04-17046. Guaranteed Loans-Rescheduling Terms and Loan Subordinations

AGENCY:

Farm Service Agency, USDA.

ACTION:

Final rule.

SUMMARY:

The Farm Service Agency (FSA) is amending its regulations governing servicing of loans made under the guaranteed farm loan program. FSA is making these changes as a result of input from program participants and problems in the administration of current provisions. This rule will allow loans to be rescheduled with balloon payments under certain circumstances and allow the approval of certain low-risk subordinations at the field office level instead of the National Office. It will also allow lenders to make debt installment payments in accordance with lien priorities, payment due dates, and clarify that packager and consultant fees for servicing of guaranteed loans are not covered by the guarantee.

DATES:

This rule is effective August 26, 2004.

FOR FURTHER INFORMATION CONTACT:

Joseph Pruss, Senior Loan Officer, Farm Service Agency; telephone: [phone]; Facsimile: [phone]; e-mail: [e-mail].

SUPPLEMENTARY INFORMATION:

Background

FSA published a proposed rule on August 19, 2003, (68 FR 49723-49726) to amend its regulations governing the servicing of loans made under the guaranteed farm loan program. The comment period ended October 20, 2003.

Summary of Public Comments

Comments addressed all of the issues related to the proposed rule. FSA considered the comments and incorporates several of the recommendations and suggestions in this rule. The following is a review of the comments and the changes made in the final rule in response to the comments.

Payment of Loan Installments

FSA proposed to allow loan installments to be paid in accordance with lien priority, due date and cash flow projection in the normal course of business, but when it became evident that the borrower would be unable to make all installments, the lender had to apply payments to the guaranteed loan first. One respondent suggested that the proposal was too subjective and the Agency should adopt a policy that would require loans to be paid according to lien priority, and any exceptions would require Agency approval. The respondent also pointed out that the risk of guaranteed loans not being paid in an orderly manner is not only at liquidation and that the determination of when guaranteed loan payments would be required to be made first was extremely subjective. Two respondents generally agreed with the proposal, but one pointed out, however, that the risk to the government is not only at liquidation and questioned whether the proposal would work in practice. One respondent believed the rule should specify that a lender must apply payments to the loan as the borrower specified. Another respondent stated that the normal course of business rule should be expanded to include all situations.

The Agency agrees that the proposal was too subjective and that loan installments should be paid in lien priority in certain cases while understanding that exceptions are required so that lenders can conduct routine business practices. As a result, the agency will require a lender to pay loan installments in the order of lien priority only when the lender receives a payment from the sale of encumbered property. This policy is consistent with current practice under state laws. In other situations, where payment is received from the sale of unencumbered property or other sources of income, loan installments will be paid in order of their due date. This is consistent with typical routine business practices. This objective and simple policy should be consistently carried out by lenders. Any deviations will require Agency approval.

Regarding the comment that would allow the borrower to tell the lender which loan a payment should be applied to, the Agency has always maintained that the lender/borrower relationship is not something the Agency should interfere in, as the Agency has no authority or inclination to specify that a lender has to apply payments to whichever loan their borrower chooses. Based on the comments received, which were generally supportive, the Agency will implement the proposed change as modified.

Approval of Subordinations

FSA proposed to place authority for subordination approval at the local level when the lender is refinancing existing debt secured by a lien superior to the guaranteed loan and no additional debt is being incurred. Two respondents supported the proposal, but suggested that the Agency allow additional subordinations to be approved at the local and State level. The proposal was fully supported by four respondents.

The Agency will not adopt additional changes to allow all subordinations of guaranteed loans to be approved at local and State levels. Subordinating guaranteed loan security is rarely in the Government's best interest and, therefore, it is necessary for top level management to be informed of all requests where additional debt is being incurred by guaranteed borrowers. Based on the unanimous support of the other respondents, the Agency adopts its proposed policy on subordinations as final.

Payment of Interest on Repurchased Loans

FSA proposed to correct wording concerning interest payments to specify that the holder, not the lender, would request Agency repurchase of the loan after unsuccessfully requesting the lender to do so. Two comments were received regarding this change. One supported the change, while the other acknowledged that it is simply a correction in wording. The present language has the words “lender” and “holder” reversed, and the change will correct the error. The proposed correction is adopted in the final rule as a result of the comments received.

