Sources of FCA Revenue for FY 1999 - 2003 Revenue Source ASSESSMENT Assessments of Banks, Associations and related entities FY 1999 FY 2000 FY 2001 FY 2002 FY 2003 Proposed Budget $35,009,000 $34,810,000 $33,846,000 $36,057,000 $36,057,000 Meeting Statutory Examination Requirements The Farm Credit Act requires FCA to examine each FCS institution at least once during each 18-month period. Nonetheless, in accordance with our risk-based examination program, we maintain the flexibility to complete examination activities at any time, as needed. Consistent with this philosophy, we have maintained a policy of examining System banks and direct-lender associations with greater than $1 billion in total assets at least once every 12 months because of these institutions' relative importance to the overall financial soundness of the System. FCA conducted 106 examinations in FY 2001, including examinations of 93 FCS direct-lender associations, six Farm Credit Banks, two service corporations, one Agricultural Credit Bank, the FCS Financial Assistance Corporation, Farmer Mac, the FCS Building Association, and the National Consumer Cooperative Bank, which is not an FCS institution. The Small Business Administration (SBA) and the United States Department of Agriculture (USDA) also used FCA's examination expertise in 2001. SBA contracted with FCA to conduct examinations of financial companies licensed by SBA to make guaranteed loans to small businesses. USDA contracted with FCA to conduct examinations of financial companies licensed by USDA to make guaranteed loans under USDA's Business and Industry Guaranteed Loan program. While the safety and soundness of the System remains the primary objective of FCA, we 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 System during that period. 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 FCS 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. Measuring the System's Safety and Soundness The FCA Financial Institution Rating System (FIRS) provides a general framework for collecting and evaluating all significant financial, asset quality, and management factors to assign a composite rating to each institution on a scale of 1 to 5. We evaluate the risk in each bank and direct-lender association at least every 90 days on the basis of quantitative and qualitative benchmarks to ensure that assigned ratings reflect current risk and conditions in the FCS. A 1 rating means an institution is sound in every respect. A 3 rating means an institution displays a combination of financial, management, or compliance weaknesses ranging from moderately severe to unsatisfactory. A 5 rating means there is an extremely high immediate or near-term probability of failure. Throughout FY 2001, FIRS ratings as a whole reflected the stable to improving financial conditions of FCS institutions, and the overall trend in FIRS ratings continued to be overwhelmingly positive. By the end of the second quarter, there were several more 1-rated institutions (69, or 55 percent) than 2- and 3-rated institutions (56, or 45 percent). There was only one 3-rated institution, which had $19 million in total assets at September 30, 2001, which merged with another association on November 1, 2001. The strength of FCS institutions displayed by these ratings reflects a financially safe and sound Farm Credit System, which was achieved in part by government payments that allowed many borrowers to meet debt obligations during a period of low market prices for a number of commodities. The overall financial strength maintained by the System reduces the risk to investors in FCS debt, the Farm Credit System Insurance Corporation, and FCS institution stockholders. Identifying Potential Threats to Safety and Soundness In addition to quarterly FIRS reviews, we use a semiannual financial forecasting model to identify and evaluate prospective risk in institutions over the upcoming 12 to 24 months under "most likely" and "worst case" scenarios, respectively. By evaluating each institution's financial condition and performance under various scenarios, we can identify institutions with emerging risk and the potential for adverse performance. This evaluation enhances our ability to carry out our risk-based supervision program to ensure that the boards of directors of FCS institutions address and correct problems before irreparable harm occurs to an institution's financial |