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FALL 2012 CENTRAL NEWS AND VIEWS FOR EIGHTH DISTRICT BANKERS FEATURED IN THIS ISSUE: Recovery Continues for Banks | Follow Agricultural Financial Conditions with New Survey The Drought’s Impact on Eighth District Agricultural Conditions By Gary Corner T he drought that impacted much of the United States this summer has had varying impacts on both crop and livestock producers across the U.S. and in the Eighth District. For crop producers, particularly producers of corn and soybeans, the reduction in crop yields has led to a spike in commodity prices. However, government-backed crop insurance programs provide many of these producers—and their lenders—with an important safeguard against the yield reductions from this drought. As a result, the impact of the drought on crop producers appears to be somewhat tempered. Livestock producers, on the other hand, generally do not benefit from these same insurance safeguards. Facing a spike in their input costs, as feed costs rose and as pastureland conditions deteriorated, livestock producers have had to make more immediate choices. Some have chosen to cull their herds at temporarily depressed prices. Those who chose to maintain the size of their herds until input costs decline have taken a calculated risk that conditions will improve. This risk, however, could lead to even more severe losses for these producers and, perhaps, their lenders. Unfortunately, rains that blanketed much of the country in September TABLE 1 Drought Impact on Agriculture Bank Performance June 2012 District Number of Ag Banks June 2011 Nation District Nation 147 1,519 152 1,526 Average Assets $142M $134M $133M $124M Ag Loans to Total Loans 38.48% 43.49% 36.77% 41.70% Return on Average Assets 1.29 1.28 1.05 1.08 Net Interest Margin 3.90 3.86 3.97 3.91 Return on Equity 11.57 11.81 9.78 10.46 Provision Expense to Avg. Assets 0.19 0.16 0.36 0.24 Nonperforming Loans and OREO to Total Loans and OREO 1.49 1.97 1.66 2.43 SOURCE: Reports of Condition and Income for Insured Commercial Banks. Compiled by Daigo Gubo. occurred too late to have any material impact on this year’s crop yields, feed costs or pastureland conditions. Weather conditions in the months ahead will serve as a strong indicator for how crop and livestock producers will fare in the spring. Mild Winter and Early Planting At the beginning of the year, agriculture conditions suggested that 2012 would be a strong year for the industry. Farm incomes had been strong for most of the past decade, and a mild winter facilitated early planting. The winter wheat crop yield was strong. The continued on Page 5 T H E F E D E R A L R E S E R V E B A N K O F S T. L O U I S : C E N T R A L T O A M E R I C A’ S E C O N O M Y® | STLOUISFED.ORG CENTRAL VIEW News and Views for Eighth District Bankers Vol. 22 | No. 3 www.stlouisfed.org/cb EDITOR Scott Kelly 314-444-8593 firstname.lastname@example.org Central Banker is published quarterly by the Public Affairs department of the Federal Reserve Bank of St. Louis. Views expressed are not necessarily official opinions of the Federal Reserve System or the Federal Reserve Bank of St. Louis. Subscribe for free at www.stlouisfed.org/cb to receive the online or printed Central Banker. To subscribe by mail, send your name, address, city, state and ZIP code to: Central Banker, P.O. Box 442, St. Louis, MO 63166-0442. To receive other St. Louis Fed online or print publications, visit www.stlouisfed.org/subscribe Follow the Fed on Facebook, Twitter and more at www.stlouisfed.org/followthefed The Eighth Federal Reserve District includes all of Arkansas, eastern Missouri, southern Illinois and Indiana, western Kentucky and Tennessee, and northern Mississippi. The Eighth District offices are in Little Rock, Louisville, Memphis and St. Louis. Follow Regional Agricultural Financial Conditions with New Quarterly Survey By Kevin L. Kliesen A s noted in this issue’s cover article, “The Drought’s Impact on Eighth District Agricultural Conditions,” the summer drought has decimated Eighth District corn and soybean crops and forced many livestock and dairy operations to cull their herds because of parched pastures and high feed costs. What impact will this have on farm income, farmland prices and farm credit Kevin L. Kliesen is a conditions? business economist While the final harvest tallies won’t and research officer be available for several more months, at the Federal the St. Louis Fed’s new quarterly surReserve Bank of vey of the expectations of agricultural St. Louis. banks, the Agricultural