Balloon Payments

The proposal to allow balloon payments in restructuring guaranteed loans generated several comments, mostly positive. One respondent was opposed to all balloon payments, and viewed them as a way to guarantee nonpayment of the loan. Another respondent generally supported the proposal but did not believe it was necessary to have an appraisal showing the loan would be secured when the balloon payment was due. This respondent also suggested that the Agency set a minimum number of years before the balloon payment comes due and that a lien on all assets be taken when restructuring with balloon payments. One respondent supported the proposal but was concerned that lenders use of appraisals would vary widely. One respondent wondered if lenders, at the time of the restructuring, would have to develop a positive cash flow projection for the time when the balloon payment came due and noted that foundation livestock herds were not specifically discussed.

Three respondents fully supported the proposal. Another respondent also supported the proposal, but recommended that the appraisal requirement should only apply to loans with an unequal or graduating amortization, which would be more risky to the Agency.

The Agency believes the balloon payment option is a necessary tool that lenders can use to salvage operations that would otherwise be liquidated. With the proper controls in place, this servicing option can be very beneficial to users of the guaranteed loan program. In response to concerns regarding lenders conducting a wide range of appraisals, FSA has added more direction in §762.145(b)(4). The paragraph explains that the projected value for real estate will be derived from a current appraisal adjusted for depreciation of depreciable property such as buildings and other improvements that occurs until the balloon payment is due. A current appraisal is required for equipment security. The lender will project the value of the equipment at the time the balloon payment is due based on the remaining life of the equipment or the depreciation schedule on the borrower's Federal income tax return. The Agency does not agree that appraisals are not necessary, or should be required only when there is unequal or graduating amortization. An appraisal will always be necessary when restructuring with a balloon payment in order to provide some assurance that there is adequate security for the debt. Lenders, however, will not have to develop long-term cash flow projections as the volatility of the agricultural sector and changing nature of individual farming operations often render long-term projections meaningless.

Foundation livestock was not mentioned in the proposed rule because balloon payments for guaranteed loans secured by livestock or crops alone will not be authorized. Unlike real estate and equipment, livestock and crops are perishable, and balloon payments on such operations are extremely risky.

The Agency does agree with the suggestion that it should set a minimum number of years before the balloon payment comes due, the time depending on the type of loan being restructured. Therefore, § 762.145 provides that balloon payments for loans secured by real estate will have a minimum of 5 years before the balloon comes due. For other loans, there will be minimum of 3 years. If statutory term limits prevent such terms, balloon payments will not be used. As suggested, to further protect the Government's interest when a balloon payment is set up, a lien on all assets will be required.

Revised Security Requirements for Loans Rescheduled With Balloon Payments

FSA proposed to require loans restructured with balloon payments to be fully secured when the balloon payment became due. Three comments were received addressing the issue of security requirements. One respondent agreed with the requirements, but believes they should be more specific as to how a lender is to arrive at the value of the security used to protect the balloon installment. Two respondents fully supported the proposal, while one questioned if Preferred Lender Program lenders would be allowed to use their in-house appraisals to support the fully secured claim.

Additional guidance has been provided on appraisal values as discussed above. Current Agency policy on lenders not being allowed to use in-house real estate appraisals will not change. The potential for conflict of interest is too great to entertain such a proposal.

Payment of Packager and Outside Consultant Fees

Five comments, all positive, were received regarding the proposed clarification that packager fees and outside consultant fees for servicing are not covered by the guarantee. One respondent believed the Agency should allow for the payment of in-house fees. The respondent stated that inside legal counsel may have knowledge of cases, which could actually make the process more efficient, thereby saving on legal expenses. Two respondents support the proposal, but believe it should be clarified to state that the costs also cannot be passed on to the borrower.

No changes will be made in the final rule as a result of these comments. The Agency agrees in theory that inside legal counsel's knowledge of individual cases may lead to greater efficiency, and the intent of the regulation is that, if available, this counsel may be used by the lender. However, the guarantee was never intended to cover costs incurred by employees of the lender, including staff legal counsel. The Agency disagrees that it should regulate what fees lenders can pass on to their customers. It is not the mandate of the Agency to dictate terms between lenders and their customers. However, neither is the guarantee intended to cover lender labor costs for services the lender agreed to perform when obtaining the guarantee. Therefore, the Agency will not cover these costs when passed on to the lender's borrower as part of any loss claim.

Lender Bids at Foreclosure Sales

The proposal to specify the amount a lender will bid at foreclosure sales generated numerous comments. FSA proposed that the lender's bid would be the lesser of the net recovery value plus the prior lien amount, and the unpaid balance of the loan plus the prior lien amount. One respondent fully supported the proposal and believes it is good business practice and is consistent with what is done for the Agency's direct loans.

