she would benefit if serviced under the act.
                           However, this borrower, who recently became delinquent again, told us
                           she planned to apply for servicing when she received the next servicing
                           notification because FmHA had reduced her neighbors’ debt. According to
                           one county supervisor, many borrowers at his county office who paid
                           current had low-valued loans that were secured by high-valued assets.
                           These delinquent borrowers paid when they realized F~HA would not
                           reduce their debts.

                           -__
Few Borrowers Confused      Delinquent borrowers generally were not confused or overwhelmed by
                            F~HA'S application package. Only five borrowers, or 14 percent of the 35
by FmHA Application
                            we interviewed who did not apply for servicing, said that the package
Process                     was confusing. One borrower said he was confused by the large notifica-
                            tion and application package. He also said he had another job and did
                            not have the time to study and complete the package nor the money to
                            hire a lawyer to submit an application for him.



                            Page23                             GAO/RCED99-169 Agricultural   Credit Act Debt Servicing
                                          Chapter 2
                                          ImplementinS the A@icultural Credit Act
                                          Resulted in Many Delinquent Romwers’ Not
                                          Being Serviced and Substantial Costs for
                                          the Government




Table 2.2: Borrowers Offered Loan
Servicing Within 60 Days of Application                                                                                        Percentaga offered
in 10 FmHA County Offices                 County                         Total borrowers              Offers at 60 days                 at 60 days
                                          1                                                  28                         28                       100.0
                                          2                                                  38                         28                        73.7
                                          3                                                  37                           1                        2.7
                                          4                                                  58                         55                        94.8
                                          5                                                  34                           1                         2.9
                                          6                                                  58                          58                      100.0
                                          7                                                  44                          44                      100.0
                                          a                                                  ai                          22                       27.2
                                          9                                                  68                          50                       73.5
                                          IO                                                 28                          28                      loQ.0
                                          Total                                            474'                        315                        66.6

                                          %ervlclng offers 01 ellgibillty determnatlons     were pendlng for aght addltlonal borrowers, and servlctng
                                          was denled for 07 borrowers




Borrowers Did Not Apply                   Many FmHA delinquent borrowers in the county offices we reviewed did
                                          not complete applications within the 45-day time period specified by the
on Schedule                               act. For example, 143 of 450 borrowers, or about 32 percent, in eight of
                                          the county offices we reviewed did not complete their applications
                                          within the 45-day application period. The county supervisor in a ninth
                                          county told us none of his borrowers submitted complete applications
                                          within the 45-day period. According to the tenth county supervisor,
                                          while some applications were complete, most were incomplete.

                                           In response to low application rates, complaints from farmer advocates,
                                           and congressional concerns, FmHA lengthened the application period by
                                           allowing borrowers to apply under a “good faith” rule of reason.
                                           Depending on the date that the county offices mailed notices, borrowers
                                           were originally allowed from about mid-November 1988 to mid-January
                                           1989 to apply for servicing. F~HA'S “good faith” rule extended the appli-
                                           cation period into March 1989.

                                           Under F~HA'S “good faith” policy, borrowers could submit four of nine
                                           required documents within the 45.day application period and complete
                                           the application during the FmliA 60-day processing period with county
                                           office assistance. In practice, however, 2 of the county offices accepted
                                           as a “good faith” application a simple oral or written statement from
                                           borrowers, within 45 days after being notified, that they wished to be
                                           serviced. At another county office, a signed farm and home plan was
                                           accepted as a “good faith” application. After receiving “good faith”


                                              Page26                                      GAO/RCED-90169 A@icultural Credit Act Debt Service
                            Chapter 2
                            Implementing the Agricultural Credit Act
                            Resulted in Many Delinquent Rorrowem’ Not
                            Being Serviced and Substantial Co& for
                            the &emment




                            Although implementation problems delayed application processing and
                            servicing decisions, borrower participation in servicing was not
                            restricted. Despite the schedule delays, F~HA continued processing appli-
                            cations for servicing, and county supervisors told us they intended to
                            process all applications for qualified borrowers regardless of the time
                            schedule.


                            The FmHA county offices we reviewed offered debt servicing to most bor-
F’mHA Offered               rowers who applied. The county offices offered servicing to 474 delin-
Servicing to Most           quent borrowers, or 83 percent of the 569 borrowers who applied for
Borrowers Who               servicing. About 35 percent of the borrowers were offered restructuring,
                            with and without debt write-down, and about 65 percent were offered
Applied                     net recovery value buy-out. Also, servicing offers or eligibility determi-
                            nations were pending for eight additional borrowers, or less than 2 per-
                            cent, at the time of our visits to the county offices. County staffs denied
                            servicing for 87 borrowers, or 15 percent of those who applied, for a
                            variety of reasons; the primary reason was that the borrowers sub-
                            mitted incomplete applications.


Servicing Offered Through   Nationally, as of June 30, 1989, F~HA offered restructuring with debt
                            write-down and buy-out with debt write-off to 7,509 borrowers. At that
June 30,198Q                time, F~HA had not compiled national statistics showing the number of
                            borrowers who were restructured without debt write-down. In January
                            1990, F~HA reported that, as of November 30, 1989, the number of ser-
                            viced borrowers had increased to 9,637 borrowers-4,608      borrowers
                            were offered restructuring with debt write-down and 5,029 borrowers
                            were offered buy-out with debt write-off. An additional 9,599 borrowers
                            were offered restructuring without debt write-down. Further, 6,341 bor-
                            rowers received debt settlement rather than servicing under the act.

                            The county offices we reviewed, as of June 30,1989, had made servicing
                            offers to 474 of the 482 borrowers who qualified for servicing-166
                            borrowers, or 35 percent, received primary servicing and 308 borrowers,
                            or 65 percent, received net recovery value buy-out offers. Five bor-
                            rowers had servicing offers pending and three borrowers had eligibility
                            determinations pending. Table 2.3 shows that, as of June 30, 1989, the
                            county offices had completed servicing 191 borrowers, or about 40 per-
                            cent of the qualified borrowers.




                             Page 27                           GAO/RCED.99.169 Agriculhual   Credit Act Debt Servicing
                                             Chapter 2
                                             Implementing the Agriculh~ral Credit Act
                                             Resulted in Many Delinquent Borrowers’ Not
                                             Being Serviced and Substantial Costs for
                                             the Government




                                             farm operating loan. While 15 percent of the borrowers had only emer-
                                             gency loans, 24 percent did not have emergency loans, We did not com-
                                             pile summary data on loan size and type for serviced borrowers
                                             nationwide.


Borrowers Serviced Had                       Borrowers with all sizes of F~HA debt benefited from the act. As table
                                             2.4 shows, in the county offices we reviewed F~HA offered restructuring
Large, Moderate, and                         or net recovery value buy-out to 19 borrowers, or 4 percent of the bor-
Small
- . Amounts of FmHA                          rowers we reviewed, whose total F~HA debt before servicing exceeded $1
debt                                         million. One county office, for example, offered net recovery value buy-
                                             out to a borrower who owed F~HA more than $4 million. Also, FmHA
                                             offered restructuring or net recovery value buy-out to 172 borrowers, or
                                             40 percent of those WCreviewed, whose total FmHA debt before servicing
                                             was in the $250,000 to $999,999 range, and to 243 borrowers, or 56 per-
                                             cent of those we reviewed, whose total FmHA debt before servicing was
                                             less than $250,000.


Table 2.4: Borrowers by Range of Debt Prior to Loan Servicing in 10 FmHA County Offices
                                                                Range of debt (Dollars in thousands)
                       Total                                                                                         $1 ,“$I;&        $3,000 and
County           borrowers’      $1 to 49      sot099      $looto249     $250to499      $500to999                                             over
1                        28             0                3               12   ~~          13                0                    0                   0
2                        38             7                0                8               11                4                    0                   0
3                        37              1               4               10               11                6                    4                   1
4                        58              6               5               20               19                8                    0                   0
5                        34              2               4                9               13                6                    0                   0
6                        29              1               3               14                7                2                    1                   1
7                        33              3               4               13               12                1                    0                   0
8                        81             16              14               IO               17               14                    9       ~~   _~ 1
9                        68              9              11               25               18                4                    1               0
10                       28              1               4               16                6                0                    1                   0
Total                   434            46              60              137     -~       127                46                16                      3

                                             “We did not record debt prfor to sewc,ng for 29 and 11 ellglble borrowers I” counties 6 and 7, respec-
                                             t~vely, who had declined FmtiA s servicing offer 01 were rn medlatlon We Included such borrowers 10our
                                             compllatlons for the other counties We also did not record lnformatlon for the aght borrowers in four
                                             counties who had not received offers




Borrowers Serviced Had a                     FmHA  offered restructuring or net recovery value buy-out to delinquent
Variety of FmHA Loan                         borrowers with most types of farmer program loans, including farm
                                             operating, farm ownership, natural disaster emergency, economic emer-
Types                                        gency, and soil and water loans. Also, some serviced borrowers had


                                             Page 29                                 GAO/RCED-W-169 Agriculhtral        Credit Act Debt Servicing
                                              Chapter 2
                                              Implementing the Agricultural Credit Act
                                              Resulted in Maw Delinauent Borrowers’ Not
                                              Being Serviced a&d Sub&&al    Costa for
                                              the Government




Table 2.5: Borrowers by Type of Loans in 10 FmHA County Ofiices
                                                  Borrowers with no                       Borrowers with only                 Borrowers with a -
                                                   emergency loans                         emergency loans                  combination of loans
                                                             Percent of                             Percent of                         Percent of
County                      Total borrowersa     Number           total                  Number           total             Number           total
1                                          28          4           143                           6             21.4                18             64 3
2                                        38                   a             21 1                 a             21 1                22             57 9
3                                        37                   4             108                  7             la.9                26             70 3
4                                        58                  17             29 3                15             25 9                26             44 a
5                                        34                  12             35 3                 3              a.8                19             55.9
6                                        29                   7             24 1                 3             10.3                19             65 5
7                                        33                  14             42 4                 2               61                17             51.5
6                                        ai                  la             22 2               -12             148                 51             63.0
9                                        68                  20             29 4                 4               59                44             64 7
10                                       28                   2               71                 4             143                 22             78 6
Total                                   434                106             -24.4                64             14.7              264              60.6

                                              aWe did not determine loan type for 29 and 11 ellglble borrowers in counties 6 and 7. respectively. who
                                              had declined FmHA’s servung offer or wele in mediation We included such borrowers r our complla-
                                              tlon for the other counties We also did not record InformatIon for the eight borrowers in four counties
                                              who had not received offers



                                              In March 1988, F~HA estimated that debt forgiveness for delinquent bor-
Borrowers Received                            rowers through write-downs and write-offs would total about $9.4 bil-
Loan Servicing at                             lion. This estimate excluded any potential future recovery through
Substantial Cost to                           recapture agreements. Nationally, as of June 30, 1989, FmHA had
                                              approved write-downs or write-offs that total almost $1.4 billion. In
FmHA                                          January 1990, FmHA reported that, as of November 30, 1989, approved
                                              debt forgiveness had increased to a total of almost $1.8 billion. In addi-
                                              tion, another $933 million in write-offs resulted from FmHA'S debt settle-
                                              ment activities.

                                              By June 30, 1989, the FmHA county offices we reviewed had offered to
                                              write down or write off over $91 million of the $126 million owed by
                                              350 delinquent borrowers. F~HA also offered restructuring without
                                              write-down to an additional 84 borrowers who owed FmHA almost $13
                                              million. The debt forgiveness received by the 350 borrowers represents
                                              about two-thirds of the total debt owed F~HA by the 434 borrowers
                                              offered restructuring or net recovery value buy-out that we reviewed.
                                              FmHA will incur additional losses on some restructured loans because of
                                              restructuring features such as interest rate reductions and term exten-
                                              sions. However, we did not calculate the additional losses associated
                                              with restructured loans.


                                              Page 31                                   GAO/llCED-90.169 Agricultural      Credit Act Debt Servicing
                                                                     --
                                           Chapter 2
                                           Implementing the Agricultural Credit Act
                                           Resulted in Many Delinquent Borrowers’ Not
                                           Being Serviced and Substantial Costs for
                                           the Government




Table 2.7: Borrowers by Range of Write-Downs and Write-Offs in 10 FmHA County Offices
                                                        Range of debt reduction (Dollars in thousands)
                       Total                                                                                                        $3,000 and
Countv           borrowers’      $1 to 49    $50 to 99 $100 to 249 $250 to 499 $500 to 999                                                over
 1                        26            1            6           io ~~          9               0                            0               0
2-..~    -
                          ia            3-           4             7            4               0                            0                  0
3                       30             2               4                   a              a                4                 3                   1
4                       50            11              12                  14             11                2                 0                  0
5                       25             2               2                   6             12                3                 0                  0
6                       23             i               6                  12              i                2                  1                 0
7                       30             6              6---                13     -~       5                0                 0                  0
a                       66            17               a                  10             13               14                  4                 0
9                       67            12   ~-    -~   12                  27             12                3                  1                 0
10                      15             3               3                   a              0                1                  0                 0
                                                                                                                                   __.-
Total                  350            59              63             115                 75              29                   9                  1
                                           “We did not compile servicing lnformatlon for 29 and 11 ellglble borrowers in counties 6 and 7, respec-
                                           tlvely, who had declined FmHA’s serwang offer or were I” mediation We Included such borrowers in our
                                           comp~iat~ons for the other counties We also did not record lnformatlon for the eaght borrowers I” four
                                           counties who had not received offers



                                           The following case studies illustrate borrowers serviced under the Agri-
Examples of Serviced                       cultural Credit Act. The cases cannot be projected to the county offices
Borrowers                                  or the states we reviewed, or to the nation overall.

                                           Borrower A: A soybean and wheat farmer bought out his $29,000 FmHA
                                           debt for the $4,726 net recovery value of his collateral. The borrower
                                           had four outstanding F~IIIIAloans: a farm ownership loan, a natural dis-
                                           aster emergency loan, and two farm operating loans. The borrower had
                                           not made a loan payment on any of the four FmHA loans since May 1984.

                                            Borrower B: A dairy farmer, who owed F~HA over $489,000, had his
                                            debt restructured with rescheduling, reamortization, and a write-down
                                            of over $256,000. The borrower had two farm ownership and three farm
                                            operating loans. The borrower became delinquent when his cattle herd
                                            developed a contagious disease, which forced him to dispose of them
                                            and go out of business for two months. FmHA county office staff charac-
                                            terized the borrower as a “good, hard-working dairy farmer.” Neverthe-
                                            less, they told us t,hcsborrower probably would become delinquent on the
                                            restructured debt.

                                            Borrower C: This farmer had been borrowing from FmHA for 13 years.
                                            He is a peanut, soybean, corn, and hog farmer, who owes FmHA about


                                            Page 33                                   GAO,‘RCED-90.169 Agricultural    Credit Act Debt Servicing
chapter 2
Implementing the Agricultural Credit Act
Resulted in Manv Delinauent Romwem’ Not
Being Serviced &d Subskmtial Costs &nor
the Government




servicing, full payment on one $44,000 emergencyloan was due and
FITIHA had deferred payments on a $17,000 emergencyloan. The bor-
rower had made no payments on any of his debts. As a result of restruc-
turing, the borrower’s $42,000 annual loan payment was reduced to
$24,000.




Page 36                           GAO/RCEBtNW39 Agrktituml   Credit Act Debt Servicing
                             Chapter 3
                             Restructured Borrowers Financially Weak
                             After Servicing




                             classifies farm operations with positive cash flow margins into two
                             income/solvency categories?

                         l   Favorable farm operations have a positive net cash income and a debt-
                             to-asset ratio of 40 percent or less.
                         l   Marginal solvency farm operations have a positive net cash income but
                             a debt-to-asset ratio above 40 percent.

                             In addition, ERS considers farm operations with a debt-to-asset ratio
                             greater than 100 percent to be technically insolvent because the sale of
                             farm assets, if required, would be insufficient to retire the debt.


                             On the basis of IJSDA’S criteria, most borrowers who received debt
Few Borrowers                restructuring offers in the county offices we reviewed will still be finan-
Financially Sound            cially weak even after their debt is serviced. Financial data for bor-
After Restructuring          rowers whose debt PmEIA offered to restructure indicated that only 9
                             percent had favorable financial potential for successful farming opera-
                             tions. Financial data indicated that the remaining 91 percent had limited
                             potential for successful farming operations without continued FmAA
                             financial assistance-additional    loans and restructuring.

