Natural Resources Conservation Service Wetlands Reserve Program Compensation for Easements

1. Natural Resources Conservation Service Wetlands Reserve ProgramCompensation for Easements Presenter: Donna Smith, Senior Auditor, USDA OIG

2. WRP Program - Background • WRP has been managed by NRCS since 1995. During the time NRCS has managed WRP, the program has expanded from a nine-State pilot program limited to a mere 50,000 easement acres, to a nationwide easement acquisition effort involving more than a million of acres of land. • At the end of fiscal year 2003, WRP had a total enrollment level of 1,470,998 acres on 7,831 projects. • Approximately 80 percent of these acres were subject to permanent easements; 14 percent were 30-year easements; and 6 percent were cost-share agreements.

3. WRP Program - Background • In the case of WRP conservation easements, landowners reserve five specific rights: • title, • quiet enjoyment, • control of access, • subsurface resources, and • recreational uses such as hunting and fishing, and the leasing of these rights for economic gain

4. Why OIG Did This Audit • A 2003 OIG survey of the WRP in two States (CA and FL) identified potential issues with the agency’s WRP easement valuation process. • OIG met with NRCS NHQ staff and it was decided that the a two State survey was too limited in scope to reach conclusions about WRP easement valuations for the program as a whole. • A nationwide audit of the WRP easement valuation process was initiated.

5. Sites Visited We performed fieldwork at: • NRCS National Headquarters in Washington, D.C. • NRCS State Offices in California, Minnesota, and Iowa • Conducted phone interviews with NRCS staff at 10 State offices: Arkansas, Illinois, Indiana, Florida, Louisiana, Michigan, Missouri, Mississippi, Washington, and Wisconsin • The 13 States visited or contacted represented about 72 percent of all WRP easement acquisition funds for fiscal years 1999-2003.

6. People Interviewed • NRCS NHQ Staff • OGC’s Deputy Assistant General Counsel • NRCS staff at 13 State offices and 21 district offices • 18 NRCS contract appraisers working in 13 States • Valuation experts at the FS, DOI, & State Agencies • FSA staff at the National, State, and county office levels concerning treatment of crop base on WRP easement lands

7. OIG Findings • NRCS needed better controls over the easement appraisal process. • WRP easement payments appeared to exceed the statutory payment cap. • Federally-purchased crop base wasn’t being retired. • Landowners continued to receive FSA farm subsidy payments for easement encumbered lands.

8. Finding No. 1 NRCS Needed Better Appraisal Controls NRCS spent more than $1 billion since 1995 acquiring WRP easements, and processed more than 7,000 appraisal reports, yet the Agency lacked: • Staff qualified to oversee the appraisal function • Clear appraisal policies and procedures • An effective internal review process

9. Control Problem #1 NRCS Needed Staff Qualified to Oversee the Appraisal Function • NRCS had no chief appraiser to develop and oversee the agency’s WRP easement valuation procedures and practices. • NRCS had no staff appraisers needed to determine whether contracted appraisal reports estimated values that were appropriate and properly supported and done in compliance with required appraisal methods and techniques.

10. Consequences: • The WRP easement valuation methodology developed by the agency did not appear to comply with the authorizing statue’s compensation directions. • Contract appraisers in all 13 reviewed States routinely included “non-agricultural” rights (i.e. development, recreation, water, or mineral rights) in WRP easement estimates even though NRCS appraisal instructions directed exclusion of such values. • Contract appraisers in 10 of the 13 reviewed States included the value of crop base in WRP easement compensation estimates, even though doing so was contrary to NRCS policy.

11. Control Problem #2Lack of Clear Appraisal Policies and Procedures • The WRP manual did not sufficiently describe the function and timing of technical appraisal reviews and how NRCS staff should respond to them. Consequences: Technical appraisal reviews were often done after NRCS had already paid the landowner, were conducted by appraisers who weren’t properly qualified, and noted problems weren’t necessarily corrected.

