Lenders shocked at lax oversight

Nov 18, 2011
by DTN

Rural bankers and brokers are in no mood for mercy. They are furious with MF Global, the CME Group and federal regulators who allowed the country’s third largest clearinghouse to dip into customer accounts for their own high-risk trades.

Depending on what assets MF Global customers owned in their accounts, they are receiving about 60 percent to 75 percent of their equity now and perhaps more later.

Some of the industry leaders assembled in Indianapolis earlier this month for the Agricultural Bankers Conference and spent days scrambling to find alternative lending for cattle feeders and grain elevators whose MF Global hedging accounts are missing large chunks of their money at the moment.

Due to wide variation in account positions, customers have been paid only 60 percent to 75 percent of the equity in their accounts, depending on whether they had excess funds, were on call, owned Treasury bills or other variables.

The scramble to make up the difference is deadly serious since customers who can’t come up with the balance to keep their margin funds current may be forced to liquidate their positions, leaving them vulnerable to future market swings.

“When you get a commodity statement from your broker every month, you know it’s your money. Everybody knows these are supposed to be segregated, sacred funds,” said Mark Nowak, a senior loan officer with Farmers State Bank in Freeborn, MN. “I’ve talked to a lot of people in the grain industry over the last week, and there’s a sentiment that maybe the CME has been so focused on volume that they haven’t watched their business close enough.”

“Segregated is supposed to mean segregated,” agreed Joe Kessie, Lake City Bank in Warsaw, IN, who also was critical of regulators and the industry for lack of oversight. “Why put more fear into an already volatile market?” Mark Gold, a broker and CEO of Top Third Ag Marketing in Chicago, never traded through MF Global, but was surprised that customer funds could go missing. “I’ve been involved in investments for 35 years. I was always taught that segregated accounts were segregated accounts,” he said.

Gold expects most of the cash from brokerage accounts will ultimately be refunded, maybe about 80 percent. “But 20 percent could be in legal battles for the next three to five years,” he said. “It’s going to get harder to go out into the country and persuade farmers their accounts are safe.

And if someone offers you an off-exchange product, run for the hills. If you think there’s risk in exchange-traded products, wait until you see the risk in off-exchange products. These derivatives are out of hand.”

Gold doesn’t think the situation has stabilized yet. He advised bankers to tell their customers to “have as little extra cash in brokerage accounts as possible.”

The situation could also steer farmers and small traders away from futures contracts, not just for the margin call risk but also from the fiduciary risk. Gold said that’s because exchanges are saying they will protect nothing above and beyond marginable positions on futures, so anyone trading with futures contracts or marginable positions is at risk.

Grain industry leaders contacted by DTN believe the debacle will permanently change hedging practices in agriculture if the CME system isn’t changed. “Lenders are discovering that the ‘rock solid’ protection they’ve thought they had for funding margin calls is suddenly not there,” said Diana Klemme, a broker for Midwest grain elevators who serves on the National Grain and Feed Association risk management committee.

Klemme said the transfers from bankrupt MF Global are continuing and it’s a monumental process. “The money being sent now is 75 percent of the maintenance margin requirement based on the open positions held, and using futures prices on the date of the transfer. There were some issues with Kansas City wheat and Minneapolis wheat, “but apparently proportional money from those exchanges will be forthcoming,” she said.

When the transfers to new clearinghouses are complete, Klemme believes the next phase will be for all parties— from farmers to lenders to elevators to regulators—“to consider alternate ways to truly segregate customer funds to maintain confidence in the system.”

If that doesn’t happen, banker Nowak thinks farmers could be left with only spot markets and few forward contracting choices.

“Agricultural price protection could get washed out along with MF Global,” he said. — DTN