Two respondents were in favor of the proposal, but believe it should be strengthened by stating that the limits are actual limits and lenders will not be able to claim losses due to excess bids. They stated that, as written, there are too many maybes, and the wording should state that loss claims will be reduced, not that they may be reduced due to improper bidding. One comment suggested that the proposed change would not always lead to the result that was anticipated. It was pointed out that a bid is sometimes made subject to a prior lien, in which case the lender would not want to bid the net recovery value. It was also pointed out that the proposal does not contain a definition of net recovery value, which could lead to confusion. The definition of net recovery value is included among the definitions in 7 CFR 762.102.

One respondent requested that the Agency reconsider the proposal. The respondent believes the lender knows best the individual circumstances of each loan and could best determine the amount they should bid and that the proposal could actually have the opposite result of what is intended. Also, since several states have their own unique laws regarding foreclosures, redemption, and time periods which a lender must consider, the proposal would possibly hamper the lender's liquidation of the account.

Another respondent also believes the proposal is too restrictive and limits the flexibility provided by the current regulations. The respondent provided several examples of situations where bidding as proposed may not be in the best interest of the lender, the Government, or the borrower, and may lead to a borrower losing their right of first refusal. The respondent recommended that the final rule give the creditor the option to bid net recovery value, appraised value, or investment, whichever is the most advantageous in the particular circumstance, as approved by the Agency's State Office. If a prior lien has a very low interest rate, it would not make sense to require the lender to pay that debt off when acquiring the property, especially if there is a redemption period involved. Also, in some states, it is very difficult to obtain a deficiency judgment, and bidding the net recovery value or appraised value has not been a common practice.

After considering the comments received, the Agency has determined that it will remove the proposal regarding bidding at foreclosure sales. No changes will be made to the current language in 7 CFR 762.149 regarding this item. In the vast majority of cases, lenders make reasonable bids at foreclosure sales, and it is a rare occurrence when a lender makes an inaccurate bid, leading to a large increase in loss to the lender upon final disposition of the collateral. In those cases, the Agency will continue to use the option to reduce or completely deny loss claims as necessary and appropriate. Differences in state laws regarding foreclosure proceedings, redemption laws, and obtaining deficiency judgments make it difficult to cover all possible scenarios in one rule. It would also reduce a lender's options and flexibility in servicing loans.

Executive Order 12866

This rule has been determined to be not significant and was not reviewed by the Office of Management and Budget under Executive Order 12866.

Regulatory Flexibility Act

The Agency certifies that this rule will not have a significant economic effect on a substantial number of small entities because it does not require any specific actions on the part of the borrower or the lenders. The Agency, therefore, is not required to perform a Regulatory Flexibility Analysis as required by the Regulatory Flexibility Act, Public Law 96-534, as amended (5 U.S.C. 601). This rule does not impact small entities to a greater extent than large entities.

Environmental Evaluation

The environmental impacts of this final rule have been considered in accordance with the provisions of the National Environmental Policy Act of 1969 (NEPA), 42 U.S.C. 4321 et seq., the regulations of the Council on Environmental Quality (40 CFR parts 1500-1508), and the FSA regulations for compliance with NEPA, 7 CFR part 1940, subpart G. FSA concluded that the rule does not require preparation of an environmental assessment or Environmental Impact Statement.

Executive Order 12988

This rule has been reviewed in accordance with E.O. 12988, Civil Justice Reform. In accordance with that Executive Order: (1) All State and local laws and regulations that are in conflict with this rule will be preempted; (2) no retroactive effect will be given to this rule except that lender servicing under this rule will apply to loans guaranteed prior to the effective date of the rule; and (3) administrative proceedings in accordance with 7 CFR part 11 must be exhausted before requesting judicial review.

Executive Order 12372

For reasons contained in the Notice related to 7 CFR part 3015, subpart V (48 FR 29115, June 24, 1983) the programs and activities within this rule are excluded from the scope of Executive Order 12372, which requires intergovernmental consultation with state and local officials.

Unfunded Mandates

This rule contains no Federal mandates, as defined by title II of Unfunded Mandates Reform Act of 1995 (UMRA), Public Law 104-4, for State, local, and tribal governments or the private sector. Therefore, this rule is not subject to the requirements of sections 202 and 205 of UMRA.

Executive Order 13132

The policies contained in this rule do not have any substantial direct effect on states, on the relationship between the national government and the states, or on the distribution of power and responsibilities among the various levels of government. Nor does this rule impose substantial direct compliance costs on state and local governments. Therefore, consultation with the states is not required.