                             F~HA   stopped analyzing a borrower’s restructuring options as soon as a
                             positive cash flow was reached. This approach minimized the govern-
                             ment’s losses but is a primary reason many borrowers had very low
                             cash flow margins following restructuring. Additionally, FmHA based its
                             restructuring decision on a borrower’s projections of income and
                             expenses, and such projections may not accurately reflect financial con-
                             ditions. FmIlA state and county officials expressed concerns about the
                             ability of some restructured borrowers to continue farming operations
                             without continued FI~IIAfinancial support. Some restructured borrowers
                             expressed concern about their ability to repay their restructured debt
                             and to continue farming without additional FmIIA financial assistance.


Restructured Borrowers       Few of the 160 restructured borrowers in the county offices we
Had High Debt-To-Asset       reviewed had debt-to-asset ratios indicating favorable farming opera-
                             tions. Only six restructured borrowers in the county offices we reviewed
Ratios                       had positive cash flows and debt-to-asset ratios of 40 percent or less,




                             Page 37                             GAO/RCED-90.169 Agricultural   Credit Act Debt Servicing
                                                          Chapter 3
                                                          Restructured Borrowers FinanciaUy Weak
                                                          After Servicing




                                                          Additionally, table 3.2 shows that the 160 restructured borrowers had
                                                          average assets and F~HA debts of $229,128 and $229,322, respectively,
                                                          for an average net worth of negative $194 and an average debt-to-asset
                                                          ratio of 100.1 percent.


Table 3.2: Average Financial Data for Restructured Borrowers by Income/Solvency Category in 10 FmHA County Offices
Income/
solvency                                      Before servicing             Debt write-            After servicing
category               Assets    FmHA debt ~~_.,-~~D/A ratio   Net worth
                                                                   ~~~ -~~.~    down   FmHA  debt      D/A ratio   Net worth
Favorable"                       $221,275     $106,600                  462%        $114,675            $54,146            $52,454              23.7%       $168,821
MarglnaF                         $284,775     $285,313                1002%             $(538)          $69,030           $216,282              75.9%        $68,493
MarginalC                                     $341,903                1933%                                               $255,135             1442%
                      ~$229.,~---..$176,895           -       .~~~                 $(165,008)~-
                                                                                 ~~~-                 __~$86,461                                             $(78,240)
Overall    averaged                           $306,553                133.8%        $(77,424)            $77,079          $229,322             100.1%           $(194)

                                                          aAverage for 6 borrowers who had a debt-to-asset     ratio of 40 percent 01 less after servung

                                                          “Average for 75 borrowers who had a debt-to.asset        ratio between 41 and 100 percent after serwxng

                                                          ‘Average for 79 borrowers who had a debtMo-asset ratio greater than 100 percent after serwcmg Also,
                                                          debt before serwmg less write-down does not equal debt after sewcmg because one borrower in this
                                                          category made a payment to FmHA dung the serwmg process

                                                          ‘Average for 160 borrowers after servicing. Excludes one borrower whose fmanclal data was not avall-
                                                           able at the time of WI reww and five borrowers who did not accept restructuring offers Also, debt
                                                           before servicing less write-down does not equal debt after serwxng because one borrower made a
                                                           payment to FmHA during the servicing process


                                                                                            -
Restructured Borrowers                                    Implementing regulations for the act required FmHA to restructure delin-
Had Low Cash Flow                                         quent borrowers’ loans until borrowers were able to project a feasible
                                                          plan of operations for the upcoming year. In designing the DALR$ com-
Margins                                                   puter program for det.ermining servicing entitlement, FITIHA considered
                                                          that a feasible plan existed when a positive cash flow was reached, even
                                                          if the positive cash flow was as small as one dollar. Also, the restruc-
                                                          turing analysis excluded consideration for unplanned expenses, equip-
                                                          ment replacements, and new investments.

                                                          Such a small cash flow margin equals the one F~HA requires for its direct
                                                          farm loans, but it is substantially less than the margin FIIIHA requires on
                                                          farm loans made by private lenders that are guaranteed by FITIHA. In a
                                                          1989 report on FmHA’S loan-making policies, we recommended the need
                                                          for a reserve requirement in FITHA’s direct farm loans.’ F~HA’S guaran-
                                                          teed farm loan regulations require borrowers to have cash flow margins
                                                          that meet or exceed all anticipated farm and family living expenses, plus

                                                           ku’mcrs    Ilome Admmlslratlon       Sounder bans Would Require Revised Loan-Making Criteria (GAO/
                                                          RCED-89-9, Feb. 14, 19%1)-



                                                          Page 39                                     GAO/RCED-90-169 Agricultural         Credit Act Debt Servicing
                            Chapter 3
                            Restructured Rorrow~rs Financially Weak
                            After Servicing




                            example, when a borrower has a yearly cash flow of $100 or less, unex-
                            pected expenses, such as equipment failure, could quickly deplete cash
                            reserves.


Borrowers’ Projections      F~HA   based its restructuring decisions on borrowers’ projections of
                            income and expenses, and such projections may not always accurately
May Represent Unrealistic   reflect borrowers’ farming activity and financial conditions. For
Cash Flow Estimates         example, five county supervisors told us they generally accepted a bor-
                            rower’s estimates of farm operating and family living expenses unless
                            the estimates deviated significantly from the borrower’s previous fivc-
                            year history. Also, borrowers’ reports on the amount of land they would
                            farm need not be based on the amount they own or have previously
                            farmed. Further, county supervisors did not verify that borrowers
                            reported all assets and debts.

                            County and state FmHA staffs told us that borrowers could manipulate
                            the financial data, such as income and expenses, for input into the DALK$
                            computer program in order to influence servicing outcomes. For
                            example. five county supervisors said that borrowers who want to
                            qualify for restructuring could provide farm and home plans showing
                            operating expenses that are less than projected farm income. The DALR$
                            computer program would then show a positive cash flow, which quali-
                            fies borrowers for restructuring. Likewise, they said that if borrowers
                            wanted to buy out their debt at the net recovery value of collateral, they
                            could design their farm and home plans to show that they were farming
                            a small amount of available land and generating income that was less
                            than expenses. The WI,It$ computer program would then show a nega-
                            tive cash flow, which qualifies borrowers for buy-out. However, bor-
                            rowers may not get the servicing they seek if county supervisors
                            determine that inaccurate or unrealistic information has been submitted.
                            F~~IAguidance provides for county offices to determine whether income
                            and expense information strbmitted by borrowers is realistic.

                            The February 1989 GAOreport on E‘~IM’Sloan-making policies showed
                            that borrowers often included unrealistic income and expense projec-
                            tions in their farm and home plans. This practice results in overstating
                            borrowers’ cash flow positions and financial strengths. A farm and
                            home plan is the basic financial statement provided to F~IIA by bor-
                            rowers when they request new or additional loans and loan servicing.
                            We did not validate farm and home plan projections for borrowers who
                            were restructured under the .%gricultrrral Credit Act since we had previ-
                            ously reported on probk~ms with thc‘ir validity. and WIG’s Office of


                            Page 41                            GAO/RCEDYO-169 Agricultural   Credit Act Debt Srrvicing
                            Chapter 3
                            Restructured Borrowers Financially Weak
                            After servicing




                            The Agricultural Credit Act does not preclude borrowers from obtaining
Restructured                additional loans at the same time their delinquent debt is being restruc-
Borrowers   Can   Obtain    tured. We found that borrowers had taken advantage of this possibility
Additional Loans and        by requesting and obtaining new funds at the same time their delinquent
                            debt was being restructured. In addition, restructured borrowers who
Restructuring               become delinquent again are eligible for repeated loan servicing. Under
                            the act, the future creditworthiness of a borrower whose loans are
                            restructured is to be determined without regard to the restructuring.


Borrowers Obtained New      Over 14 percent of the 569 borrowers applying for servicing in the
F’mHA Loans at Same Time    county offices we reviewed requested additional FmHA loans when they
                            applied for servicing. The county offices considered delinquent bor-
Delinquent Debt Was Being   rowers to be eligible for additional loans if they qualified for restruc-
Restructured                turing. The following example illustrates one borrower who received
                            approval for additional F~HA loan money at the same time F~HA was
                            restructuring his prior delinquent loan.

                            Example C: FMHA offered to restructure a delinquent borrower’s
                            $85,000 debt with a $75,000 write-down. At the same time, the county
                            supervisor approved the borrower’s request for a $48,300 operating
                            loan. The county supervisor noted in his request for the state director’s
                            approval that while the borrower had submitted a marginal farming
                            proposal for the $48,300 loan, he believed the borrower could pay the
                            loan because the borrower and his wife were personable and
                            industrious.


Act Allows Repeated Loan    The Agricultural Credit Act does not preclude borrowers from returning
Servicing                   to FmHA for additional loan servicing in the future. For example, restruc-
                            tured borrowers may farm a year or longer, become delinquent on their
                            FmHA restructured loans, and then request additional loan servicing. At
                            that time, borrowers could qualify for additional restructuring, with or
                            without debt write-down, or net recovery value buy-out with debt write-
                            off. Borrowers whose debts are restructured may continue to be restruc-
                            tured an unlimited number of times as long as they remain in F~HA'S
                            portfolio.

                            FmHA regulations require county supervisors to keep borrowers techni-
                            cally current by using any of the primary servicing options, except debt
                            write-down, as soon as they become 30 days past due on a loan pay-
                            ment. While these actions will keep borrowers technically current on
                            their loan payments for a period of time, unpaid interest could continue


                            Page 43                            GAO/RCENM%169 &riculturd   Credit Act Debt Servicing
                       Chapter 3
                       Restructured Borrowers Financially Weak
                       After Servicing




                       lender of last resort” for the nation’s high risk farm borrowers. We
                       expect such borrowers to request additional direct loans and loan ser-
                       vicing from F~HA in the future. The Agricultural Credit Act does not
                       preclude this from happening again and again in the future. In fact, the
                       act provides that the future creditworthiness of a borrower whose loans
                       are restructured is to be determined without regard to the restructuring.
                       Thus, these borrowers, and F~HA, are likely to continue on what we have
                       referred to in past reports as a loan-making and loan-servicing treadmill.


                       On March 6, 1990, the House of Representatives passed and referred to
Recent Congressional   the Senate H.R. 4077 which would, in addition to doing other things, (1)
Initiatives            limit a borrower to one write-down or write-off, (2) limit a borrower to
                       no more than a $250,000 write-down or write-off, and (3) preclude a
                       write-down or write-off on loans made on or after January 6, 1988. We
                       agree with these amendments to the Agricultural Credit Act. Also, we
                       recognize that limiting the write-down amount will preclude some bor-
                       rowers from qualifying for restructuring. For example, 20 of the 77 bor-
                       rowers who qualified for restructuring with a debt write-down at the
                       county offices we reviewed had write-downs that exceeded $250,000.
                       These borrowers may not have qualified for restructuring if the ser-
                       vicing consideration stopped with a $250,000 write-down. All 20 of
                       these borrowers were in a weak financial condition after servicing: their
                        cash flow margins ranged from $2 to $25. As of June 28, 1990, the
                       Senate had not passed a bill similar to H.R. 4077. However, various
                        changes to the act are contained in the proposed 1990 Farm Bill, which
                        passed the Senate Committee on Agriculture, Nutrition, and Forestry on
                        May 17, 1990.

                                            ---
                       We recommend that the Secretary of Agriculture direct the F~HA Admin-
Recommendation to      istrator to revise existing regulations implementing the debt restruc-
the Secretary of       turing provisions of the Agricultural Credit Act to provide restructured
Agriculture            borrowers with a lo-percent cash flow margin after servicing. This
                       margin should provide restructured borrowers with the minimum ability
                       to meet unplanned expenses and equipment replacements.

                       -
                        In order to (1) improve the quality of loans in F~HA’S farmer loan pro-
Recommendation to       gram portfolio and the results of FmHA’S debt servicing actions, (2) pre-
the Congress            vent F~HA’S borrowers from repeatedly obtaining debt relief, (3)
                        promote fiscal accountability by FmHA’S borrowers, and (4) limit the
                        amount of debt relief provided to borrowers who receive primary loan


                       Page 45                             GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
ChangesNeeded to Preclude and Limit Benefits
for Certain Delinquent Borrowers

               USDA  has interpreted the Agricultural Credit Act as requiring that bad
               faith borrowers-those     whose delinquency was due to circumstances
               within their control or who did not act in good faith in connection with
               the terms of their F~HA loan agreements-be allowed to buy out at the
               net recovery value of their collateral and receive substantial debt write-
               offs. The basis for USDA’S interpretation of the act is not apparent. We
               believe present law does not require that bad faith borrowers receive
               net recovery value buy-out. In our view, the net recovery value buy-out
               option is available only to good faith borrowers-those      whose delin-
               quency was due to circumstances beyond their control and who acted in
               good faith in connection with the terms of their FmHA loans.

               Also, the act permits some benefits for delinquent borrowers that are
               not in the government’s or taxpayers’ best interest. First, present law
               does not limit preservation benefits to only good faith borrowers. As a
               result, bad faith borrowers may reacquire their farms or farm home-
               steads under preservation servicing options if F~HA forecloses on their
               farm properties. Second, the act permits F~HA county supervisors to
               offer restructuring without considering borrowers’ unsecured assets,
               which could be used to reduce the amount of debt relief. Also, the act
               does not allow FmHA to include such assets in computing the net
               recovery value buy-out amount. Excluding unsecured assets increases
               the amount of debt relief and thus reduces the government’s recovery
               when borrowers’ loans are restructured with debt write-down or bought
               out at the net recovery value of collateral.

               In March 1990, the House of Representatives passed and referred to the
               Senate a bill which would, in addition to doing other things, require bor-
               rowers to act in good faith to be eligible for net recovery value buy-out
               and to reacquire their farms through preservation servicing, and allow
               FmHA to consider a borrower’s assets in its servicing decisions. As of
               June 28, 1990, the Senate had not passed a similar bill. However,
               various changes to the act are contained in the proposed 1990 Farm Bill,
               which passed the Senate Committee on Agriculture, Nutrition, and For-
               estry on May 17, 1990.




               Page 47                       GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
Chapter 4
Changes Needed to Preclude and Limit
Benefits for Certain Delinquent Borrowers




in process of referring 66 other borrowers to           IJSDA'S   Office of General
Counsel for a bad faith opinion.

The FIIIIIA supervisor at one of the county offices we reviewed told us he
had determined borrowers eligible for servicing even though he believed
they had acted in bad faith. This supervisor identified 15 borrowers to
whom he did not attempt to deny servicing although he believed they
had acted in bad faith. Eleven of these 15 borrowers qualified for net
recovery value buy-out, and three qualified for restructuring. The
remaining borrower did not apply for servicing. The county supervisor
did not attempt to obtain a TJSDA Office of General Counsel opinion to
deny primary servicing to the 14 borrowers who applied. Instead, he
serviced the borrowers as if no potential bad faith activity had been
observed. The supervisor serviced the 14 borrowers because he believed
they could not project a positive cash flow, and they would have
received net recovery value buy-out offers even if a formal Office of
General Counsel opinion showing bad faith had been obtained.

Another F~HA supervisor at one of the county offices we reviewed con-
sidered borrowers to have acted in bad faith if they (1) disposed of
security property without FIIIHA approval; (2) repaid other lenders more
than required while becoming delinquent on FmBA loans; (3) abandoned
property securing FtnH.4 loans; or (4) had resources available that. could
have been, but were not, used to make FmHA loan payments. This super-
visor had offered, or was in process of offering net recovery value buy-
out to 6 of 13 bad faith borrowers. The remaining seven borrowers
would have been offered primary servicing but were disqualified
because of their bad faith actions. These seven borrowers will be eligible
for preservation servicing if FmlIA forecloses on their property.

F~HA uses the same servicing process for borrowers who act in bad faith
that it uses for other borrowers in determining eligibility for restruc-
turing and net recovery value buy-out options. When a county super-
visor determines that a borrower is not eligible for loan restructuring
because the borrower acted in bad faith, the DALR$ computer program is
used to analyze the borrower’s application. &et recovery value buy-out
is offered after F&U state office approval, even though a borrower has
acted in bad faith, when the DAI.R$ program shows the borrower does not
qualify for restructuring. Conversely, buy-out is not offered when the
IIAIX$ program shows the borrower would have qualified for restruc-
turing. In this case, the collateral securing the loans is subject to foreclo-
sure by I:mIIA.



