The government agency that guarantees loans to farmers is tightening the guidelines on the interest rates that may be charged, because the current policy is so vague that it has exposed lenders to lawsuits.
But while banking industry officials applaud the attempt, they say that what the Farm Service Agency has proposed — tying the rates to national benchmarks — is too rigid, especially for rural lenders.
"If you're a small rural bank, your cost of funds may have nothing to do with what Wall Street says is prime," said John Blanchfield, senior vice president of the American Bankers Association's Center for Agricultural and Rural Banking. "There is a risk that small banks won't be able to price at that price."
As it stands, the only guideline lenders must follow when using the government guarantee is that they may not charge more than they would their "average agricultural loan customer" — in other words, a customer whose loan is not guaranteed.
The problem, lenders say, is that the term "average agricultural loan customer" is unclear and opens them up to accusations that they are overcharging.
The proposed rule, published in the Federal Register on Sept. 30, calls for interest rates on short-term operating loans to be capped at 250 basis points above the prime rate at the time the loan is written. Real estate loans would be capped at 350 basis points above the 10-year Treasury note rate. Lenders with a formal risk-based model for pricing could continue to use that system.
In the proposed rule, the Farm Service Agency, an arm of the Agriculture Department, said it is seeking to "simplify compliance."
Bob Bonnet, the agency's chief of guaranteed lending, said the proposal lines up with historical rates on guaranteed loans. The average rate on long-term loans since 1999 was 291 basis points above the 10-year Treasury, while the short-term average for the same period was 195 basis points above prime.
Mike Jorgensen, the president of the $40 million-asset Nebraska State Bank in Oshkosh, said he sees the value in using the benchmarks as a base for pricing, but has a problem with the caps. His concern "deals with fluctuation in yield curves and the availability to book or sell loans into the secondary market," Mr. Jorgensen said in a comment letter to the agency last week.
The caps would leave "little or no margin" on selling short-term loans on the secondary market, while long-term loans could potentially sell at a loss, he wrote.
Mark Scanlan, director of the Independent Community Bankers of America's office of agriculture and rural policy, said the current volatility of the credit markets makes bankers "queasy about having their rates capped." He added that farm lending is not "cookie cutter," so a rule based on averages does not take into account "the variability between customer needs and characteristics."
The rule's ambiguity helped pave the way for qui tam lawsuits, cases filed by private citizens on behalf of the government, that claim lenders did not provide a rate that reflected the benefit they were receiving from the guarantee. The precedent was set in a 2004 case where a farmer turned lawyer sued his former lender, Gold Banc Corp. Inc. of Leawood, Kan. That case was settled for $16 million. Similar suits were settled in Oklahoma in 2006 and 2007.
Lenders have since cautiously set their rates, out of fear of litigation, Mr. Blanchfield said.
In an interview, Mr. Jorgensen said: "The problem is that even if lenders are doing it correctly, that doesn't preclude an attorney from filing a class-action lawsuit against a bank. A bank could potentially spend a sizable amount defending itself."
Mr. Blanchfield said that while the rule has caused some bankers to be more cautious, it "is a significant loan program that has worked extremely well."
In fiscal 2008 lenders originated 8,900 Farm Service Agency loans, for total of $2.25 billion.
The ABA and the ICBA are still drafting their official recommendations, but both organizations prefer tying rates to the market conditions of an area. They also said the rule change is particularly pressing because guaranteed loan demand is expected to rise as commodity prices have fallen and the national economy faces a grim 2009.
Mr. Bonnet said the agency has received about 20 responses to the proposed rule. The comment deadline is Dec. 1.