Paperwork Reduction Act

The amendments to 7 CFR part 762 contained in this rule require no revisions to the information collection requirements that were previously approved by OMB under control number 0560-0155.

Federal Assistance Programs

These changes affect the following FSA programs as listed in the Catalog of Federal Domestic Assistance: 10.406 Farm Operating Loans; 10.407 Farm Ownership Loans.

List of Subjects in 7 CFR part 762

• General—Agriculture
• Loan programs—Agriculture

Accordingly, 7 CFR is amended as follows:

PART 762—GUARANTEED FARM LOANS

1. The authority citation for part 762 continues to read as follows:

Authority: 5 U.S.C. 301; 7 U.S.C. 1989.

2. Amend § 762.140 by revising paragraph (d) to read as follows:

§ 762.140

General servicing responsibilities.

* * * * *

(d) Loan installments. When a lender receives a payment from the sale of encumbered property, loan installments will be paid in the order of lien priority. When a payment is received from the sale of unencumbered property or other sources of income, loan installments will be paid in order of their due date. Agency approval is required for any other proposed payment plans.

* * * * *

3. Amend § 762.142 by redesignating paragraph (c)(3)(ii) as (c)(3)(iii) and adding new paragraph (c)(3)(ii) to read as follows:

§ 762.142

Servicing related to collateral.

* * * * *

(c) * * *

(3) * * *

(ii) The lender may, with written Agency approval, subordinate its interest in basic security in cases where the subordination is required to allow another lender to refinance an existing prior lien, no additional debt is being incurred, and the lender's security position will not be adversely affected by the subordination.

* * * * *

4. Amend §762.144 by revising paragraph (c)(3)(iii) to read as follows:

§ 762.144

Repurchase of guaranteed portion from a secondary market holder.

* * * * *

(c) * * *

(3) * * *

(iii) In the case of a request for Agency purchase, the Agency will only pay interest that accrues for up to 90 days from the date of the demand letter to the lender requesting the repurchase. However, if the holder requested repurchase from the Agency within 60 days of the request to the lender and for any reason not attributable to the holder and the lender, the Agency cannot make payment within 30 days of the holder's demand to the Agency, the holder will be entitled to interest to the date of payment.

* * * * *

5. Amend § 762.145 by revising paragraphs (b)(4) and (b)(7) to read as follows:

§ 762.145

Restructuring guaranteed loans.

* * * * *

(b) * * *

(4) Loans secured by real estate and/or equipment can be restructured using a balloon payment, equal installments, or unequal installments. Under no circumstances may livestock or crops alone be used as security for a loan to be rescheduled using a balloon payment. If a balloon payment is used, the projected value of the real estate and/or equipment security must indicate that the loan will be fully secured when the balloon payment becomes due. The projected value will be derived from a current appraisal adjusted for depreciation of depreciable property, such as buildings and other improvements, that occurs until the balloon payment is due. For equipment security, a current appraisal is required. The lender is required to project the security value of the equipment at the time the balloon payment is due based on the remaining life of the equipment, or the depreciation schedule on the borrower's Federal income tax return. Loans restructured with a balloon payment that are secured by real estate will have a minimum term of 5 years, and other loans will have a minimum term of 3 years before the scheduled balloon payment. If statutory limits on terms of loans prevent the minimum terms, balloon payments may not be used. If the loan is rescheduled with unequal installments, a feasible plan, as defined in § 762.102(b), must be projected for when installments are scheduled to increase.

* * * * *

(7) The lender's security position will not be adversely affected because of the restructuring. New security instruments may be taken if needed, but a loan does not have to be fully secured in order to be restructured, unless it is restructured with a balloon payment. When a loan is restructured using a balloon payment the lender must take a lien on all assets and project the loan to be fully secured at the time the balloon payment becomes due, in accordance with paragraph (b)(4) of this section.

* * * * *

6. Amend § 762.149 by adding paragraph (d)(3), and amending paragraph (i)(2) by adding a new last sentence to read as follows:

§ 762.149

Liquidation.

* * * * *

(d) * * *

(3) Packager fees and outside consultant fees for servicing of guaranteed loans are not covered by the guarantee, and will not be paid in an estimated loss claim.

* * * * *

(i) * * *

(2) * * * Packager fees and outside consultant fees for servicing of guaranteed loans are not covered by the guarantee, and will not be paid in a final loss claim.

* * * * *

Signed at Washington, DC, on July 2, 2004.

James R. Little,

Administrator, Farm Service Agency.