Page 49                              GAO/RCED-90.169A~cultural     Credit Act Debt Servicing
Chapter 4
Changes Needed to Preclude and Limit
Benefits for Certain Delinquent Borrowers




According to the DALK$ printout, this borrower owed F~HA $625,952 in
outstanding principal and unpaid interest. The debt covered six natural
disaster emergency loans and two farm operating loans, valued at
$602,560 and $23,392, respectively. The net recovery value was
$87,277. In addition, the appeals officer decided that the borrower was
also required to pay FmHA $30,000 for the value of other property not
accounted for in the appraisal of loan security. The total buy-out.
amount, which included real estate and chattels, was $117,277. The bor-
rower will receive a $508,675 write-off if he pays the buy-out amount.

This borrower will be eligible for preservation benefits if he does not
pay the buy-out amount and FIIIHA forecloses on his propert,y. The
market value of his 31 l-acre farm, which could be acquired through the
leaseback/buyback option, is $44,000.

Example B: The FmHA county office determined that this borrower was
ineligible for loan restructuring because the delinquency was due to cir-
cumstances within his control. The county office supervisor told us the
borrower had previously applied to FmHA for loans to buy additional
land and equipment. The county office did not approve the applications
and advised the borrower that the equipment was excessive to his
needs. For example, the county office determined that the equipment
purchases resulted in the borrower having $268 per acre worth of
equipment, while the state average was $50 per acre. Subsequently, the
borrower made the purchases with loans from other lenders. The bor-
rower repaid the other lenders, including making advance principal pay-
ments; however, he became delinquent on his FIIIHA debt.

The borrower appealed the county office’s decision. An appeals officer
decided that while the borrower was ineligible for restructuring because
of his excessive machinery purchases, he was eligible for net recovery
value buy-out since he did not have a feasible plan of operations,
including a positive cash flow, and the net recovery value exceeded the
present value of the restructured loans when the county office ran the
DALR$ computer program. At the time of our review, the borrower had
not responded to the county office’s net recovery value buy-out offer.

According to the DALR$ printout, this borrower owed F~~HA $186,616 in
outstanding principal and unpaid interest. The debt covered four nat-
ural disaster emergency loans and two farm ownership loans, valued at
$117,716 and $68,900, respectively. The net recovery value, which
covers real estate, was $134,815. The borrower will receive a $51,801
write-off if he pays the buy-out amount.


Page 51                              GAO/RCED-SO-169 Agricultural   Credit Act Debt Servicing
                      Chapter 4
                      Changes Needed to Preclude and Limit
                      Benefits for Certain Delinquent Borrowers




                      showed he had $91,284 in his checking account when he applied for
                      restructuring. At that time, he was $76,269 past due on his scheduled
                      F~HA payments. Also, the borrower may have converted some F~HA
                      security property. A letter in the county office files states that the bor-
                      rower sold cattle, which was security for an FmIlA loan, without county
                      office approval and did not pay any of the sales proceeds to F~HA.

                      The county office det,ermined that this borrower was not eligible for net
                      recovery value buy-out since the DAI,K$ computer program showed he
                      would have had a feasible plan of operations with restructuring. The
                      borrower would have been offered restructuring if he had not caused
                      the delinquency. He was not eligible for net recovery value buy-out
                      because hc qualified for restructuring. The borrower appealed the
                      county office’s decision: an appeals officer upheld the county office’s
                      decision.

                      According to the DAIM printout, this borrower owed F~HA $348,223 in
                      outstanding principal and unpaid interest. The debt covered two farm
                      ownership loans (totaling $69,631), one farm operating loan ($242,742),
                      and one natural disaster emergency loan ($35,850). He will be eligible
                      for preservation servicing consideration if FmIIA forecloses on his prop-
                      erty. The market value of his 1,163.acre farm, which he could reacquire
                      through the leaseback/buyback option, is $151,000. A prior lien of
                      $9,000 exists on the borrower’s farm real estate.


                      FmIiA  county supervisors did not include assets that were not pledged as
Assets Not Securing   security for FmIIA debts when computing the type and amount of debt
FmHA Debt Are Not     relief for delinquent borrowers. The act permits FmIIA county supervi-
Considered in         sors to offer restructuring without considering borrowers’ unsecured
                      assets which could be nscd to reduce the amount of debt relief. IIow-
Servicing Decisions   ever, the act does not allow F~HA to include such assets in computing the
                      net recovery value buy-out amount. Excluding unsecured assets
                      increases the amount of debt relief and thus reduces the government’s
                      recovery when borrowers’ loans are restructured with debt write-down
                      or bought out at the net recovery value of collateral. At the county
                      offices we reviewed, wc identified two borrowers to whom F~HA offered
                      net recovery value buy-out without considering their unsecured farm
                      and nonfarm assets when calculating the buy-out amounts. In both
                      instances, the borrowers had reported their unsecured assets to I~~IIA. In
                      addition, some borrowers had not identified all assets in their servicing
                      application.



                       Page 53                             GAO/RCED-W-169 Agricultural   Credit Act Debt Servicing
              Chapter 4
              Changes Needed to Preclude and Limit
              Benefits for Certain Delinqurnt Borrowers




              those assets. In determining servicing options and t,hc resulting write-off
              amount, FmlIA’S county office did not consider unsecured assets of
              $21,000 in cash and 19 acres of land that the borrower had reported in
              his servicing application. Subsequently, the borrower paid FmIIA the
              $72,405 net recovery value buy-out amount to settle his $166,000 out-
              standing debt and rec*eivcd a $93,595 debt u-rite-off.

              FnlfIA would have saved at, least $21 .OOOif it could have applied the cash
              to reduce the borrower’s debt in processing his servicing application.
              The borrower would still have qualified for net recovery value buy-out,
              but the government’s loss would have been less. Also, E’mfIA might have
              realized additional savings if it could have considered the value of the
              borrower’s 19 acres of lmsccured land.

              Borrower F: This borrower reported unsecured assets that FmII.4 did not
              consider in processing his servicing application. The amount of debt that
              F~HA wrote off would have been less if FmIIA could have considered
              those assets. In determining servicing options and the resulting write-off
              amount, FmIIA’S county office did not consider unsecured land that the
              borrower had report,cd in his servicing application. Subsequently, the
              borrower paid F~IA t IW $83,7 14 net recovery value buy-out amount t,o
              settle his $580,706 outstanding debt. As a result. hc received a debt
              write-off of about $500.000.

              The borrower rcportcld LOFIMM that he owned 683 acres of land. County
              office records showed E‘I~~I~A
                                          had liens on 400 acres of this land. FmIIA
              might have realized a savings if it could have considered the value of
              the borrower’s remaining 283 acrtls of unsecured land when computing
              the debt write-off.

              In addition, FmIIA county office staff told us this borrower had sold an
              unknown amount of land to a trust and then rented 1,000 acres back
              from the trust. The borrower did not use proceeds from the sale to pay
              his FmIIA debt. According to a IISDA Office of General Counsel regional
              attorney, the borrowt*r ;rpparently was t,rying to conceal ass&s from
              IMIA in the trust.



              Some loan servicing under the Agricultural Credit Act, such as writing
Conclusions   off substantial amounts of debt for borrowers who acted in bad faith
              and not considering t l-r<)value of unsecured assets in servicing decisions,
              are not in the government’s or taxpayers’ best interest. According to
              IXN, the Agricultural (‘redit Act provided I+nfil\ no alternative but, to


               Page 55                             GAO/RCED-SO-I69 Agricultural   Credit Act Debt Servicing
                     Chapter 4
                     Changes  Needed to Preclude and Limit
                     Benefits for Certain Delinquent Romowers




                     also believe that (1) there should be a good faith requirement for a bor-
                     rower to reacquire the farm homestead through preservation servicing
                     and (2) FIIIHA needs to take into consideration all assets of a borrower in
                     determining the net recovery value buy-out amount. As of June 28,
                     1990, the Senate had not passed a bill similar to H.R. 4077. However,
                     various changes to the act are contained in the proposed 1990 Farm Bill,
                     which passed the Senate Committee on Agriculture, Nutrition, and For-
                     estry on May 17, 1990.

                                                -~~
                     To make it clear that bad faith borrowers cannot receive debt relief ben-
Recommendations to   efits and to discourage other borrowers from acting in bad faith, we rec-
the Congress         ommend that the Congress amend the Agricultural Credit Act of 1987
                     (P.L. 100-233, Jan. 6, 1988). This can be done by enacting provisions
                     similar to sections 2 and 5 of H.R. 4077 which require borrowers to act
                     in good faith to be eligible to reacquire their farms through preservation
                     servicing and to be eligible for net recovery value buy-out. Also, we rec-
                     ommend that the Congress amend the Agricultural Credit Act to require
                     borrowers to act in good faith to be eligible to reacquire their farm
                     homestead through preservation servicing. This can be done by adding
                     the following new paragraph “(g)” to 7 IJ?X. 2000 (c)( 1) and redesig-
                     nating existing paragraph “(g)” to “(h)“:

                     “(g) have acted in good fait II, as defined in regulations issued by the Secretary, in
                     connection with the loan of such borrower-owner for which such property served as
                     security.”

                     To provide F~HA with authority to consider all assets of delinquent bor-
                     rowers under consideration for debt reduction and to reduce the cost of
                     debt write-downs and w-rite-offs, we recommend that the Congress
                     amend the Agricultural Credit Act of 1987 (P.L. 100-233, Jan. 6, 1988).
                     This can be done by enacting a provision similar to section 4 of H.R.
                     4077, which allows FIIIII~\to consider all assets of a borrower, other than
                     those necessary for family living or farm operating expenses, in deter-
                     mining the value of restructured loans. Also, we recommend that the
                     Congress amend the Agricultural Credit Act to allow EWIA to take into
                     consideration all assets of a borrower in determining the net recovery
                     value buy-out amount. This can be done by amending 7 USC. 2001
                     (c)(6) by inserting after the phrase “an amount equal to the recovery
                     value” the following:

                     “plus any other amount the Secretary determines based on consideration of the bor-
                     rower’s other unsecured awts,      .”



                     Page 57                             GAO/RCED-90169 Agriculhwal   Credit Act Debt Servicing
Chapter 5

Agriculturd Credit Act May Encourage Loan
Defaults by Solvent Borrowers

                       Under the Agricultural Credit Act some delinquent borrowers received
                       debt reduction that borrowers who kept their loans current are not eli-
                       gible to receive. This has raised equity questions, and, in fact, some cur-
                       rent borrowers told us they were considering becoming delinquent on
                       their FWIA loans so as to qualify for debt relief, but it is too early to tell
                       if they will actually do so.’ Borrowers who intentionally become delin-
                       quent may not get the benefits of the act they seek because their actions
                       may disqualify them from the primary loan servicing and net recovery
                       value buy-out options. IIowever, county supervisors may be unable to
                       deny debt servicing to such borrowers because of difficulties in con-
                       cluding that borrowers caused their own delinquencies.


                       The act, through various debt relief options such as restructuring with
Cost of Farming        write-down and net recovery value buy-out with write-off, decreased
Reduced for Serviced   the cost of farming for delinquent borrowers by reducing or eliminating
Borrowers              their loan payments. h’ondelinquent borrowers, on the other hand, could
                       not obtain similar reductions in their expenses. They had to continue to
                       make their loan payments even though they lived in the same commu-
                       nity and faced the same general farming conditions as delinquent bor-
                       rowers. Such conditions can include a depressed farm economy, adverse
                       weather, and decreased real estate values.

                       The following examples show how FmHA’s restructuring and net
                       recovery value buy-out actions reduced or excused payments for some
                       borrowers.

                       Example A: A borrower who was current on his $330,552 FmHA debt had
                       an annual payment of $161,641, including $142,000 owed at year-end on
                       a farm operating loan. A delinquent borrower in the same community
                       had a similar F~HA debt of about $332,228, with an annual payment of
                       about $20,053. The delinquent borrower, who had not made any pay-
                       ments on three of his four loans, was $24,595 behind in payments. FmHA
                       restructured the delinquent borrower’s debts by reamortizing payments,
                       lowering interest rates, and writing down $152,641. Through restruc-
                       turing, F~IIA reduced the delinquent borrower’s FmHA debt to $179,647
                       and his annual payment to $11,095.




                       ‘As mentioned inch 1, nondehnqutnt borrowers expcrlencing financial stress may be eligible for all
                       pnmary loan service programs, wccpt debt writedown. Such borrowers, however, must be unable to
                       pay their debt as scheduled brfwt~ FrnlIA ~11 use a primary loan service program.



                       Page 59                                GAO/RCEDSO-169 Agricultural      Credit Act Debt Servicing
                      Chapter 5
                      Agricultural Credit Act May Encourage Loan
                      Defaults by Solvent Borrowers




                      Most borrowers that we interviewed who were current on their F~HA
F’mHA Nondelinquent   loan payments-18 of 30 current borrowers at the county offices we
Borrowers Question    reviewed-questioned     the equity of the Agricultural Credit Act. Some
Equity of the         current borrowers expressed concern that certain borrowers who had
                      mismanaged their farming operation had their debt reduced, while other
Agricultural Credit   borrowers who struggled in order to make their loan payments received
Act                   no debt relief. Some current borrowers who said their debts should have
                      also been reduced told us they were looking for ways to become delin-
                      quent so they could qualify for a reduction of their FmHA debt. Also,
                      several county office staff members told us that although borrowers in
                      their communities farmed under similar economic and climatic condi-
                      tions, some paid their FmHA debt while others did not.


Similar Farming       Delinquent and nondelinquent borrowers in the same community
                      operate under similar economic and climatic conditions. However, while
Conditions            one borrower may have been able to pay his FmHA debt, another may
                      have become delinquent for a variety of reasons, including ineffective or
                      expensive farming and management techniques. For example, some cur-
                      rent borrowers told us they farmed the land themselves and bought
                      used equipment, while some delinquent borrowers in the same area paid
                      others to farm their land or bought new equipment.

                      The following example shows that one borrower repaid his commercial
                      debt, while another borrower in the same community became delinquent
                      on his FmHA debt.

                      Example D: One borrower told us he and his neighbor bought a parcel of
                      farmland and divided it in half. This borrower obtained his loan from a
                      commercial lender while his neighbor obtained an FmHA loan. The com-
                      mercial borrower fdrmt>d his half of the land himself and repaid his
                      commercial loan. However, the neighbor, he told us, hired someone to
                      farm the other half of the land, bought a boat, and became delinquent on
                      the FmHA loan. FmHA’S county office records showed the FmHA delinquent
                      borrower had a $477,396 outstanding balance on his FmHA loans when
                      he applied for servicing, including $40,245 on the farm ownership loan
                      that he obtained to purc*hase the land. Subsequently, FmHA offered to
                      write off the delinquent borrower’s debt to the $164,242 net recovery
                      value of collateral. The delinquent borrower will receive a $313,154
                      debt write-off if he pays the buy-out amount.




                       Page 61                            GAO/RCED-SO-169 Agricultural   Credit Act Debt Servicing
              Chapter 5
              Agricultural Credit Act May Encourage Loan
              Defaults by Solvent Borrowers




              The borrower told us he has been searching for a way to qualify for
              restructuring or net recovery value buy-out. The county supervisor did
              not provide such servicing because the borrower had been current on his
              FmHA loan payments.

              The borrower told us he would become delinquent except that it would
              make him ineligible for an FmHA guaranteed farm operating loan. He said
              that he would probably become delinquent on his FmHA direct loans if he
              could farm without a 1990 guaranteed loan. He hoped to generate suffi-
              cient income from his 1989 farm operation to finance his 1990 farm
              operation without a guaranteed loan.

              Example F: A peanut, corn, wheat, and soybean farmer who has partici-
              pated in FKHA loan programs for over 12 years repaid 14 FmHA loans and
              as of November 1988 was current on his three remaining loans. These
              loans had an outstanding balance of $62,043. The borrower told us he
              had informed the county supervisor that he would not make his 1989
              annual payment until late in 1989. The county supervisor offered to
              reschedule the borrower’s payment. However, the borrower said he still
              would not make the payment because he wanted to become delinquent
              so he could qualify for restructuring with a debt write-down.

              Example G: A soybean, corn, and wheat farmer who has participated in
              FmHA  loan programs for 10 years was current on his two remaining loans
              as of November 1988. These two loans had an outstanding balance of
              $142,004. The borrower told us he could continue paying his debt on
              schedule, but he intended to become delinquent so that he could apply
              for debt relief under the act. He expected a large wheat harvest in 1989,
              but rather than use the proceeds from the wheat sale to make his FmHA
              payment he was going to use the proceeds to finance his 1990 farming
              operation. County office records showed that this borrower became
              delinquent in January 1989, and FmHA provided him a notice of servicing
              availability in August 1989.


