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believe the continuing use of FCA examination resources by SBA and USDA is a positive reflection on the expertise of FCA examiners and serves to broaden their examination skills while increasing job satisfaction and employee retention.

Differential Supervision and
Enforcement

When an institution is not properly managing its risks or complying with laws and regulations. FCA's goal is to use suitable means to influence the institution's board of directors to adjust its practices. When examiners discover unsafe or unsound conditions or violations of laws or regulations, we communicate the required corrective actions to the institution's board through a Report of Examination (Report). The board then must provide FCA with a written response that addresses how the problems will be corrected, including specific time frames for correction. The number of Reports with required actions during FY 2001 comprised 28 percent of the total issued, compared with 38 percent of the Reports issued during FY 2000 and 66 percent of Reports issued during FY 1999. This declining trend in required actions correlates with the improving risk-bearing capacity of the

We use a three-tiered supervision program (normal, special, and enforcement) to distinguish the risks and special oversight needs of institutions. Institutions under normal supervision are generally performing in a safe and sound manner and in compliance with applicable laws and regulations. These institutions have demonstrated they can correct identified weaknesses in the normal course of business. Nonetheless, our examinations may identify violations of laws or regulations or potentially unsafe or unsound practices that require corrective actions by these institutions. In addition, we regularly recommend to institution boards ways to improve the efficiency or effectiveness of their risk management processes or controls to maintain a financially sound institution. This practice of requiring corrective actions and recommending improvements to processes or controls is critical to our success in supervising regulatory compliance and the safety and soundness of FCS institutions. At fiscal year-end 2001, all FCS institutions, except one with total assets of $19 million, were under normal supervision.

For institutions displaying conditions that are serious but do not necessarily critically impair the safety and soundness of the institution, we increase the concern from normal supervision to special supervision, and our examination oversight increases accordingly. Special supervision gives the institution's board and management the opportunity to correct the problems discovered during the examination or oversight process before irreparable harm occurs to the institution. This process has been successful when the institution's board and management are both willing and able to correct the identified problems. The institution is allowed time to correct identified weaknesses before more rigorous enforcement actions by the Agency become necessary. During FY 2001, only one institution was under special supervision.

When an institution is engaging in unsafe or unsound practices or exhibits characteristics that pose excessive risk to the institution, and the board and management are unable or unwilling to correct identified weakness and violations, a formal enforcement action may be necessary. FCA uses various forms of enforcement authority to ensure that the operations of PCS institutions are safe and sound and comply with laws and regulations. This authority includes the power to enter formal agreements; issue orders to cease and desist, levy civil money penalties; and suspend or remove officers, directors, and any other persons or forbid them from engaging in FCS institutions' affairs. If the FCA Board votes to take an enforcement action, the institution performs under enforcement supervision

and our examiners oversee the institution's performance to ensure compliance with the enforcement action. Throughout FY 2001, no institutions were under enforcement supervision.

On a national level, FCA actively monitors risks that may affect groups of Farm Credit System institutions or even the entire System. These systemic risks cover the agricultural, financial, and economic environment within which System institutions operate. Our job is not to forecast specific events, but to understand the environment well enough so that we can take steps in advance to help System institutions should adverse trends develop. Systemic risks that we will be closely watching include those discussed below.

Decline in the U.S. Economy

The economic slowdown, which began in the United States in late 2000, suddenly accelerated with the terrorist attacks on September 11, 2001. Since then, consumer confidence has declined sharply; retail sales have had the largest falloff in nine years; industrial output has had a nearly unbroken string of monthly declines since September 2000; business investment is off sharply; unemployment is climbing jobless claims are at a nine-year high; and the Federal budget surplus has reportedly disappeared.

The U.S. economy entered into a recession during 2001 with Gross Domestic Product (GDP) expected to shrink during the last two quarters of the year. On the plus side, its appears an aggressive fiscal stimulus by Congress will combine with interest rate cuts by the Federal Reserve to stimulate growth. While growth could return to normal levels by the second or third quarter of 2002, the slump in the economy could be longer lasting. Further downside risk to the forecast would come from another serious terrorist attack on the U.S. or adverse developments in the war on

terrorism.

