Farm Service Agency Continues Close Scrutiny of Loans to Contract Poultry and Hog Producers
May 3rd, 2012
USDA’s Farm Service Agency (FSA) provides guaranteed loans and direct loans to farmers for the purchase or operation of their farms. FSA can provide lenders with a guarantee of up to 95 percent of the loss of principal and interest on a guaranteed loan. FSA has a duty, both to the public and to farmers receiving the loans, to ensure that the risks of making these loans are manageable and that the farmers who receive the loans have a reasonable opportunity to repay them.
In recent years, FSA has increased its scrutiny of loans to poultry and hog producers who raise their animals in vertically integrated systems under production contracts with poultry processors or meatpackers. FSA realized that the integrators in these systems could control and manipulate the conditions under which these producers operate and put them at risk of defaulting on FSA loans.
In 2009, FSA issued a Notice to its state and country offices requiring that staff look more closely at the business plans submitted by poultry contract growers to assess whether the performance assumptions in a plan are realistic in light of the ability of poultry integrators to manipulate a grower’s operation. The Notice stated that when a producer’s business plan depends on income from other sources in addition to income from land owned by the producer, the producer’s income must be dependable and likely to continue.
FSA found that, especially for new loan applicants, a contract with a poultry integrator that guaranteed only a single flock – a flock-to-flock arrangement – was not dependable. The agency determined that for a poultry production contract with a new applicant to be considered dependable, the contract must:
- be for a minimum period of 3 years;
- provide for termination based on an objective “for cause” criteria only;
- require that the grower be notified of specific reasons for cancellation; and
- specify a minimum number of flock placements per year.
In 2010, USDA expanded the guidance to cover loans to hog contract producers. In a November 2010 Notice, the FSA also provided an additional requirement for loans to poultry and hog producers – that the production contract “provide assurance of the producer’s opportunity to generate enough income to develop a cash flow budget and repay the loan.” The assurance is required to be stated in the contract, which must incorporate requirements, such as minimum number of poultry flocks or hog “turns” per year, minimum number of bird or hog placements per year, or similar quantifiable requirements.”
In April 2012, FSA issued an Amendment to the Handbook for the Farm Loan Program that reaffirmed the guidance on loans to contract poultry and hog producers. The Amendment also extended the guidance to loan applicants requesting funding to expand their poultry or hog operation by adding more houses or barns or buying more land to increase the size of the operations. The production contract must at least cover the facilities financed with guaranteed funds.
USDA’s concerns about the dependability and continuation of the income of contract producers are valid. In the 2011 Packers and Stockyards Annual Report released in March 2012, the Packers and Stockyards Administration concluded that poultry growers are particularly susceptible to extraction of income by integrators after the contract is executed. Poultry growers and hog growers can be trapped in a contract by high rates of investment in their facilities and low rates of compensation in the production contract. This gives integrators the opportunity to extract even more wealth by requiring upgrades to houses and barns after the contract is signed.
The PSA Report estimated that poultry growers are losing equity at a rate exceeding the loss of equity due to inflation. Based on a per farm asset value for 2009 of $624,047, the gap on earnings to inflation represents an annual loss on equity of $16,903 per farm. The median return on equity from USDA Economic Research Service data for growers that were earning 90 percent of more their gross income from production contracts is negative (-0.509) when averaged over the 7 years from 2003 to 2009.
USDA is to be commended for continuing its policy of requiring that poultry and hog contracts must demonstrate dependability and likely continuation before providing farm program loans to producers. But much more must be done to ensure that all poultry and livestock farmers, both those with production contracts and independent producers, receive a fair return on their investments.
The Grain Inspection Packers & Stockyards Administration (GIPSA) regulation issued in November 2011 made some improvements. Congress, however, blocked additional improvements via a legislative rider on the agricultural appropriations bill last year. The Senate appropriations bill past last week removes that rider, but action now turns to the House, where action on agricultural appropriations for FY 2013 is expected in the next month. NSAC urges Congress to cease blocking implementation of the comprehensive GIPSA regulation required under the 2008 Farm Bill. Continuation of the rider, among other things, will put taxpayers on the line to bail out loans benefiting the integrators.