              The Agricultural Credit Act provided an opportunity for delinquent bor-
Conclusions   rowers to receive debt reductions. Because loan payments were reduced
              or eliminated for some delinquent borrowers, the cost of farming for
              them is less than that for Fmf3.4borrowers who made their loan pay-
              ments. As a result, some c,urrent borrowers perceive themselves as
              penalized for paying their debt, and some of those we interviewed
              expressed plans to default on their loans so they could qualify for future
              debt relief under the act.


              Page 63                             GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
Page 65   GAO/RCEDM-169   A@icuh~rd   Credit Act Debt Servicin9
Appendix II

FhHA County Offices Reviewed by GAO



                              Mandan
                              N. Dak.          Vermillion
                                                S. Dak.                Moorehead
                                                                         Minn.                     M




              Littlefield


                                  Kingfisher
                                     Okla.




                    Page 67                                 GAO/RCED90.169 A@icultural   Credit Act Debt Servicing
            Appendix III
            Comments From the Under Secretary for
            Small Community and Rural
            Development, USDA




r
    Page 2 - GAODraft    Report RED-90-169

    deferral relief.   See Coleman V. Block, 580 F. Supp. 194, 211 (D.N.D. 19~34)
    and United States v. Hamrick 713 F.2d 69 (4th Cir. 19S3). Moreover, we
    understand that GA0 ha s test fied before the Senate Agriculture   Coinnitteets
    Credit Subcommittee that their own counsel agree with-this    view. Also, the
    assertion on page 39 that certain borrowers did not qualify for net
    recovery buy-out because they acted in bad faith seems inconsistent    with
    the report’s primary assertion that bad faith borrowers do qualify for net
    recovery buy-out.
    (D) On pages 20 and 21 the report asserts that after acceleration       the
    borrower can request a meeting, an appeals hearing, an independent
    appraisal,  consideration     of preservation loan servicing end a voluntary
    assignment.   In accordance with FmHAregulations       these procedures occur
    prior to acceleration.       Also, cn page 21 the report states that borrowers
    ten request a voluntary assignment of their security property to hoHA. We
    assume this maans that borrowers may requeit to voluntary convey their
    property to FnHA. FnHA accepts voluntary assignments as a method of paying
    loans, in particular     dairy assignments, end assigmaants of agricultural-
    program benefits.      However, the context of the statement in the report
    suggests the writer mean a voluntary conveyance of FmHAreal estate
    security.
    (E) On page 39 the report appears to limit preservation         loan servicing
    options to situations    where FtdfA forecloses on collateral.        FmHAhas an
    additional   program whereby borrowers may enter into a preacquislticn
    contract with PmHAto receive preservation        loan servicing    if FnHA acquires
    the property.     These contracts are authorized by $610 and 614 of the ACA.
    Also, F&A offers preservation      loan servicing whenever it acquires loan
    security regardless of whether FITHAconducted the foreclosure.
     (F) On page 62 the report asserts that the ACA does not preclude additional
    loan making after a borrower receives loan servicing.    We recontnend that
    the assertion be revised to state that the ACA requires the borrower's
    creditworthiness  be evaluated without regard to whether the borrowers’ loan
    account has been serviced.    This is what 8353 (k) of the ACA requires.




              Page 69                          GAOjRCED-90.169A~cultural Credit Act Debt Servicing
Major Contributors to This Report


                        John P. Hunt, Jr., Assistant Director
Resources,              Patrick J. Sweeney, Assignment Manager
Community, and          Clifford J. Diehl, Senior Evaluator
Economic -
Development Division,
Washington, D.C.

                        John T. McGrail, Senior Attorney
Office of the General
Counsel

                        Jesse J. Flowers, Evaluator-in-Charge
Atlanta Regional        Lois L. Shoemaker, Site Senior
Office                  Signora May, Staff Evaluator
                        Jose Ramos, Staff Evaluator
                        Graham Rawsthorn. Staff Evaluator


                        Donald W. Birkman, Site Senior
Kansas City Regional    William H. Morgan, Staff Evaluator
Office                  Olin S. Thummel, Staff Evaluator




 ~28032)                Page 71                       GAO/RCED-Sol69 Agricultural   Credit Act Debt Servicing
:
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             Appendix III
             Comments From the Under Secretary for
             Small Community and Rural
             Development, USDA




r                                                                                                    1

    page 3 - GAODraft      Report RCED-W-169

    (G) On page 81 the report asserts that a borrower who is current in his or
    her loan payments cannot receive dabt relief.        This is only true for debt
    write-down.     Current borrowers experiencing   financial  stress may be
    eligible    to receive a rescheduling  (with or without best rates and terms)
    of their loan payments, loan deferrals,      conservation easements and softwood
    timber restructuring.
    The recommendations are discussed       as follows:
    RE0DMMENDATION   1. Revise regulations implementing the Agricultural Credit
    Act to provide restructured  borrowers with a IO-percent cash flow margin
    after servicing.
    RESPONSE: FbHA agrees and supports legislation          being proposed in the 1990
    Farm Bill to require a 5 percent debt. service        margin.  If this is passed,
    E&IA will implement as quickly as possible.

    REaMWIDATIcN 2. Alert County Offices that borrowers may attempt to
    intentionally become delinquent to qualify for debt relief.
    RESPONSE: FmBA agrees with this recommendation. Legislation    has been
    proposed that addresses the issue in the ACA that currently allows
    borrowers to take advantage of the law. As changes in the law pass, EW-IA
    will implement as quickly as possible.
    RECOMMENDATION   3. Notify farmer program borrowers that intentionally
    causing delinquencies   could disqualify them from obtaining debt relief.
    RESWNSE: FmHAagrees and is considering           revising regulations      to require a
    notice outlining borrowers’ responsibilities         and accountability      be sent to


    ,$I&&-



    Under Secretary
      for Small Community
      and Rural Development
    Attachment




             Page 70                            GAO/RCEDSO169 Agricultural    Cnzdit Act Debt Sewicin~
Appendix III

Comments From the Under Secretary for Small
Commti@ and Rural Development, USDA


                                                         DEPARTMENT     OF AGRICULTURE
                                                             OFFICE OF THE SECRETARY
                                                              WASHINtTON. 0 c. 20250
                                                                                                        JUN 14     IQ@(I



                         sulslm:         GAD Draft   Report RCFD-90-169, “F&IA: Changes Needed in Lcen
                                         Servicing   Under the Agricultural Credit Act”

                                   TO:   John W. Harman
                                         Director
                                         Food and Agriculture    Issues
                                         Resources, Community, and Economic
                                            Development Division

                         THROUGH: La Verne Ausman h+
                                  Administrator
                                  Farmers Home Administration

                         Cosnents to the subject         draft   report   are as follows:
                         (A) On page 3 the report states in the last paragraph that only me-third
                         of those who qualified    for servicing     in the counties examined were offered
                         restructuring,    and the remaining two-thirds      qualified for net recovery
                         buy-out.     We recommend that these sentences be reviewed to state that FuHA
                         determined that one-third of the borrowers were eligible         for servicing,   and
                         that two-thirds    were not eligible    for servicing and were offered net
                         recovery buy-out.     In accordance with $353 (c) (6) of the Agricultural
                         Credit Act (ACA) only those borrowers determined inaligible         for servicing
                         can be offered net recovery buy-out.
                         (B) On page 17 the report asserts that the borrower must be IS0 days
                         delinquent to qualify for debt write-down.   Borrowers may qualify for debt
                         write-down so long as their account is delinquent.
                         (C) On pages 7, 17, 64 and 76 the report states that USDA’s and hoHA’s
                         rationale     for offering   net recovery buy-out to borrowers who acted in bad
                         faith is not apparent.        Please find attached an Office of General Counsells
                         memorandumdated January 31, 1993, on this subject.           Our position       is the
                         $353 (b) of the ACA sets out eligibility        requirements for primary loan
                         servicing,      and includes good faith as an eligibility    requirement.         Section
                         353 (b) states that the requirements apply to primary loan servicing,                which
                         is explicitly      defined in $602 of the ACA, and does not include net recovery
                         buy-out.      Therefore, in accordance with well established      legal precepts, a
                         statutory     scheme which sets out details in one section, does not apply to a
                         different     program which contains different    requirements in its statutory
                         authorization.        Also, our advice considered the protracted     litigation
                         involving     loan deferrals   and the court opinions which found that borrowers
                         who had converted EWlA loan security        are entitled  to apply for loan
               i   --.        _-                                                                                                  I

                                     Page 68                              GAO/RCED-99.169 A@iculhud   Credit Act Debt Servicing
Appendix I

Agriculturti Credit Act’s
Implementation Schedule


                                 Delinquent borrowers notified of Agricultural     Credit Act benefits     ’



                                                                  4
                                                                                                           L
                                                    Borrowers request servicing
                                                                                                                 45 days


                                                                  4
                                                                                                           L
                                 County offices process applications   and prepare servicing offers              60 days



    n    mmmmmmmmmmmmmmmmm~
                         h
        Primary servicing                                                                     value buy-out
        (Present value of the restructured                                    (Present value of the restructured loans is less
        loans equals or exceeds the net                                       than the net recovery value of collateral)
        recovery value of collateral)




              Restructuring   offered

                                                                             Borrower with non-FmHA creditors offered mediation
                                                                                                                                            15 days
I
                          1                     L
          Borrower accepts or rejects           -    45 days                      -~.                  +
                                                                                                                                       ‘
          restructuring offer                                                           Borrower     requests mediation                     30 days
                                                                        r-


                          1                     h                                                                                           15 days
                                                                              If mediation results in a feasible plan,
          FmHA completes       restructuring         45 days                  restructuring offered
i
                                                                              If mediation does not result in feasible plan,
                                                                              borrower notified of additional options
                                                                        \~~


                                                                                                                                            45 days




                                                       Source GAO Analysts 01 FmtiA s lnterlm Regulations for the Agricultural Credit Aci of 1987




                                                       Page 66                                     GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
                         Chapter 6
                         Agricultural Credit Act May Encourage Loan
                         Defaults by Solvent Borrowers




                         We understand why borrowers who have paid their F~HA debts would
                         desire the same debt reduction benefits as those received by borrowers
                         who have defaulted on their loans. However, current borrowers who
                         take intentional actions to cause their becoming delinquent may be dis-
                         qualified from the benefits they seek to obtain, such as restructuring
                         with debt write-down and net recovery value buy-out with debt write-
                         off. While F~HA may deny primary debt servicing if it determines bor-
                         rowers have intentionally defaulted on their loans, detecting such action
                         will be difficult for county supervisors who rely primarily on borrowers’
                         farm and home plan financial data as a basis for servicing decisions. To
                         the extent that borrowers causing their own delinquency are not
                         detected, the future cost of debt servicing under the act will likely be
                         compounded.


                         We recommend that the Secretary of Agriculture direct the FmHA Admin-
Recommendations to       istrator to (1) alert county offices that borrowers may intentionally
the Secretary of         become delinquent in an attempt to qualify for debt relief under the act
Agriculture              and (2) notify farmer program borrowers that intentionally causing
                         delinquencies could disqualify them for debt relief under the act.


                         In commenting on a draft of this report, USDA agreed with our recom-
A5crLLY vvLLULLzntsand   mendations and stated that F~HA will take appropriate implementation
Our Evaluation           actions.




                         Page 64                            GAO/RCED-W-169 Apsicultural Credit Act Debt Servicing
                       Chapter 5
                       Agricultural Credit Act May Encourage Loan
                       Defaults by Solvent Rorrowers




Incentives to Become   Some borrowers and F‘~HA officials told us that since the act provides
                       debt reduction benefits only to delinquent borrowers it has created an
Delinquent             incentive for current borrowers to become delinquent on their F~HA
                       debt. For example, three F~HA borrowers who were current on their loan
                       payments told us they were considering becoming delinquent so they
                       could apply for servicing. Also, four F~HA county supervisors, the chiefs
                       of farmer programs in four F~HA state offices, and one state office
                       director believe some borrowers who made their loan payments on time
                       in the past may attempt to become delinquent so they can apply for
                       servicing.

                       Eighteen of the 30 borrowers we interviewed who were current on their
                       FmHA  debt told us they felt penalized for paying their debt. They stated
                       that delinquent borrowers can use available income after F~HA reduces
                       or eliminates their debt to expand their farming operation by
                       purchasing additional farmland or new equipment, or on personal items,
                       such as new automobiles. On the other hand, borrowers whose F~HA
                       debts were not reduced or eliminated continued to use their available
                       income to repay their debts.

                       In addition, one county supervisor expressed opinions similar to those of
                       the borrowers we interviewed. He stated that serviced borrowers will
                       use income that is no longer needed to pay FmHA debt to rent additional
                       farmland, purchase new equipment or farm stock, and buy new cars.

                       Borrowers who intentionally become delinquent may be disqualified
                       from the benefits that they seek to obtain, such as primary loan ser-
                       vicing with debt write-down and net recovery value buy-out with debt
                       write-off. For example, since the act precludes primary servicing bene-
                       fits for borrowers who caused their own delinquencies, county supervi-
                       sors may deny primary servicing to borrowers whom they determine to
                       have caused their delinquencies by not using available resources to pay
                       their F~HA debts. In addition, borrowers may not qualify for net
                       recovery value buy-out. However, according to five county supervisors,
                       borrowers could, without detection by county office staffs, easily mis-
                       represent their income and expenses and qualify for debt relief.

                       The following three examples show how borrowers who have paid their
                       F~HA loans are looking for a way to become delinquent.

                       Example E: A soybean, wheat, and corn farmer who has participated in
                       FmHA loan programs for the past five years was current on his three
                       FmHA loans as of November 1988. His outstanding balance was $288,278.



                       Page 62                             GAO/RCED-90.169 Agricultural   Credit Act Debt Servicing
Chapter 6
Agricultural Credit Act May Encourage Loan
Defaults by Solvent Borrowerr




Example B: A borrower who was current on his $215,518 FIIIHA debt had
an annual payment of $17,909. A delinquent borrower in the same com-
munity, with a $203,758 FmHA debt, had an annual payment of $61,001,
including $46,405 on a mature loan. The delinquent borrower had not
paid on his FmHA loans since 1985 and was $90,277 behind in payments.
F~HA forgave the delinquent borrower’s entire debt when he bought out
at $0 net recovery value and, as a result, he has no annual F~HA loan
payment.

Example C: A borrower who was current on his $451,028 !+IHA debt had
an annual payment. of $48,765. A delinquent borrower in the same com-
munity, with a $932,940 FmHA debt, had an annual payment of $81,625.
The delinquent borrower was about $163,250 behind in payments. F~HA
forgave the delinquent borrower’s entire debt when he bought out at $0
net recovery value and, as a result, he has no annual FmHA loan
payment.

Additionally, some borrowers remained current on their loan payments
and received no loan servicing benefits under the act even though their
loan security decreased in value. In February 1989, we reported that
farm real estate values declined 38 percent nationally from a 1981 peak
of $844 billion to $523 billion in December 1987.2 In some midwestern
states, average land values declined over 50 percent between 1982 and
 1987.

Some borrowers owe FmHA more than their land is worth because of the
decline in land values. For example, an F~HA borrower, who is current
on his FmHA loan payments, has farmland which secures his FmHA debt.
The borrower purchased the farmland during the 1983-84 period at
$1,150 per acre. The borrower, who estimated the 1989 value of the
land at $350 to $400 an acre, told us he owes FmHA more than the land is
worth, on the basis of farm real estate market values in the community.
The county supervisor, who agreed with the borrower’s assessment of
the land value, said the borrower had requested debt relief. According to
the supervisor, such relief was not provided because the borrower was
current on his loan payments. The borrower told us he felt that he was
being penalized for making his loan payments.




‘Farmers Home Admimstrat ion: Sounder Ix~ans Would Reqmre Revised Loan-Making Criteria (GAO/
RCED-89-9. Feb 14,lRtlS~.