12. Lack of Clear Appraisal Policies and Procedures • The manual did not include directions for updating appraised values when easement acres changed. Consequences: NRCS staff adjusted easement acres, sometimes significantly, without making sure the substituted lands had the same value as the acres originally appraised.

13. Lack of Clear Appraisal Policies and Procedures • The manual did not emphasize the mandatory nature of the easement appraisal instructions. Consequences: Some staff considered the appraisal instructions to be a general guide they could modify to meet their needs without getting NHQ approval. Two of these State offices had created appraisal instructions that differed from the instructions in the WRP manual.

14. Control Problem #3NRCS Lacked An Effective Internal Review Process • NRCS did not have an adequate process for conducting internal reviews to assess WRP easement valuation controls and to follow-up on previously identified weaknesses. • Specifically, NRCS Oversight and Evaluation reviews did not evaluate WRP appraisal practices because staff did not possess the required expertise to conduct such assessments.

15. NRCS Lacked An Effective Internal Review Process Consequences: • Even though O&E staff performed six WRP reviews from 1999 – 2005, none addressed the operation and effectiveness of the program’s appraisal policies and procedures. • Even a 2004 review, conducted specifically to identify the cause of increasing WRP easement values, did not include an assessment of the appraisal process.

16. Appraisal Control Recommendations • Create and fill a Chief Appraiser position to serve as NRCS’ real property valuation expert • Improve the accuracy and reliability of WRP easement valuations by developing a technical appraisal review process to be completed by qualified review appraisers • Modify and strengthen existing written easement valuation direction • Establish procedures for conducting periodic internal reviews specifically designed to assess the adequacy and operation of prescribed WRP easement valuation controls

17. Easement Valuations

18. Finding No. 2 WRP Easement Compensation • The WRP statute specified that easement compensation could not exceed the FMV of the land before the easement less the FMV of the land after the easement (the residual value). • This “before and after” valuation methodology has long been held by Federal courts as the best measure of easement compensation. • We found that NRCS’ easement compensation methodology appeared to exceed WRP statutory payment limits.

19. NRCS Developed Alternate Valuation Methodology Rather than using the “before and after” valuation methodology referenced in the statute, NRCS adopted a process in which landowner compensation for permanent WRP easements equaled the lesser of: • Fee simple “agricultural only” values • geographic area rates (when applicable) • the landowner’s offer

20. Valuation Problem #1Easement Appraisals Did Not Reflect “Agricultural Only” Values • NRCS believed that since WRP easement appraisals were based on “agricultural only” values and the WRP easement prevented future agricultural use of the land, there was no residual value to deduct from the appraisals. • We found, however, that the majority of WRP easement appraisals represented the same FMV a typical buyer would expect to pay for the unencumbered property rather than the discounted “agricultural only” values NRCS believed it was paying.

21. Valuation Problem #2Residual Values • NRCS considered residual values associated with landowners’ reserved rights too speculativeto recognize in easement appraisals because there was no guarantee that WRP lands would forever remain suitable for hunting purposes.

22. Residual Values • We determined that NRCS’ assumption of zero residual value was incorrect because recreational and hunting uses on WRP easement- encumbered lands, and any income associated with such uses, was reasonably probable and thus recognizable in the appraisal process. • Buyers demonstrated this knowledge when they purchased WRP easement-encumbered lands for various amounts. • NRCS State offices also recognized the reasonable probability of future recreation and hunting income on their websites.

23. WRP Lands Had Residual Value • 17 of the 18 NRCS contract appraisers we interviewed said lands encumbered by WRP easements generally retained residual values related to private and leased hunting opportunities, personal recreation, and the inherent value of land ownership. • These NRCS contract appraisers, responsible for WRP easement valuations in 12 of the 13 reviewed States, estimated typical residual values of WRP easement-encumbered lands ranged from $200/acre to $2,500/acre.

24. WRP Lands Had Residual Value • To supplement and verify the accuracy of these contract appraiser interviews, we asked these and other appraisers at the Federal, State, and county levels to provide examples of actual WRP easement sales. • The appraisers provided documentation of 114 sales of WRP easement-encumbered lands, representing transactions in 8 of the 13 sampled States. • Residual values in these documented sales ranged from $60/acre to $3,600/acre.