A declining or even a slowing in the general economy has important implications for rural America and for Farm Credit System borrowers. Only 37 percent of U.S. farmers consider farming as their principal occupation, yet even these farmers (on average) rely on off-farm income for three-quarters of their total income. Rural residents with jobs tied to the travel, tourism, entertainment, and hospitality sectors have been particularly hard hit. Interest and dividend income is also declining. Since off-farm income sources are a significant source of loan repayment for many System borrowers, adverse trends in rural unemployment could lead to increased borrower financial stress.

Farm Income Up Nominally, Costs
Stable

USDA estimates that net cash income
from farming (includes government
payments) could reach $60.8 billion in
2001, up nearly 6 percent from the
previous year and 2.5 percent above the
1993 record. In real dollar terms, however,
cash income in 2001 would actually be
about 11 percent below the 1993 record.
While livestock returns have been strong
through the first half of the year, crop
returns, even though up slightly, remain
weak due to low crop prices and the high
cost of some inputs like fertilizer. In
addition, markets for higher-valued
products like beef, gourmet cheeses, wines,
and nursery products may soften. The
outlook for 2002 could be for lower cash
receipts for both crops and livestock.
particularly if export markets soften
because of the global economic slowdown.

Production expenses are forecast to be fairly stable in 2001, with moderately

New farm legislation to replace the 1996 Farm Bill, which expires at the end of 2002, is currently being debated in Congress. However, prospects for continued large payments to agriculture have recently been lowered because of the effects of the economic slowdown on government revenues as well as the new budget priorities following September 11. Fundamental shifts in program options now being considered will lead to considerable uncertainty, especially for major program crop producers. For lenders,

could mean increased risk of borrower repayment problems and uncertainty regarding land values. Lenders will need to continue to encourage borrowers to use improved risk management strategies, including hedging, crop insurance, and other risk management tools.

Farm Real Estate Values to Hold in 2001 but Could Soften in 2002

The value of U.S. farm real estate, the largest component of farm assets (78 percent), has steadily increased by a total of 27 percent during the past five years. Significant portions of that value are increasingly attributable to two factors: direct government payments and urban influence. Farmland value depends largely on expectations for earnings from farming, government program payments, and non-farm demand. Even in areas of low farm cash receipts, record levels of government payments over the past few years have helped prop up farm real estate values as these payments are capitalized into land values. Farm commodity program payments have the highest effect on land values in the areas where program crops are grown. These areas are in the middle portions of the U.S. where government payments account for between 22 and 24 percent of the market value of farmland, according to a recent study by USDA. The declining health of the urban economy and the recreational industry will have a bigger impact on dampening farm real estate prices in areas where program crops are not grown. Good examples are California and Florida, where land prices in some areas have recently declined because of low returns for certain fruit crops.

Given the anemic outlook for the general

When John Ogonowski and his wife, Peggy, were asked to help with the New Entry Sustainable Farming Project in Lowell, Massachusetts, they quickly became an important part of the program's success. The couple, whose own farming operations were financed by the First Pioneer Farm Credit, ACA, were already active members of that cooperative lending association as well as founders of a local farm preservation trust.

John lent land behind their home to the Cambodian refugees in the project. The couple's farm, White Gate, became the program's first mentor farm, a training site for the immigrants to learn modern agricultural practices. He ploughed and harrowed the land and fertilized it with compost. He excavated a pond and set up an irrigation system to water the fields of the new farmers. He ordered materials and set up a greenhouse so the growers could raise seedlings. And most impor

tantly, he taught his new neighbors the skills and the methods they needed to grow crops and manage their businesses.

John often talked about how much he loved to farm his own 200-acre land, and how wonderful it was to see the 12 Cambodian families he worked with start their own farms and fulfill their own dreams. John was also a pilot for American Airlines. He died when the plane he was piloting, Flight 11 from Boston to Los Angeles, was hijacked by terrorists on September 11 and crashed into the World Trade Center's North Tower. He leaves his wife, three children, and many friends, neighbors, and fellow farmers.