Page 60                             GAO/RCED-90.169 Agricultural    Credit Act Debt Servicing
                      Chapter 4
                      Changes Needed to Preclude and Limit
                      Benefits for Certain Delinquent Borrowers




                      In commenting on a draft of this report, USDA disagreed with our view
Agency Comments and   that the net recovery value buy-out option is available only to good faith
Our Evaluation        borrowers. USDA’S position is that the eligibility requirements of the act
                      apply solely to primary loan service programs and not to the net
                      recovery value buy-out option. The basis for USDA’S interpretation is that
                      the net recovery value buy-out authority of the act is separate from the
                      primary loan servicing authority and therefore net recovery value buy-
                      out is not subject to the eligibility provisions of the act since it is not a
                      primary loan service program.

                      We question this interpretation because the net recovery value buy-out
                      authority is an integral part of the overall statutory scheme to provide
                      benefits only to good faith borrowers and, in our view, it is not a sepa-
                      rate and distinct authority. Nevertheless, we support legislative action
                      to ensure that borrowers who act in bad faith do not receive the act’s
                      benefits.




                      Page 58                              GAO/RCED-90169 Agricultural   Credit Act Debt Servicing
                       Chapter 4
                       Changes Needed to Preclude and Limit
                       Benefits for Certain Delinquent Borrowers




                       consider net recovery value buy-out for borrowers who acted in bad
                       faith. The basis for IISDA'S position is not apparent to us. In our view, the
                       act’s net recovery value buy-out option is only available to good faith
                       borrowers as an alternative to loan restructuring. Nevertheless, legisla-
                       tive action would ensure that borrowers who act in bad faith do not
                       receive the act’s benefits. These borrowers, under present law, are also
                       eligible for preservation benefits.

                       The government’s losses in servicing delinquent borrowers has also
                       increased because the act does not require FmHA to consider unsecured
                       assets in its loan restructuring decisions and does not allow it to include
                       unsecured assets in calculating net recovery value buy-out amounts.

                       We recognize that many FmHAborrowers have become delinquent in
                       recent years because of factors beyond their control, such as the effects
                       of adverse weather on production and a depressed farm economy during
                       the early and mid-1980s. However, borrowers have a responsibility for
                       complying with the terms and conditions of their loan agreements. We
                       believe that when borrowers cause their delinquency or do not act in
                       good faith, they need to be held responsible for repaying the full amount
                       of their outstanding debt to the federal government. Giving debt relief to
                       such borrowers sets a precedent that other borrowers may attempt to
                       follow and provides no incentive for borrowers who are not delinquent
                       to abide by their loan agreements and pay their I+HA debts.

                       Further, borrowers receive substantial benefits by having debt written
                       down or written off. We believe that when delinquent borrowers have
                       available unsecured assets, F~HA needs to consider the value of those
                       assets in its servicing decisions so as to decrease the overall loss that the
                       federal government incurs as a result of servicing.


                       On March 6, 1990, the House of Representatives passed and referred to
Recent Congressional   the Senate H.R. 4077 which would, among other things, (1) require bor-
Initiatives            rowers to act in good f’aith to be eligible for net recovery value buy-out
                       and to reacquire their farms through preservation servicing; (2) allow
                       FmlIA to consider all assets of a borrower, other than those necessary for
                       family living or farm operating expenses, in determining the value of
                       restructured loans; and (3) require FmHA to consider the value of all
                       property listed on a borrower’s security agreements for loans in deter-
                       mining the net recovery value buy-out amount. We agree with the good
                       faith requirement for the act’s benefits and that FmHAneeds to consider
                       all assets in determining the value of restructured loans. However, we


                        Page 56                              GAO/RCED-90-169 Agriculhml   Credit Act Debt Servicing
                        Chapter 4
                        Changes Needed to Preclude and Limit
                        Benefits for Crrtain Delinquent Rorrowrrs




Asset Disclosu re       The act does not require FmMA to consider unsecured assets in its loan
                        restructuring decisions and does not allow it to include unsecured assets
Requi.rements           in calculating net rcrovery value buy-out amounts. As a result, FmHA
                        does not consider borrowers’ assets that are not pledged as security for
                        FIIIHA loans when computing the type and amount of debt relief to offer
                        delinquent borrowers. Ifowcver, the act requires borrowers who apply
                        for servicing to present FIIIHAwith information showing a plan of opera-
                        tions and how farm operating, family living, and debt servicing
                        expenses will be met. FTIIH&requires borrowers who apply for servicing
                        t,o submit a current farm and home plan, which includes projected
                        income and expenses and a statement of assets and liabilities, County
                        offices use borrowers’ farm and home plans in computing the amount
                        and type of servicing.

                        FFTIHA county  offices are supposed to review borrower applications and
                        determine completeness and accuracy of the reported financial informa-
                        tion. In April 1989, FINIII\provided to its county staffs policy guidance
                        stating that borrowers should use available assets to repay t,heir F~IIA
                        debts-including      assc%tsthat are not used as security for FmIlA loans.
                        However, the notice confused, rather than clarified, FmIIA’S policy on
                        whether or not to include unsecured assets when computing servicing
                        for delinquent borrowers. While focusing on t,hc treatment of cosigners’
                        assets when computing servicing benefits for delinquent borrowers, the
                        notice provided that borrowers’ unsecured assets should be considered
                        in determining how, and to what, extent, borrowers can be serviced.
                        PrnLIA’S Director of Loan Servicing and Property Management agreed the
                        notice was confusing because it covered cosigners and borrowers’
                        unsecured assets. IIe told us FrnIfA plans t,o rewrite the guidance to
                        clarify when count,y offices should use unsecured assets in determining
                        debt servicing benefits


Examples of Borrowers   The following c’ases illustrate how considering unsecured assets could
Who Had Assets That     have reduced government losses in servicing borrowers under the act.
                        Both borrowers in the case examples paid FmIIA the buy-out amount,
FmHA Did Not Use to     which was substantially less than the amount of their FmIlA loans. Also,
Reduce Losses on        according to one I+IILYst,ate office chief of farmer programs, excluding
Delinquent Loans        unsecured assets imrcases the amount of debt write-down when bor-
                        rowers’ loans are restructured.

                        Borrower E: This borrower reported unsecured assets that F~IIA did not
                        consider in processing his servicing application. The amount of debt that
                        Fmllh wrote off wo111dhave been less if FITIHA could have considered


                        Page 54                              GAO/RCED-90169 Agricultural   Credit Act Debt Servicing
Chapter 4
Changes Needed to Preclude and Limit
Benefits for Certain Delinquent Borrowers




This borrower will be eligible for preservation benefits if he does not
pay the buy-out amount and FIIIHA forecloses on his property. However,
it will be to his advantage to pay the buy-out amount if he wants to keep
his farm because the market value of his real estate exceeds his out-
standing FIIIHA debt. He would have to pay the amount of his out-
standing debt to exercise the leaseback/buyback option since the market
value of his 1,174.acre farm is $lSS,OOO.

The following two cases illustrate bad faith borrowers who will be eli-
gible for preservation servicing.

Example C: The F~HA county office determined that this borrower was
ineligible for loan restructuring because the delinquency was due to cir-
cumstances within his control. The county office supervisor told us the
borrower rents his farm to his son and claims that his son has not made
any rental payments. However, the borrower’s restructuring application
showed rental income and the county office documented that the bor-
rower had been current on payments to other creditors, including
advance principal reduction payments.

The county office determined that this borrower was not eligible for net
recovery value buy-out since the DALR$ computer program showed he
would have had a feasible plan of operations with restructuring. The
borrower would have been offered restructuring if he had not caused
the delinquency. He was not eligible for net recovery value buy-out
because he qualified for restructuring. At the time of our review, the
borrower had appealed t,he county office’s decision, but an appeal deci-
sion had not been made.

According to the Mm printout, this borrower owed FmlIA $650,185 in
outstanding principal and unpaid interest. The debt covered three nat-
ural disaster emergency loans. He will be eligible for preservation bene-
fits if FIIIIIA forecloses on his property. The market value of his 3,140-
acre farm, which he could reacquire through the leaseback/buyback
option, is $470,000. A prior lien of $224,906 exists on the borrower’s
farm real estate.

Example D: The FmHAcounty office determined that this borrower was
ineligible for loan restructuring because the delinquency was due to cir-
cumstances within his control. The county office supervisor told us the
borrower’s application for restructuring showed that he had resources
available that could have been used to pay his delinquent debt. Specifi-
cally, documentation the borrower submitted to the county office


Page 62                              GAO/RCED-96-169 Agricultural   Credit Act Debt Servicing
                         Chapter 4
                         Changes Needed to Preclude and Limit
                         Benefits for Certain Delinquent Borrowers




                         A USDA Assistant General Counsel told us that, under the Agricultural
                         Credit Act, F~HA is required to give net recovery value buy-out consider-
                         ation to bad faith borrowers since buy-out is not primary loan servicing.
                         He also said that bad faith borrowers are not subject to the restruc-
                         turing eligibility provisions of the act. He further told us that to qualify
                         for net recovery value buy-out, borrowers simply must be 180 days or
                         more delinquent on their FmHA loans and be unable to show a feasible
                         plan of operations for the upcoming year. The basis for USDA'S position
                         on the bad faith borrower eligibility issue is not apparent to us. In our
                         view, the act’s net recovery value buy-out option is only available to
                         good faith borrowers as an alternative to loan restructuring when the
                         net recovery value exceeds the present value of the restructured loans.

                         Further, according to F~HA'S Deputy Assistant Administrator for
                         Farmer Programs, bad faith borrowers are eligible for preservation ser-
                         vicing if F~HA forecloses on the real estate property securing their F~HA
                         loans since the Agricultural Credit Act and the Food Security Act of
                         1985 do not preclude preservation benefits for borrowers who act in bad
                         faith. We agree that present law does not limit preservation benefits to
                         only good faith borrowers.


Examples of Bad Faith    The following two cases illustrate bad faith borrowers who were offered
Borrowers Eligible for   net recovery value buy-out.
Servicing Benefits       Example A: The FIIIHA county office determined that this borrower was
                         ineligible for loan restructuring because he did not act in good faith in
                         connection with his loan agreements. The county office supervisor told
                         us the borrower sold some farm equipment that was F~HA security prop-
                         erty. Also, the borrower subsequently had another family member, who
                         is also an F~HA borrower, sell some additional farm equipment. In addi-
                         tion, a regional attorney in IBDA'S Office of General Counsel wrote that
                         the borrower had converted numerous items of F~HA security property.
                         The sales of properties were made without county office approval. None
                         of the proceeds from the sales were applied to the borrower’s FmHA debt.

                         The borrower appealed the county supervisor’s decision. An appeals
                         officer decided that while the borrower was ineligible for restructuring,
                         he was eligible for net recovery value buy-out since the net recovery
                         value exceeded the present value of the restructured loans when the
                         county office ran the DALK$ computer program. At the time of our
                         review, the borrower had not responded to the county office’s net
                         recovery value buy-alit offer.


                         Page 50                              GAO/RCED-90-169 Agrkultural   Credit Act Debt Servicing
                           Chapter 4
                           Changes Needed to Preclude and Limit
                           Benefits for Certain Delinquent Borrowers




                           F~HA borrowers who act in bad faith are not eligible for the primary
Borrowers Who Acted        loan servicing options. However, according to USDA,they are eligible for
in Bad Faith Received      net recovery value buy-out consideration. Also, they are eligible for
Net Recovery Value         preservation servicing benefits. In January 1990 F~HA identified 218
                           bad faith borrowers nationwide who had bought out or were in the pro-
Buy-Out and                cess of buying out at the net recovery value, or had declined buy-out
Preservation Benefits      offers. At one of the FmIIAcounty offices we reviewed, we identified six
                           FmHA-determined bad faith borrowers who were offered net recovery
                           value buy-out and seven others who were considered for net recovery
                           value buy-out but were not offered it because they did not qualify. Bad
                           faith borrowers who decline buy-out offers and those not offered buy-
                           out may be eligible to reacquire their farms or farm homestead under
                           F~IIA’S preservation program if F~HA forecloses on the real estate
                           securing their loans.


Bad Faith Determinations   FmHA requires county supervisors who believe borrowers have com-
                           mitted fraud or waste, or have disposed of property securing F~HA loans
and Servicing Procedures   without approval (referred to as conversion) to obtain a written USDA
                           Office of General Counsel legal opinion before denying primary ser-
                           vicing. However, county supervisors who determine that borrowers
                           caused their own delinquency do not need a USDAOffice of General
                           Counsel opinion before denying primary servicing.

                           In January 1990, FmlI.4provided members of Congress with a list of 218
                           bad faith borrowers throughout the country who, it said, had committed
                           fraud, waste, or conversion of security property and who were involved
                           in net recovery value buy-outs. Forty-two of those borrowers had
                           bought out their debt at a net recovery value and 58 other borrowers
                           were in the process of buying out their debt. These borrowers have
                           bought out, or have the opportunity to buy out, their debt for much less
                           than the amount of their outstanding debt. These 100 borrowers include
                           8 borrowers who bought out or were in the process of buying out their
                           debt and whose buy-outs will result in write-offs of more than $1 million
                           each. For example: one borrower who, according to FmHA, committed
                           fraud owed C11.8 million and was offered a $1.1 million net recovery
                           value buy-out. This borrower will receive a $10.7 million write-off of his
                           F~HA debt if he pays the buy-out amount. Further, 118 borrowers on the
                           national list were offered net recovery value buy-outs, but they did not
                           accept the buy-out offers. These borrowers will be eligible to reacquire
                           their farmland or farm homestead if FIMIA forecloses on their properties.
                           In addition to these ‘L18 bad faith borrowers, 1~1.4 had referred or was



                           Page 48                              GAO/RCED-96-169 Agricultural   Credit Act Debt Servicing
                      Clulpter 3
                      Reetmctured Ronmver~ Financially Weak
                      After servicing




                      servicing and net recovery value buy-out, we recommend that the Con-
                      gress amend the Agricultural Credit Act of 1987 (P.L. 100-233, Jan. 6,
                      1988). This can be done by enacting provisions similar to sections 5 and
                      6 of H.R. 4077 which provide limitations on the net recovery value buy-
                      out and restructuring options of the Agricultural Credit Act.


                      In commenting on a draft of this report, USDA agreed with the need for a
Agency Comments and   cash flow margin for FmHA'S restructured borrowers and stated that it
Our Evaluation        supports legislation proposed in the 1990 Farm Bill which requires a 5-
                      percent cash flow margin. IJSDA did not agree to implement a 5-percent
                      margin or the lo-percent margin we recommended without legislative
                      change. USDA stated that FITIHA would implement a margin requirement as
                      quickly as possible if such a change is enacted.

                      As we show in this report, most FmHA restructured borrowers remained
                      financially weak after restructuring. We believe their potential for
                      farming successfully would be better assured if E~HA restructured their
                      debt until cash flow margins of at least 10 percent, to cover unforeseen
                      expenses, were achieved. Also, a lo-percent margin is consistent wit,h
                      F~HA’S guaranteed farm loans.




                      Page 46                          GAO/RCED-SO-169 Agricultural   Credit Act Debt Servicing
              Chapter 3
              Restructured Borrowers Financially Weak
              After Servicing




              to compound, increasing borrowers’ overall debt and weakening their
              financial position.

              If borrowers do not pay their debt, primary loan service programs, such
              as reamortizing and rescheduling payments, will not produce positive
              cash flow indefinitely. These primary servicing tools may simply delay
              future debt write-down or write-off. IJltimately, delinquent borrowers
              will become eligible for the additional loan servicing authorized by the
              Agricultural Credit, Act of 1987, including debt write-down and write-
              off.


              A primary objective of the Congress in passing the Agricultural Credit
Conclusions   Act was to ensure that F~HA delinquent borrowers were able to continue
              their farming or ranching operations. That is not occurring. A very large
              majority of the borrowers remained financially weak after F~IIA restruc-
              tured their delinquent debts. These borrowers are maintaining a high
              debt load coupled with low cash flow margins. Considering their weak
              financial condition, F~HA'S restructuring provided the borrowers with
              only minimal potential for farming successfully without continued debt
              assistance. Their success could have been better assured if FII~HA had
              designed the DALR$ computer program to continue considering restruc-
              turing options until a borrower projected a cash flow margin of at least
               lo-percent above expenses. This restructuring practice would have pro-
              vided borrowers a cash reserve that is consistent with FmHA's criteria for
              its guaranteed loans and would have improved restructured borrowers’
              potential for farming successfully with less dependence on F~HA for con-
              tinued financial assistance.