25. WRP Lands Had Residual Value • We were also able to identify the residual values of easement-encumbered lands for 14 of the 37 WRP easement transactions we reviewed at the California, Minnesota, and Iowa NRCS State Offices. • Residual values for these 14 WRP easement-encumbered properties ranged from $125/acre to $1,500/acre, or 8 percent to 53 percent of the amount NRCS had originally paid the landowners. • In 12 of those transactions, residual values were estimated within weeks of the NRCS fee simple purchase. In the other cases, residual values were established during that same FY when the properties were sold subject to the WRP easements.

26. Problem #3 Cost to Do “After” Appraisals • NRCS’ alternate easement valuation methodology was predicated, in part, on the agency’s desire to avoid the time and expense of conducting two appraisals for every WRP easement. • NRCS was concerned that requiring “before and after” land values for every WRP easement would significantly increase program delivery costs.

27. Cost to Do “After” Appraisals Was Negligible • NRCS contract appraisers estimated that completing “after” appraisals to identify residual values would increase their fee by about 50 percent. • Using appraisal costs provided by NRCS staff and contract appraisers, we estimated NRCS would have spent an additional $1 million during fiscal years 1999–2003 to obtain appraisals quantifying residual values. • This amount equates to about one-tenth of 1 percent of the $724 million the 13 States spent acquiring WRP easements during that same period.

28. Problem #4 Payments Based on Area Rates Did Not Ensure Statute Compliance NRCS thought that the agency’s decision not to recognize residual values during the WRP easement appraisal process might not necessarily equate to excess landowner compensation because the majority of landowner offers were based on geographic area rates that limited landowner compensation to less than the easement’s FMV, and that these “discounted values” eliminated any excess payments arising from ignored residual values.

29. Payments Based on Area Rates Did Not Ensure Statute Compliance • First, State offices have the discretion to create, modify, or discontinue the use of geographic area rates at any time. Some States don’t use such rates at all. • Also, geographic area rates are not designed to be less than or equal to the FMV of the easement. Geographic rates simply represent per acre values above which NRCS is not willing to pay.

30. Payments Based on Area Rates Did Not Ensure Statute Compliance • Second, a significant majority of easement payments (about 75 percent of those in the 13 reviewed States) were based on appraised values that fell below the established geographic area rates.

31. Payments Based on Area Rates Did Not Ensure Statute Compliance • Third, even landowner compensation based on geographic area rates can be overstated when residual values are ignored. • For example, suppose a parcel has a fee simple agricultural FMV of $1,000/acre, but the landowner is paid only $800/acre based on the geographic area rate established by that particular State. • If the property has a residual value greater then $200/acre, the landowner has been overpaid.

32. Consequences of Not Recognizing Residual Values • NRCS’ alternate easement valuation process appeared to exceed the statute’s payment limits and potentially misstated landowner compensation. • Using value estimates provided by NRCS contract appraisers, we estimated that NRCS might have saved the program at least $159 million from 1999 to 2003 in the 13 reviewed States if it had used “before” and “after” appraisals and recognized residual values when determining landowner compensation.

33. Easement Value Conclusions • Appropriate easement compensation is best determined by an appraiser on a case-by-case basis, reflecting the unique characteristics of both the land being appraised and the market conditions in the area.

34. Recommendations Instruct appraisers to estimate WRP easement compensation as the difference between the FMV of the entire property before the easement and the FMV of the entire property after the easement.

35. Crop Base Issues

36. Finding No. 3 Treatment of Federally-Purchased Crop Base • Lands with crop base can have greater values than lands without base. • NRCS guidance directed applicants to move crop base off proposed WRP lands prior to the appraisal, if/when other farmland was available. • If the crop base was included in the appraisal (i.e. NRCS paid for the base), the landowner was supposed to retire it.

