CoBank Surprises Wall Street

By Marcia Zarley Taylor
DTN Executive Editor

HADDONFIELD, N.J. (DTN) -- A move intended to strengthen the nation's banking system now has some Farm Credit System bond holders fuming.

The Farm Credit System's regulator began efforts to modify capital requirements in 2014 so its cooperative lenders would be more transparent and comparable to commercial banks. The Dodd-Frank Wall Street Reform Act and international Basel III frameworks aimed to strengthen commercial banks, but FCA voluntarily planned to make similar rules effective for the Farm Credit System in 2017.

At issue now is the reaction by Denver-based CoBank, the Farm Credit System's largest bank, to redeem $405 million of subordinated notes sold in April 2008, near the height of the home mortgage crisis.

Unlike huge Wall Street banks at the time, Farm Credit institutions were healthy but their country elevator customers were desperate to meet daily margin calls in unusually wild commodity markets. The system needed capital to boost lending capacity for those urgent loans and was willing to pay a premium to get it.

Repayment of CoBank's 7.875% notes next week would be two years ahead of their full 10-year term, leaving bondholders with few alternatives to replace that kind of rate in today's near-zero-interest climate. On the other hand, farmers, ranchers and farm cooperatives will benefit from the savings by lowering the bank's expenses. Some insiders describe it as a case of winners and losers.

CoBank believes the move is justified because subordinated notes -- a type of unsecured capital that commands a premium in money markets -- will no longer qualify as capital under new leverage ratios announced by FCA in March. Paying a premium for that money no longer makes economic sense.

What's more, CoBank's legal agreement with bondholders allows prepayment in the event of notification of such a regulatory change.

"We believe the redemption is consistent with the terms of the notes and will redeem the notes as previously announced on April 15, 2016. Investors will get paid principal in full and accrued interest to the date of redemption," David Burlage, chief financial officer of CoBank, said in a statement emailed to DTN.

Investors are challenging that decision, saying federal rules have not even been published and won't go into effect until January 2017. They worry the escape clause could set a precedent for other system institutions.

Besides CoBank, St. Paul-based AgriBank has yet to decide if it will retire about $500 million of similar unsecured notes as early as July. It believes the terms of its subordinated notes include a provision making them redeemable following changes to the bank's regulatory capital requirements, it told DTN. AgriBank said it has disclosed anticipated changes to capital requirements in quarterly public financial reports since September 2014.

UNHAPPY INVESTORS

Still, some investors remain unhappy. The system's bondholders include multi-billion-dollar investment management firms and giants like insurance companies. About a dozen investors have issued complaints with FCA. Some creditors who stand to lose money have threatened never to buy another CoBank or Farm Credit System bond again.

Gary Van Meter, FCA's director of the office of regulatory policy, said each Farm Credit institution needs to decide on its own whether to redeem their subordinated notes, based on legal counsel and advice. He agreed subordinated notes cannot qualify as capital under FCA's new leverage ratio standard.

"A point worth considering is in the end, the bank needs investors. But they also have borrowers out there. If they look at the circumstances and feel they can make a decision that it's good for their borrowers, so be it. They can save some money for the farmers and ranchers they serve," Van Meter said.

Van Meter believes all Farm Credit institutions will be able to meet the more rigorous financial standards when they go into effect next year. Basel III was designed to improve the quality and quantity of capital at the world's financial institutions, Van Meter said.

In its annual 2015 report, CoBank reported strong capital, liquidity and loan quality levels. At that time, the bank's permanent capital ratio was 14.95%, compared with the 7% minimum established by FCA. It also announced its 16th straight year of growthin profitability, "an accomplishment unlikely matched by any other financial institution in the world," its CEO Robert Engel said.

Marcia Taylor can be reached at marcia.taylor@dtn.com

Follow Marcia Taylor on Twitter@MarciaZTaylor

(AG/BAS)

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