              Requiring a larger cash flow margin, however, would force FmHA to
              restructure borrowers‘ loans even more than it did. Such a restructuring
              practice would likely result in write-downs for some borrowers who did
              not receive write-downs, and greater write-downs for some borrowers
              who did receive write-downs. Likewise, a larger cash flow margin would
              likely result in an increased number of net recovery value buy-out offers
              because the act prohibits writing down borrowers’ debts past the net
              recovery value of collateral. However, considering the weak financial
              condition of most restructured borrowers, FmfIA'S primary servicing has
              provided only minimal potential for successful farming operations.

              Further, because most, restructured borrowers were only marginally sol-
              vent, at best, they more than likely will continue to need financial assis-
              tance. This assistance will probably come from F~HA because it is “the


               Page 44                            GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
                         Chapter   3
                         Restructured Borrowers Financially   Weak
                         After servicing




                         Inspector General plans a review in this area as part of its audits on
                         FmHArestructuring activities.


FmHA Officials and       F~HA  county and state office officials in each selected state expressed
Restructured Borrowers   concern to us about the ability of many restructured borrowers to con-
                         tinue farming operations without continued F-IIIHA financial support. For
Expressed Doubts About   example, one county supervisor said that loan servicing will not keep all
Chances for Success      restructured borrowers farming and, for many, servicing was only
                         delaying their inevitable failure. According to the chief of farmer pro-
                         grams in one state, additional loans or debt servicing will be necessary
                         to keep many restructured borrowers farming because they operate on
                         tight cash flow margins. He also said that, as long as F~HA continues to
                         lend delinquent borrowers money, they will continue farming even
                         though it is not profitable because they have no alternative jobs. Con-
                         versely, supervisors said that some restructured borrowers will succeed
                         without additional financial assistance from F~HA. One county super-
                         visor said that payments from IJSDA’S Conservation Reserve Program
                         will help keep some borrowers farming.

                         Because of projected low cash flows, some borrowers also expressed
                         concern about their ability to repay their restructured debt and continue
                         farming without future F~HA assistance. The following two cases illus-
                         trate borrowers’ concerns.

                         Example A: FIIIHA’S restructuring of a delinquent soybean and cattle
                         farmer’s $1.3 million debt included writing down over $700,000 and
                         deferring payments on $400,000. Prior to servicing, this borrower owed
                         $257,880, which was due immediately on three fully matured loans, in
                         addition to annual payments of $137,248 on nine other loans. His annual
                         payments declined to $19,000 with restructuring. However, the bor-
                         rower told us he would be unable to make the payments on the restruc-
                         tured debt with his next year’s farm income. Further, he said he may
                         not try to make the payment.

                         Example B: F~HA restructured a delinquent soybean farmer’s $97,000
                         debt by reamortizing and rescheduling payments. This servicing reduced
                         his annual payments from $9,733 to $9,421, or by $312. The borrower
                         wrote the county office that he accepted the restructuring offer even
                         though his income was unchanged and he had been unable to make pay-
                         ments in the past. In expressing concern about his ability to repay the
                         restructured debt, the borrower noted that restructuring had only
                         slightly lowered his annual payments.


                          Page 42                              GAO/RCEB90-169 A@icultural   Credit Act Debt Servicing
                                        Chapter 3
                                        Restructured Borrowers Financially Weak
                                        After Servicing




                                        a lo-percent reserve. F~HA expected that borrowers would use the
                                        reserve for new investments and for contingencies or emergencies asso-
                                        ciated with their farming operations. In May 1988, FmHA proposed a 5-
                                        percent margin in restructuring delinquent borrowers’ debts but with-
                                        drew the proposal because of adverse public comments.

                                        Because the DALR$ analysis includes consideration of projected income
                                        and expenses for the upcoming year, the restructuring decision may
                                        allow borrowers to continue farming for at least one year-assuming
                                        the projections are accurate and there are no major unplanned expenses
                                        or crop failures. However, in our opinion, the likelihood that borrowers
                                        with minimal cash flow margins will be able to continue farming over a
                                        longer term without additional F~HA loans or servicing seems minimal.

                                        Most of the 160 borrowers in the county offices we reviewed had low
                                        cash flow margins for the upcoming year. For example, as table 3.3
                                        shows, 59 percent of the restructured borrowers had cash flow margins
                                        of $100 or less.

Table 3.3: Borrowers by Cash Flow
Margin After Restructuring in 10 FmHA                                        Positive cash flow margin
County Offices                                                              $11 to     $ly&     $1,001 to             Over            Total
                                        County               $0 to 10         100         ,        10,000          $10,000      borrower9
                                        1                           2             3           1         1                  0                  7
                                        2                           11            4           2
                                                                                         - - _-___-     9                  1                 27
                                        3                            1           4            1         3                  2                 11
                                        4                           18            3           0         2                  4                27
                                        5                            3            1           2         4                  2                 12
                                        6                            4            3             1            4             0                 12
                                        7                           10            3             1            1    -__     0                  15
                                        8                           2             7             6            3            3                  21
                                        9                           4             3             0            0            1                   8
                                        10                          8             1             1            3            7                  20
                                        Total                      63            32           15            30           20                 160
                                        Note Margin based on borrowers' prqected income and expenses for the "fxxrrung year
                                        ~'Excludes one borrower whose f!nanclal data was not available at the time of our reww and fw bor
                                        rowers who did not accept reWucturlng offers


                                        A low cash flow margin by itself does not always mean financial failure;
                                        however when a low cash flow margin is combined with high debt, the
                                        financial strength of farm borrowers can deteriorate rapidly. For




                                        Page 40                                 GAO/RCED-90-169 Agricultural      Credit Act Debt Servicing
                                          Chapter 3
                                          Restructured Borrowers Financially Weak
                                          After Servicing




                                          which is USDA’S criterion indicating a favorable financial condition for
                                          farming. Generally, restructured borrowers with debt-to-asset ratios
                                          greater than 40 percent indicate potential for a marginally solvent
                                          farming operation. However, their potential could be improved with a
                                          high cash flow margin. Nine other borrowers had debt-to-asset ratios of
                                          between 41 and 70 percent, but they also had positive cash flows that
                                          provided greater than a lo-percent reserve. Consequently, we consid-
                                          ered these nine borrowers to also have potential for successful farming.

                                          Table 3.1 shows that the remaining 145 borrowers had such high debt-
                                          to-asset ratios that even when considering their positive cash flows,
                                          they had limited potential for successful farming in the near future
                                          without continued FmHA loan assistance, such as new loans or the ser-
                                          vicing of existing loans. For example, one restructured borrower had a
                                          222 percent debt-to-asset ratio, a $2 cash flow margin, and a $246,000
                                          negative net worth after FmHA rescheduled, reamortized, deferred and
                                          wrote down about $50,000 of his $180,850 debt. Further, even though
                                          some restructured borrowers had a positive cash flow after restruc-
                                          turing that provided at least a lo-percent reserve, they had debt-to-asset
                                          ratios above 70 percent, thus limiting their potential for successful
                                          farming operations without F~HA assistance

Table 3.1: Borrowers by Farm Income/
Solvency Categories After Restructuring                         Favorable                    Marsinal solvency                             Total
in 10 FmHA County Offices                 County                    O-40%           41-70%     71-100%      Over 100%                borrower9
                                          1                                 0                1         2             4                             7
                                          2                                 2                5            6               14                      27
                                          3                                 0                2            1                8                      11
                                          4                                 1                4           10               12                      27
                                          5                                 1                1            1                9                      12
                                          6-                                0                6            4                 2                     12
                                          7                                 0                2            8                 5                     15
                                          8                                 2-               7            5                 7                     21
                                          9                                 0                0            2                 6                      8
                                          10                                0                2            6 ~~_____       12                      20
                                          Total                           ~6              30b            45               79                  160

                                          ‘Excludes one borrower whose flnanclal data was not wallable   at the time of our rewew and five bor-
                                          rcwer~ who did not accept restructurrng offers

                                          “Nine of these 30 borrowers had high cash flow margIns. suggesting a more favorable potential for
                                          successful farmlng operations than rndlcated solely by thar debt-to~asset ratio Comblnlng these “one
                                          borrowers wth the SIXborrowers I” the favorable category results I” a total of 9 percent of the 160
                                          restructured borrowers hawng the potential for successful farming operations




                                          Page 38                                 GAO/RCED-90.169 Agricultural        Credit Act Debt Servicing
Restructured Borrowers Financially Weak
After Servicing

                        Most delinquent borrowers whose debt FmHA offered to restructure in
                        the county offices we reviewed will remain financially weak even after
                        their debt is serviced. A primary purpose of the act’s debt restructuring
                        option was to keep borrowers on the farm or ranch to the maximum
                        extent possible. However, we determined that only 15 borrowers, or
                        about 9 percent of the 160 borrowers we reviewed in the F~HA county
                        offices,, projected the financial strength for successful farming opera-
                        tions after restructuring. The other 91 percent have such high debt-to-
                        asset ratios and/or low cash flow margins’ for the upcoming year that
                        their potential appeared limited for successful farming operations
                        without continued FmIlA financial assistance.

                        The act does not preclude borrowers who were restructured and who
                        become delinquent again from getting additional loans or returning for
                        further loan servicing, including restructuring with or without debt
                        write-down or net recovery value buy-out with debt write-off. In March
                         1990, the House of Representatives passed and referred to the Senate a
                        bill which would, among other things, limit a borrower to one write-
                        down or write-off, limit the write-down or write-off amount to
                        $250,000, and precludt, a write-down or write-off on loans made on or
                        after January 6,1988. As of June 28,1990, the Senate had not passed a
                        similar bill. However, various changes to the act are contained in the
                        proposed 1990 Farm Bill, which passed the Senate Committee on Agri-
                        culture, Nutrition, and Forestry on May 17, 1990.


                        Section 615 of the Agricultural Credit Act of 1987 directed FmHA to
Act Aimed to Continue   modify delinquent farmer program loans to ensure that borrowers
Borrowers’ Operations   would be able to continue farming or ranching operations. Continued
                        farming operations would require operating capital and sufficient
                        income to cover all operating, family living, and debt servicing expenses.
                        If borrowers could not generate sufficient funds from their farm and
                        nonfarm operations. they might then require debt assistance to continue
                        farming.

                        IISDA’SEconomic Research Service (ERS) has developed criteria that can
                        be used to indicate whether or not serviced borrowers will be able to
                        continue operations. ~12sclassifies the financial condition of farm opera-
                        tions on the basis of an analysis of income and leverage position. EFs


                        ‘Cash flnw margin is the dlffermw between income and expenses, including farm operating, family
                        living, and debt servicing expenses



                        Page 36                               GAO/RCED-90.169 A~culhud         Credit Act Debt Servichqj
Chapter2
Implementing the Agricultural Credit Act
Resulted in Many Delinquent Borrowers’ Not
Being Serviced and Substantial Costs for
the Govemment




$4.2 million on seven natural disaster emergency loans and one soil and
water loan. His last payment to FmHA was made in 1981. The borrower
reported few assets to F~HA when applying for restructuring, except a
late model, luxury automobile. The county supervisor told us he sus-
pected the borrower had transferred assets to his son. However, the
county supervisor had not pursued a formal, legal opinion on conver-
sion. F~HA offered this borrower an opportunity to buy out his debt for
the $496,000 net recovery value of his collateral. The borrower will
receive a $3.7 million debt write-off if he pays the buy-out amount.

Borrower D: A farmer who grows soybeans, corn, wheat, cotton, and
oats, had his total $900,000 F~HA debt written off through net recovery
value buy-out. The borrower had four natural disaster emergency loans.
County office staff told us the borrower had not made a payment on any
of the loans since November 1986. The FmHA district director declined a
$15,000 offer from the borrower in 1987 to settle his debt because the
borrower had $174,950 in intermediate assets with no hens, fixed assets
of $535,000 with liens of $483,765, and a net income of $30,000. Also,
the county supervisor had documented that the borrower’s production
expenses and standard of living were very high.

Borrower E: A borrower, who was no longer farming, owed FmHA almost
$805,000 on 10 natural disaster emergency and three farm operating
loans. The borrower had about $73,000 worth of equipment as collateral
for the 13 FmHA loans, Be had not made a payment to FmHA on the emer-
gency loans since 1983 or on the farm operating loans since 1!%5. FmHA
offered to write off $738,928 of his debt through net recovery value
buy-out.

Borrower F: This farmer has been borrowing from FmHA since 1979. The
borrower formerly grew barley and corn but now raises horses. He owed
FmHA over $449,000 on four natural disaster emergency and economic
emergency loans. While the borrower made a payment on one loan in
1988, he had not made a payment on the other three since 1983. F~HA
offered to write off over $248,000 of the borrower’s debt if he paid the
$201,000 net recovery value of his collateral. Also, the county super-
visor told us the borrower lives above community standards and had
built a race track to train horses.

Borrower G: A soybean, corn, cattle and grain farmer who owed FmHA
$269,000 had his debt restructured with rescheduling and interest rate
reduction. The borrower had six outstanding FmHA loans including four
natural disaster emergency and two farm operating loans. At the time of


 Page 34                            GAO/RCED-90.169 Agricultural   Credit Act Debt Servicing
                                                  Chapter 2
                                                  Implementing the Agricultural Credit Act
                                                  Resulted in Many Delinquent Borrowers’ Not
                                                  Being Serviced and Substantial Costs for
                                                  the Government




                                                  Table 2.6 shows that 273 borrowers, or about 63 percent of the 434 bor-
                                                  rowers we reviewed, received net recovery value buy-out offers with
                                                  debt write-off. The remaining 161 borrowers, or 37 percent, received
                                                  restructuring offers with or without debt write-down. The financial con-
                                                  dition of the borrowers after restructuring is analyzed in chapter 3.


Table 2.6: Borrowers, Debt Amount, and Debt Reduction, by Servicing Category in IO FmHA County Offices
Dollars   In mtlhons
                         Primary servicing
                        without write-down               Primary servicing with write-down                       Net recovery value buy-out
                       Number of Debt before            Number of Debt before Amount of                      Number of Debt before Amount of
County                 borrowers     servicing          borrowers      servicing write-down                  borrowers     servicing    write-off
1                               2         $03                    5           $1 6        $1 0                          21              $56          $4.6
2                              20          34                    7             32          14                          11               20           1.5
3                               7           14                     4             24             14                     26              184          14.7
4                               8           17                    19             56             27                     31         -     a.7          5.7
5                               9           2.0                    3             12             08                     22    --         7.9          6.7
6                               6           06                     6             13             05                     17               8.5          6.5
7                               3           02                    12             28             11                     18               44           35
8                              15           12                     7             44             23                     59              28.7
                                                                                                                                       .-.
                                                                                                                                                    21.3
9                               1           01                     7             22             12                     60              13.3         12.0
10                             13           21                     7             16             06                       8              2.3           1.7
__-.
Total*                         64-       813.0                    77          $26.2"         $13.0                    273             $99.7b      $76.2

                                                  “We d!d not complle servicing lnformatlon for 29 and 11 el!gable borrowers I” counties 6 and 7, respec-
                                                  t~vely. who had declined FrnHA’s servlung offer 01 were in medlatlon. We Included such borrowers tn our
                                                  compllatlons for the other counties We also did not record information for the aght borrowers in four
                                                  countes who had not recwed offers

                                                  “Totals do not add due lo rowing


                                                  Nationally, as of June 30. 1989,82 percent of FmHA’S delinquent bor-
                                                  rowers were offered write-downs and 76 percent were offered write-offs
                                                  of less than $250,000. Also, 92 borrowers were offered write-downs or
                                                  write-offs in excess of $1 million. As table 2.7 shows, at the county
                                                  offices we reviewed FmHA offered to reduce the debt of 236 borrowers
                                                  through write-downs or write-offs of less than $250,000. The county
                                                  offices also offered to reduce the debt of ten borrowers by more than $1
                                                  million.




                                                   Page 32                                 GAO/RCED-W-169 Agricultural        Credit Act Debt Servicing
                                       Chapter 2
                                       Implementing the Agricultural Credit Act
                                       Resulted in Many Delinquent Rorrowers’ Not
                                       Being Serviced and Substantial Costs for
                                       the Govemment




                                       FIIIHA rural housing loans. Figure 2.1 shows the number and type of                            FIIIHA
                                       loans held by borrowers who were offered servicing in the county
                                       offices we reviewed.