37. Federally-Purchased Crop Base Was Not Retired • In 10 of the 13 States reviewed, NRCS allowed WRP easement appraisals to include the value of crop base without ensuring landowners retired that base with FSA. • This occurred because NRCS’ policy concerning treatment of crop base was not clear. • The proper treatment of crop base was not included in the main section of the WRP manual. The only mention of crop base appeared in the exhibit of sample appraisal instructions, and that direction didn’t tell staff how to ensure crop base was retired if/when included in appraised values.

38. Improper Treatment of Crop Base • NRCS also had not issued any instructions requiring landowners to retire Federally-purchased crop base. • Specifically, NRCS had not required landowners to complete and sign FSA Form CCC-505, which certifies the landowners’ agreement to voluntarily retire Federally-purchased crop base acres. • Under its Regulations FSA must receive the CCC-505 form in order to retire the crop base from the farm program. If FSA does not receive this form, FSA will automatically reassign the crop base to other areas of the landowner’s farm if possible.

39. Improper Treatment of Crop Base • Crop base values had been included in 32 of the 37 WRP easement appraisals we reviewed, even though in seven of those cases the landowners could have transferred the base to other farmland prior to the appraisal. • In those seven cases, because the landowners had other available farmland, and because FSA had not received a CCC-505 form, FSA reassigned the crop base acres. • This allowed the seven landowners to continue receiving Federal benefits totaling about $840,000 for crop base that had been purchased by NRCS.

40. Recommendations • Incorporate crop base direction in the body of the WRP Manual and notify all field staff of these requirements. • Notify landowners applying for WRP easements that crop base included in appraisals must be retired. • Have landowners complete the CCC-505 crop base retirement form prior to closing. • Provide the landowner’s CCC-505 form to FSA at easement closing to ensure the Federally-purchased base is retired.

41. Coordination with FSA

42. Finding No. 4 Coordination with FSA • Under Federal law, landowners cannot receive farm subsidy payments for lands subject to WRP easements. • The WRP Manual directed NRCS staff to notify FSA after individual WRP easements were recorded. • However, NRCS did not have a confirmation process to ensure all WRP easement information had been properly conveyed to FSA.

43. FSA Was Unaware of Recorded WRP Easements • We found that 3 of the 17 easements we reviewed in California still had crop base acres assigned to WRP easement-encumbered land and that the landowners had inappropriately continued to receive Federal farm subsidy payments. • In each case, the NRCS California State office had communicated the recorded WRP easement information to the NRCS district offices. However, the NRCS district offices had not conveyed the WRP easement information to their FSA counterparts.

44. WRP Easement Notification Consequences: • The three landowners continued to receive farm program payments totaling $258,411 even though their lands were subject to WRP conservation easements.

45. FSA Easement NotificationOIG Follow-Up Audit • OIG conducted a follow-up audit of easement- encumbered lands in CA to determine the extent of this problem. • The audit reviewed 55 WRP and EWP easements acquired by NRCS from FY 1999 to FY 2005. • In 33 of the 55 closed cases (60%), FSA had not been notified about NRCS’ acquisition of the conservation easements. • Landowners received about $1.3 million in FSA farm subsidy payments for ineligible easement encumbered lands.

46. FSA Easement Notification Best Practices: • Coordination with FSA could be improved with the addition of follow-up procedures like those developed by the Iowa State Office. • The Iowa State Office provides an annual listing of all recorded WRP easements, sorted by county, to the FSA State office. The FSA State office then disseminates this information to its county offices. • When provided with a complete listing of all WRP easements acquired by NRCS throughout the year, the FSA county offices are able to accurately reduce cropland acres and identify any landowners receiving inappropriate farm subsidy payments.

47. Recommendations • NRCS State offices should provide at least annually a listing of all recorded WRP easements, sorted by county, to NRCS district offices and FSA State offices. • NRCS State offices should also provide FSA State offices with a listing of all previously acquired WRP easements, sorted by county, so that FSA can ensure there are no landowners receiving crop base payments on lands subject to WRP easements.

48. Natural Resources Conservation Service Wetlands Reserve ProgramCompensation for Easements Audit Team: Fred San Buenaventura, RIG Donna Smith, Senior Auditor Michael Chung, Auditor