Figure 2.1: Number and Type of Loans
Held by Borrowers Who Were Offered
                                       1200   Number   of Loans
Servicing in 10 FmHA County Offices




                                       Loan Typ

                                       Note. We did not compk loan type data for 40 ellglble borrowers I” two counties who had declmed
                                       FmHA’s serwng offer or were r medlatlon We also did not complle data for the etght borrowers who
                                       had not received offers
                                       Source. GAO analysts of serviced borrowers’ flies


                                       Table 2.5 shows that 264 borrowers, or about 61 percent of the 434 bor-
                                       rowers we reviewed, had a combination of loan types which included an
                                       emergency loan (economic and/or disaster) and at least one other loan
                                       type, such as a farm ownership or farm operating loan. For example,
                                       one borrower owed $406,812 on a combination of five different F~HA
                                       loan types-farm    operating, farm ownership, natural disaster emer-
                                       gency, economic emergency, and rural housing. Also, while 106 bor-
                                       rowers, or 24 percent, had no emergency loans, 64 borrowers, or 15
                                       percent, had only emergency loans, covering either natural disasters or
                                       economic emergencies.




                                       Page 30                                GAO/RCED-96.169 Agricultural     Credit Act   Debt   Servicing
                                          Chapter 2
                                          Implementing the Agricultural Credit Act
                                          Resulted in Many Delinquent Rorrowers’ Not
                                          EJeing Serviced and Substantial Costs for
                                          the Government




Table 2.3: Borrowers Who Had Debt Servicing Offered and Completed in 10 FmHA Countv Offices as of June 30. 1989
                                        Primary servicing       Percentage       Net recovery value buy-out     Percentage
County           Total borrowers   Offered        Completed      completed        Offered       Completed        completed
1                           28                7                7                1000                     21                     IO               47.6
2                           38           27                   25                  92.6                   11                      a               72.7
3                           37           il                    5                  455                    26                      1                   39
4                           58           27                   20                  74 1                   31                     11               355
5                           34           i2                    4                  333-                   22                      1                4.5
6                           58           13                    5                  38.5                   45                      2                   44
7                           44           19                    6                  31 6                   25                     14               560
a                           81           22                     1                  44                    59                      5                   8.5
9                           68                a                3                  37.5                   60                     38               633
10                          28           20                   20                 1000                      8                     5               62.5
Total                      474a         166                   96                 57.6                   308                    95                30.8

                                          aServlcmg offers orellglb~llty detemnations     were pendmg for elghtaddltional    borrowers, and serwmg
                                          was denled for 07 borrowers




FhHA Denied Servicing to                  FmHA   denied servicing to 87 borrowers, or 15 percent of the 569 bor-
                                          rowers who applied in the county offices we reviewed. County staffs
Some Borrowers                            denied servicing to 65 borrowers who, according to the county staffs,
                                          did not submit complete applications, and to 7 borrowers whose delin-
                                          quencies were due to circumstances within their control or who did not
                                          act in good faith in terms of their F~HA loan agreements. These seven
                                          borrowers did not qualify for net recovery value buy-out. In addition,
                                          county staffs determined that the estates of eight deceased borrowers
                                          were ineligible for primary servicing, and seven other borrowers did not.
                                          meet various other FML~ eligibility requirements, such as the need to
                                          reaffirm their F~HA debt after bankruptcy. These 87 borrowers, who
                                          were denied eligibility for primary loan servicing and net recovery value
                                          buy-out, may qualify for preservation servicing in the event of foreclo-
                                          sure on the collateral that secures their F~HA debt.


                                                 offered loan servicing to borrowers with large, moderate, and
                                              FI~IHA
Borrowers Offered                         small amounts of debt and with most types of FmHA loans. In the county
Servicing Varied by                       offices we reviewed, 4 percent of the borrowers had an F~HA debt of $1
Loan Size and Type                        million or more before servicing, 40 percent had an F~HA debt in the
                                          $250,000 to $999,999 range, and 56 percent, had an FIIIHA debt of less
                                          than $250,000. Also, 6 I percent of the borrowers had a combination of
                                          loan types which incSlutled an emergency loan (economic and/or dis-
                                          aster) and at least OIWother type of loan, such as a farm ownership or


                                              Page 28                                   GAO/RCED-90-169 Agricultural        Credit Act Debt Servicing
                         Chapter 2
                         Implementing the Agricultural Credit Act
                         Resulted in Many Delinquent Borrowers’ Not
                         Being Serviced and Substantial Costs for
                         the Government




                         applications, county supervisors met with borrowers to obtain addi-
                         tional information needed to complete application packages during the
                         following 60-day period.


County Staff Generally   County office supervisors provided us with several reasons explaining
                         why they did not process applications and complete servicing decisions
Unprepared to Process    on schedule. First, the large volume of applications overwhelmed some
Large Volume of          county office staffs, which were simultaneously processing new loan
Applications             requests and servicing applications. County and state personnel in these
                         counties told us that new loan applications were heaviest during the
                         January to April period, when servicing requests were also being
                         processed. F~HA attempted to service borrowers by authorizing over-
                         time, hiring temporary staff, and detailing staff to counties with heavy
                         workloads.

                         Second, F~HA implemented the act with interim regulations that have
                         not been finalized and operating instructions that were frequently
                         revised. Between September 1988 and June 1989, F~HA sent its county
                         and state offices an extensive series of notices that provided new imple-
                         menting guidance or revisions to previous guidance. According to some
                         county supervisors, the lack or revision of guidance caused uncertainty
                         and duplication of work in processing applications. For example, F~HA
                         issued revised guidance in May 1989 for calculating net recovery value.
                         One county supervisor told us he had to recalculate the net recovery
                         value for 12 borrowers when he received the revised guidance.

                         Third, FmHA'S key computer software programs for processing applica-
                         tions, computing servicing decisions, and tracking progress were not
                         fully operational when restructuring began. These programs required
                         revisions after servicing began, and the tracking program was not opera-
                         tional at some county offices as late as August 1989. For example, the
                         DALR$ program, which allowed county offices to process applications in a
                         short time in comparison to manual processing, was revised during
                         implementation on the basis of reviews by USDA'S Office of Inspector
                         General and testing and validation of the program by a private
                         accounting firm.

                         Finally, servicing completion was delayed because some borrowers
                         chose to participate in mediation with F~HA and other lenders in a fur-
                         ther attempt to develop a feasible plan of operations and qualify for
                         restructuring. Other borrowers appealed various R~HA servicing deci-
                         sions, such as their ineligibility for primary loan service programs.


                          Page26                             GAO/RCED-96.169 Agricultural   Credit Act Debt Sew
                            Chapter 2
                            Implementing the Agricultural Credit Act
                            Resulted in Many Delinquent Borrowers’ Not
                            Being Serviced wd Substantial Costs for
                            the Government




                            Another borrower said he did not request servicing because of the size
                            of the notification package. He told us he did not understand what he
                            was supposed to do with the material and he believed some of the infor-
                            mation in the package did not apply to him. A third borrower told us he
                            did not request servicing because he was waiting for FmHA to provide
                            instructions on filling out the application. This borrower expected
                            someone from FmHA to come to his house to assist him in completing the
                            application.


                            F~HA  did not fully meet the act’s implementation schedule. For example,
Act’s Implementation        about one-third of the qualified borrowers at the county offices we
Schedule Not Met            reviewed were not. serviced within the act’s required time frames. Bor-
                            rowers were not scrvic,ed on schedule because they did not apply on
                            schedule and because county office staffs were unprepared to process
                            the large volume of applications. However, FmHA’S failure to strictly
                            comply with the act’s deadlines increased, rather than restricted, bor-
                            rower participation.


Borrowers Not Serviced as   FmHA  provided delinquent borrowers with notice of the act’s benefits
Scheduled                   and application packages in mid-November 1988. Based on this begin-
                            ning date there were specific deadlines for (1) borrowers to apply for
                            servicing; (2) FmIIA to process applications and make servicing offers; (3)
                            borrowers to accept. reject, and appeal offers, or request mediation with
                            their creditors; and (4) F~IIA to complete servicing of qualified bor-
                            rowers (see app. 1).

                            FmIIA county offices should have completed making servicing offers by
                            mid-March 1989 and completed servicing by .June 1989, if borrowers
                            applied on time and did not appeal a servicing decision or request medi-
                            ation Table 2.2 shovvs that the county offices we reviewed had made
                            offers to 315 borrowers. or 66 percent of the 474 qualified applicants at
                            the end of the 60-da>, processing period.




                            Page 24                             GAO/RCED90-169 Agricultural   Credit Act Debt Servicing
                                        Chapter 2
                                        Implementing the Agricultural Credit Act
                                        Resulted in Many Delinquent Borrowers’ Not
                                        Being Serviced and Substantial Costs for
                                        the Government




Table 2.1: Notified Borrowon who
Applkd for Servktng in 10 FmHA County                            Borrowers                                                      Percentage of
onicrr                                                           eligible to          Borrowers             Borrowers               borrowers
                                                                    receive         initially sent         applied for            applying for
                                        County                   packages              packages              servicing              servicinga
                                        1                                   56                   56                   28                      500
                                        2                                  a5                    a4                   50                      595
                                        3                               ~~~~--
                                                                          114                  114                    59                      51 a
                                        4                                   93                   92                   60                      65 2
                                        5                                 319                  311                    45                      145
                                        6                                 123                  115                    71                      61 7
                                        7                                   92                   92                   47                      51.1
                                        a                                 197                   196                   97                      49 5
                                        9                                 166                   164                   a3                      506
                                        10                                  48                   48                   29                      60.4
                                        Total                           1,293                1,272                  569                       44.7

                                        Note All tables in this report are based on our analysts of lnformatlon obtalned I” the FmHA county
                                        offtces we rewewed.
                                        “Percentage based on borrowers mltially sent notlflcatlon packages


                                        At the county offices we reviewed, borrowers did not apply for servicing
                                        primarily because they (1) were inactive borrowers and generally no
                                        longer farming or (2) chose to negotiate a settlement of the FmHA debt
                                        rather than servicing under the act (referred to as debt settlement). In
                                        addition, some borrowers chose to pay their F~HA debts current or to
                                        pay them off.


Borrowers No Longer                     Many delinquent borrowers who did not apply for servicing in the
Actively Farming                        county offices we reviewed were inactive borrowers. According to F~IHA,
                                        inactive borrowers include those who are no longer farming and those in
                                        bankruptcy, foreclosure, or collection-only status with little or no collat-
                                        eral. In the county offices we reviewed, 309 delinquent borrowers, or 44
                                        percent of those who did not apply for servicing, were considered inac-
                                        tive by F~HA county office staffs.

                                        Delinquent borrowers we interviewed gave similar reasons for not
                                        applying for servicing. Twenty borrowers, or 57 percent of the 35 delin-
                                        quent borrowers we interviewed, did not apply for servicing because
                                        they were no longer actively farming. For example, one borrower who
                                        owed F~HA about $102,000 on six loans quit farming several years ago
                                        and now works in construction. Another borrower who owed F~HA
                                        about $126,000 on three loans did not apply because he no longer farms
                                        and has sold his farm equipment.


                                        Page 22                                   GAO/RCED-W-169 Agricultural        Credit Act Debt Servicing
Chapter 2

Implementing the Agricultural Credit Act
Resulted in Many Delinquent Borrowers’ Not
Being Serviced and Substantial Costs for
the Government                 -
                        R~HA   notified virtually all borrowers who were 180 days or more delin-
                        quent on their loans of available Agricultural Credit Act servicing bene-
                        fits. In evaluating the results of FIIIHA’S efforts to implement the act, we
                        found the following:

                        On a national basis, only about 50 percent of the notified delinquent bor-
                        rowers applied for servicing. Only 45 percent of the notified borrowers
                        applied at the 10 county offices we reviewed; borrowers at these offices
                        did not apply primarily because they were inactive farmers or because
                        they chose to negotiate a settlement of their FmHA debt.
                        FTIIHA serviced about 8:s percent of the borrowers who applied at these
                        county offices including borrowers with large, moderate, and small
                        amounts of debt. Also, while emergency loans were the most prevalent
                        loan type for serviced borrowers, most borrowers held a combination of
                        EMmAA  loan types.
                        The cost of debt relief has been substantial and will increase as FmIIA
                        continues servicing under the act. Nationally, PmHA estimated it would
                        write down and write off $9.4 billion of delinquent debt. At, the county
                        offices we reviewed, $9 1 million, or almost two-thirds of the total $139
                        million debt of delinquent borrowers who were offered servicing, was
                        written down or writf.ckn off.


                        In mid-November 1988, F~IIA notified more than 66,400 delinquent bor-
Most Eligible           rowers across the nation of the availability of loan servicing. FIIIHA
Borrowers Notified of   informed delinquent borrowers of debt restructuring and other servicing
Servicing               benefits available under t,he act and how to apply for servicing. At the
                        10 county offices we reviewed, county supervisors sent notices of ser-
                        vicing availability, including application forms, to 1,272 borrowers.’
                        However, 21 additional delinquent borrowers at the selected county
                        offices should have been but were not, initially notified of the act’s
                        servicing.

                        These borrowers were not notified primarily because of administrative
                        errors and FmIIA county office staffs’ confusion about notification
                        requirements. For example, some delinquent borrowers were incorrectly
                        shown on FmHA reports as being less than 180 days delinquent on their
                        loan payments. Also, when mailing notification packages, F~IHA county
                        office staff overlooked other borrowers who were 180 days or more
                        delinquent. Further, one county office failed to notify seven borrowers

                        ‘The 10 county offices actually mailed more than 1,272 notices because cosigners, partners, and COT-
                        porate shareholders were also notifkd. However, we rliminatcd duplicate notices for our an:rlysis.



                        Page 20                                GAO/RCED-90.169 Agricultural      Credit Act Debt Servicing
Chapter 1
Introduction




Second, we assessed whether or not changes to the act are needed tv
protect the government’s and taxpayers’ interests. In doing so, we ana-
lyzed the act’s requirements and FmllA’s implementing regulations for
offering servicing. Specifically, we analyzed the act and its legislative
history to determine if the Congress intended for FrnElA to offer net
recovery value buy-out and preservation service options to delinquent
borrowers who had caused their delinquencies or otherwise acted in bad
faith. We also analyzed delinquent borrowers’ financial reports, main-
tained by FKIHA county offices, to determine if serviced borrowers had
other assets that, conld have been used to reduce their FrnIIA debts.

Third, we analyzed the act’s potent.ial impact on F~~IIAborrowers who
were not 180 days or more delinquent on their loans when FmIlA mailed
application packages in November 1988. We compared loan payments
for serviced delinquent borrowers with those for selected nondelinqucnt
borrowers who (1) had similar outstanding FI~IIAloan balances and (2)
farmed in the same community under similar economic and climatic con-
ditions. We also intrar\%wed 30 selected nondelinquent borrowers, I~MIA
state and county officials, and 17 county c~ommittec members to obtain
their opinions on t h(aiId'S impact.

To det,ermine E’mIIA’S policies, plans, and practices for servicing dclin-
quent borrowers, we rcbviewed FIT~IIA regulations, announcements, con-
gressional testimony, arti&s, studies, and other documents relating to
servicing under the Agricultural Credit Act. We also obtained informa-
tion on I+HA’S servicing activities by interviewing agency officials at
FmIIA headquarters and at, each selected state and county     office. Further,
to determine the reliability of FmlIA’s MLK$ comput,er program for calcn-
lating servicing entitlrments, we reviewed a report by a private
accounting firm on testing and validation of the program.

Finally, we reviewed t JIGIXLI~~Office of Inspector General’s technical
audit reports on F~IIA’S implementation oft he act. We discussed OUT
review objectives and c,oordinatcd our work with Office of Inspector
General personnel to maximize audit coverage and minimize duplication
of effort.

We conducted our rc*\%>wfrom December 1988 through November 1989.
Tu assure comparability of data obtained at county offices, we compiled
data on FmIIA’S servicing decisions through .June 30. 1989. We performed
our work in accordanc.c with generally accepted governmental auditing
standards.



 Pagr 18                       (;AO/RCED-SG-I69 Agricultural   Credit Act Debt Servicing
    Chapter 1
    Introduction




l compiled information on borrower participation in debt servicing
  authorized by the act,
. determined if borrowers whose debts FI~HA restructured had financial
  strength to operate potentially successful farm operations after
  servicing,
. determined whether changes to the act are needed to protect the govern-
  ment’s and taxpayers’ interest by precluding and limiting benefits for
  certain borrowers, and
* determined the act’s potential impact on borrowers who were ineligible
  for servicing because they had kept their F~HA debts current.

    We performed our work at F~HA headquarters and at 10 F~HA county
    offices and their respective state offices. Appendix II shows the states
    and county offices included in our review. We selected the 10 states
    with the largest number of servicing notification packages sent by FmHA
    to delinquent borrowers in November 1988. The 10 states, in order of
    the number of notification packages, were: Texas, Mississippi, Loui-
    siana, Georgia, Minnesota, Missouri, Oklahoma, Korth Dakota, Ten-
    nessee, and South Dakota. The results of our work apply only to the
    offices we reviewed and cannot be projected to the 10 states or the
    nation overall.

    We selected a county office in each state with a relatively high number
    of borrowers and a relatively high delinquency rate. For example, only
    16 of 670 county offices in the 10 states. or about 2.4 percent, had more
    borrowers and a higher delinquency rate than the county offices we
    selected. All select,ed county offices except one had over 200 borrowers,
    and all except one had a delinquency rate greater than 51 percent. One
    county office had 1Xl borrowers, and another had a delinquency rate of
    42 percent. We used FmHA’s February 10, 1989, Farmer Program Delin-
    quency Report to determine, by state and county office, the number of
    farmer program borrowers and the rate of loan delinquency. While we
    did not always select county offices with the highest delinquency rates,
    our process allowed us to avoid selecting FnrIIA offices with minimal
    Agricultural Credit Act activity.

    To  assess F~HA’S implementation of the act and to determine the impact
    of debt servicing on twIA delinquent borrowers, we analyzed F~HA
    records and reports for 569 borrowers who applied for servicing in the
    selected county offices. FmllA had provided notification packages to an
    additional 703 borrowers, but they did not apply for servicing. We inter-
    viewed 35 of these 703 borrowers who did not apply for servicing to
    determine their rttasons for not applying. Also, we reviewed county


    Page 16                      GAO/RCED-SO-169 Agricultural   Credit Act Debt Servicing
                             Chapter 1
                             Introduction




                             as homestead protection). These two options make up what is known as
                             the preservation loan service program.

                             The Agricultural Credit Act also grants extensive appeal rights to delin-
                             quent borrowers who disagree with FmHA decisions in implementing the
                             act. Borrowers are entitled to appeal each decision that FIIIHA makes in
                             the loan servicing process. For example, borrowers may appeal FmHA
                             county office decisions on (1) their eligibility for restructuring and (2)
                             the appraised value of their collateral.


Loan Servicing Eligibility   To qualify for primary loan service programs, the act requires that (1) a
                             borrower’s delinquency must have been due to circumstances beyond
Requirements                 the borrower’s control and (2) a borrower must have acted in good faith
                             in connection with the loan agreements. IJSDA has interpreted the act to
                             require that delinquent borrowers who do not meet these conditions are
                             eligible for RIIHA net recovery value buy-out consideration, Such bor-
                             rowers may also be eligible for preservation service options.

                             The act also provides that a borrower must present a preliminary plan,
                             based on reasonable assumptions, showing that the borrower can meet
                             farm operating and family living expenses and pay all debt, including
                             any restructured debt. Borrowers who do not have a feasible plan are
                             eligible for net recovery value buy-out. Such borrowers may also be eli-
                             gible for preservation service options.

                             The act further requires that the restructured debt of borrowers result
                             in a net recovery to the government that equals or exceeds the recovery
                             from an involuntary liquidation or foreclosure on the property securing
                             a loan. The value of a restructured loan is based on the present value of
                             payments that a borrower would make if loan terms were modified
                             under any combination of primary loan service programs. The act pro-
                             vided for restructuring when the present value of a borrower’s restruc-
                             tured debt equaled or exceeded the recovery value of the collateral.
                             Conversely, the act provided for net recovery value buy-out when the
                             present value of the restructured loans was less than the recovery value
                             of collateral.


Loan Servicing Process       The act required FmHA to notify all borrowers who were 180 days or
                             more delinquent on an F~IIA loan about the availability of loan servicing.
                             Through a November 1988 mailing, FmHA notified more than 66,400 bor-
                             rowers of the types of services available under the act and provided


                             Page 14                       GAO/RCED-W-169 Agricultural   Credit Act Debt Servicing
                          Chapter 1
                          Introduction




                          November 1985; however, the Congress, in making supplemental appro-
                          priations for fiscal year 1987 (P.L. 100-71, July 11, 1987), directed F~HA
                          to reinstate the policy. Also, the liberal eligibility for emergency loans,
                          which represent the largest source of F~HA delinquent loans, increased
                          delinquencies. Further, judicial decisions in 1984 and in 1987 prevented
                          F~HA from foreclosing on delinquent borrowers.



                          The Agricultural Credit Act required F~HA to notify borrowers who
Loan Servicing Under      were delinquent 180 days or more of various debt relief measures. The
the Agricultural Credit   act allowed FIIIHA to use several loan servicing options to restructure or
Act                       reduce the debts of its delinquent farmer program borrowers. Each F~HA
                          delinquent borrower was required to apply for servicing within a spe-
                          cific period of time to be eligible for the act’s benefits. Also, each bor-
                          rower had to meet specific eligibility requirements to qualify for
                          restructuring. Further, the act required FmIIA to process applications
                          within a time-phased schedule (see app. I). FIJIHA designed a computer
                          program-Debt       and Loan Restructuring System (referred to by FmHA as
                          DALR$)-to analyze borrowers’ financial conditions to determine the ser-
                          vicing option for which they qualified.


Loan Servicing Options     The act provided FmHA three major options for servicing delinquent bor-
                           rowers. First, it provided primary loan servicing (restructuring) options
                           for good faith borrowers-those     whose delinquency was due to circum-
                           stances beyond their control and who acted in good faith in connection
                           with the terms of their RnIIA loans-in which loan terms, interest rates,
                           and amounts, were revised so the borrowers could continue farming.
                           These borrowers remained in FmHA’s loan portfolio. Second, it provided
                           an option allowing such borrowers to buy out their debts at an adjusted
                           value of the collateral securing their loans. Third, it provided preserva-
                           tion loan servicing options allowing borrowers to reacquire their farms
                           or farm homesteads from FIMA in the event of foreclosure.

                           Primary loan service programs restructure a delinquent borrower’s debt
                           until the borrower demonstrates the ability to repay the loans. The act
                           defines primary loan service programs as loan consolidation,
                           rescheduling, or reamortization; interest rate reduction; debt set-aside,
                           deferral, or write-down of outstanding principal and accumulated
                           interest; or any combination of these options. The act’s principal change
                           to FIIIHA’S loan servicing was the addition of the debt write-down option




                           Page 12                       GAO/RCEDSQ169 Agricultural   Credit Act Debt Servicing
Chapter 1

Introduction


                            The Agricultural Credit Act of 1987 (P.L. 100-233, Jan. 6, 1988) allowed
                            for substantial revisions in the Farmers Home Administration’s (FIIIHA)
                            loan servicing procedures. In particular, the act’s debt restructuring pro-
                            vision allowed for a write-down of debt to the recovery value of the
                            collateral securing the debt for delinquent farmer program borrowers. If
                            delinquent borrowers could not project a feasible plan for their farm
                            operations with debt restructuring, they could buy out their debt at the
                            net recovery value of collateral and end their FmHA debt obligation.
                            These changes were intended to preserve borrowers’ farming or
                            ranching operations while minimizing the government’s losses on farmer
                            program loans.

                            FITIHAis the credit agency in the U.S. Department of Agriculture (USDA)
                            for agriculture and rural development. FmHA serves as a temporary
                            source of credit for family farmers whose financial situation prevents
                            their obtaining credit elsewhere at reasonable rates and terms. FmHA is
                            commonly referred to as the “lender of last resort” for farmers. As such,
                            FmHA’S loan portfolio can be categorized as “high risk.”

                            F~HA  assists farmers through direct loans and guarantees on loans made
                            by other lenders for purchasing, expanding, and operating farms. FmHA’S
                            major farm loan programs include

                        0 farm ownership loans to buy and improve farm land and to construct,
                          repair, and improve buildings;
                        l farm operating loans for feed, seed, fertilizer, livestock, farm and home
                          equipment, living expenses, and seasonal hired labor;
                        . emergency loans for losses caused by natural disasters; and
                        . soil and water loans to help farmers and ranchers develop, conserve,
                          and properly use land and water resources.

                                                 -~
                            In January 1988, when the Agricultural Credit Act was enacted, F~HA
Delinquency Status of       estimated that delinquent borrowers were past due on about $9.6 billion
FhHA’s Loan                 in principal and interest payments. The outstanding principal balance on
Portfolio                   loans to delinquent borrowers was $11.4 billion of the agency’s total $26
                            billion direct loan portfolio. According to the agency, about 85,000 of its
                            242,000 farmer program borrowers were delinquent and another 33,000
                            were in bankruptcy, foreclosure, or some other “inactive” status.




                            Page 10                       GAO/RCED-W-169 Agricultural   Credit Act Debt Servicing
          Contents




Figures   Figure 1.1: FmHA Past Due Payments as of June 30,                               11
               1980-89
          Figure 2.1: Number and Type of Loans Held by Borrowers                          30
               Who Were Offered Servicing in 10 FmHA County
               Offices




          Abbreviations

           DALR$     Debt and Loan Restructuring System
           ERS       Economic Research Service
           FmHA      Farmers Home Administration
           GAO       General Accounting Office
           1ISDA     U.S. Department of Agriculture


           page 8                     GAO/RCED-90-169 Agricultural   Credit Act Debt Servicing
Contents


Executive Summary                                                                                         2

Chapter 1                                                                                                10
Introduction            Delinquency Status of FmHA’s Loan Portfolio                                      10
                        Loan Servicing Under the Agricultural Credit Act                                 12
                        Objectives, Scope, and Methodology                                               15

Chapter 2                                                                                                20
Implementing the        Most Eligible Borrowers Notified of Servicing
                        About Half of Notified Borrowers Applied
                                                                                                         21
                                                                                                         21
Agricultural Credit     Act’s Implementation Schedule Not Met                                            24
Act Resulted in Many    FmHA Offered Servicing to Most Borrowers Who Applied                             27
Delinquent Borrowers’   Borrowers Offered Servicing Varied by Loan Size and                              28
                             Type
Not Being Serviced      Borrowers Received Loan Servicing at Substantial Cost to                         31
and Substantial Costs        FmHA
                        Examples of Serviced Borrowers                                                   33
for the Government
Chapter 3                                                                                                36
Restructured            Act Aimed to Continue Borrowers’ Operations                                      36
                        Few Borrowers Financially Sound After Restructuring                              37
Borrowers Financially   Restructured Borrowers Can Obtain Additional Loans and                           43
Weak After Servicing        Restructuring
                        Conclusions                                                                      44
                        Recent Congressional Initiatives                                                 45
                        Recommendation to the Secretary of Agriculture                                   45
                        Recommendation to the Congress                                                   45
                        Agency Comments and Our Evaluation                                               46

Chapter 4                                                                                                47
Changes Needed to       Borrowers Who Acted in Bad Faith Received Net                                    48
                             Recovery Value Buy-Out and Preservation Benefits
Preclude and Limit      Assets Not Securing FmHA Debt Are Not Considered in                              53
Benefits for Certain         Servicing Decisions
Delinquent Borrowers    Conclusions
                        Recent CongressionalInitiatives
                                                                                                         55
                                                                                                         56
                        Recommendations to the Congress                                                  57
                        Agency Comments and Our Evaluation                                               58




                        Page 6                      GAO/RCED-99-169 Agricultural   Credit Act Debt Servicing
                              Executive Summary




                              their ability to repay their loans and continue farming even after F~HA
                              servicing. Also, FTIIHA officials in nine county offices anticipated that
                              restructured borrowers will become delinquent again and return for
                              debt relief. Existing law allows unlimited restructuring.


Benefits Need to Be           Under USDA’S interpretation of the act, bad faith borrowers are eligible
Precluded and Limited for     for net recovery value buy-out. F~HA reported in January 1990 that 218
                              borrowers who acted in bad faith in fulfilling their loan agreements
Certain Borrowers             received net recovery value buy-out offers. one hundred of these bor-
                              rowers had bought out, or were in the process of buying out, their debt.
                              The remaining 118 borrowers did not accept the buy-out offers. The
                              basis for IJSDA’S interpretation of the act is not apparent. In GAO’S view,
                              the net recovery value buy-out option is available only to good faith bor-
                              rowers. Nevertheless, legislative action would ensure that borrowers
                              who act in bad faith do not receive the act’s benefits.

                              The act also permits some benefits for delinquent borrowers that are not
                              in the government’s or taxpayers’ best interest. First, bad faith bor-
                              rowers may reacquire their tarms or farm homesteads under preserva-
                              tion servicing options if ~MIA forecloses on their farm properties.
                              Second, the act permits MIA to offer restructuring without considering
                              borrowers’ unsecured assets. Also, the act does not allow F~HA to
                              include such assets in computing the net recovery value buy-out
                              amount. Excluding unsecured assets increases the amount of debt relief,
                              and thus reduces the government’s recovery when loans are restruc-
                              tured with write-down or bought out at the net recovery value of
                              collateral.

                          -                    --~_
Agricultural Credit Act       Most nondelinquent borrowers interviewed by GAO questioned the equity
May Encourage Defaults        of the act because it provided debt relief only for borrowers who
                              defaulted on their FmHA loans. Some nondelinquent borrowers stated
by Nondelinquent              they intended to become delinquent to qualify for debt relief. While
Borrowers                     county supervisors can deny servicing for borrowers who cause their
                              delinquencies, it is difficult for them to do because they rely primarily
                              on borrower-submitted information as a basis for decisions.


Recent Congressional          In March 1990, the IIouse of Representatives passed a bill, H.R. 4077, to
Actions Aimed at Debt         amend the Agricultural Credit Act to prevent bad faith borrowers from
                              receiving loan write-offs and authorize F~HA to consider all borrower
Servicing Problems            assets in making loan servicing decisions. As of June 28, 1990, the
                              Senate had not passed a similar bill. However, various changes to the act


                              Page 4                        GAO/RCED90-169 Agricultural   Credit Act Debt !Wvicing
Executive Summary


                   The Farmers Home Administration (F~HA) had billions of dollars of
Purpose            delinquent farm loans in its portfolio when the Agricultural Credit Act
                   of 1987 was enacted. The act was designed not only to help delinquent
                   borrowers continue farming, but to minimize the government’s losses.
                   IIowever, EMlA estimated the act’s implementation will result in its for-
                   giving about $9.4 billion in delinquent farm loans

                   In response to a request of the Chairman, Senate Committee on Agricul-
                   ture, Nutrition, and Forestry, GAO(1) examined borrower participation
                   in debt servicing, (2) determined if borrowers whose debts FmIlA restruc-
                   tured had the financial potential to operate successful farms, (3) deter-
                   mined whether changes to the act are needed to preclude and limit
                   benefits for certain borrowers, and (4) det.ermined the act’s potential
                   impact on nondelinquent borrowers.


                   FmHA-the “lender of last resort” in the U.S. Department of Agriculture
Background         (r&DA)-provides loans to farmers who are unable to obtain credit, else-
                   where at reasonable rates and terms. In January 1988, F~HA estimated
                   that the outstanding principal balance on delinquent loans was $11.4 bil-
                   lion of its $26 billion direct farm loan portfolio. The act required FmHAto
                   notify borrowers who were delinquent 180 days or more of various debt
                   relief measures, such as restructuring loan terms and writing down debt,
                   or allowing borrowers to pay F~HA an amount, equal to the adjusted
                   value of the collateral securing the debt-referred       to as net recovery
                   value buy-out-to       end their E’mHA debt obligations.


                   As of November 36, 1989, FmaA-approved debt forgiveness totaled $1 .S
Results in Brief   billion for 9,637 delinquent borrowers who were serviced under the pro-
                   visions of the act. FI~IIAapproved restructuring the farm loans of an
                   additional 9,599 delinquent borrowers without debt forgiveness. Also,
                   6,341 other borrowers received debt settlement-costing      an additional
                   $933 million in debt write-offs-rather    than servicing under the act.

                   GAOseriously doubts that the act’s objective of keeping borrowers on the
                   farm or ranch will be achieved. First, only half of the delinquent bor-
                   rowers who were notified of the act’s benefits applied for servicing.
                   Second, only one-third of those who qualified for servicing in the 10
                   counties GAOvisited were offered restructuring. Third, slightly over 90
                   percent of those whose debt FmfIA offered to restructure in the counties
                   GAOvisited will remain financially weak after their debt is serviced.



                   Page 2                        GAo/RCED-SO-169
                                                             Agricultural   Credit Act Debt Servicing