Finance Monitor (http://research.stlouisfed.org/publications/afm/), indicates that bankers expect a significant impact on farm income across most of the District in the third quarter of 2012 compared with a year earlier. With the launch of its survey, the St. Louis Fed now joins the Kansas City, Chicago, Dallas, Minneapolis and Richmond Feds in producing a regional agricultural financial conditions report. In addition to farm income, the Monitor reports bankers’ expectations of farmland values, farm loan repayment rates, required collateral, farm loan interest rates, and credit supply and demand. (The St. Louis Fed survey was developed and conducted with the help of the Kansas City Fed.) Third-Quarter 2012 Lender Expectations Selected St. Louis Fed Sites Dodd-Frank Regulatory Reform Rules www.stlouisfed.org/rrr FRED (Federal Reserve Economic Data) www.research.stlouisfed.org/fred2 Community Development’s Household Financial Stability Initiative www.stlouisfed.org/household-financialstability On average, lenders across the Eighth District expected third-quarter 2012 farm income and capital expenditures to be significantly lower than the third quarter of 2011. Based on a diffusion index methodology with a base of 100 (results above 100 indicate proportionately higher lender expectations compared with the same quarter a year earlier; results lower than 100 indicate lower lender expectations), the average expectations index for third quarter 2012 was 81, compared with an index of 140 for the second quarter 2012. Meanwhile, farmland values were expected to remain the same, or rise slightly, over the next three months, while demand for agricultural loans was expected to remain healthy, even higher in some areas. In addition, thirdquarter 2012 loan repayment rates were expected to be on par with second-quarter 2011 rates. How close are expectations to eventual reality? A 2009 study by the Kansas City Fed (“Can the Ag Credit Survey Predict National Credit Conditions?”) shows a strong continued on Page 10 2 | Central Banker www.stlouisfed.org Q U A R T E R LY R E P O R T Recovery Continues for Banks in District, Nation By Michelle Clark Neely B ank earnings were up moderately at the national level but were mixed in District states in the second quarter, while asset quality improved once again across all states. Overall, the District and national banking industries are in considerably better shape now than they were one year ago. For all U.S. banks with assets of less than $15 billion, return on average assets (ROA) jumped 13 basis points between the first and second quarters to 1.06 percent and is up 41 basis points from a year ago. ROA dropped 2 basis points to an average of 0.91 percent for banks in District states; despite the decline, ROA in District states is still up an average of 36 basis points from a year ago. ROA increased between the first and second quarters at Arkansas, Illinois, Indiana and Missouri banks, while it declined just one basis point at Mississippi banks. ROA declined 26 basis points in Kentucky, primarily because of a seasonal decline in a line of business at one institution. Despite that drop, Kentucky banks still posted the highest ROA among District states, at 1.21 percent. At the national level, the jump in ROA in the second quarter was almost solely due to a 15-basis-point increase in noninterest income. A slight uptick in net interest income and a small decline in loan loss provisions also contributed to profit increases. Within District states, there were generally small increases or decreases in the three major components of earnings— net interest income, net noninterest expense and loan loss provisions—but no consistent pattern that explains why ROA ticked up or down. Banks in Arkansas and Indiana outperformed their national peers in the second quarter, while Illinois, Kentucky (absent the one institution), Mississippi, Missouri and Tennessee banks posted lower average profit ratios. Although loan loss provisions have dropped significantly over the last year and have provided a boost to earnings, they have likely hit a trough, as many TABLE 1 Earnings Performance1 2011: 2Q 2012: 1Q 2012: 2Q 0.65% 0.55 1.11 0.38 0.57 0.87 0.69 0.65 -0.08 0.93% 0.93 1.01 0.72 1.06 1.47 0.91 0.90 0.89 1.06% 0.91 1.09 0.74 1.07 1.21 0.90 0.91 0.83 3.90% 3.85 4.27 3.69 3.83 4.17 3.94 3.68 3.86 3.88% 3.85 4.16 3.66 3.90 4.27 3.99 3.66 3.92 3.89% 3.84 4.16 3.64 3.91 4.09 4.04 3.68 3.90 0.62% 0.74 0.52 0.96 0.66 0.53 0.60 0.53 1.02 0.37% 0.41 0.32 0.58 0.30 0.37 0.23 0.38 0.34 0.36% 0.40 0.35 0.55 0.28 0.34 0.24 0.38 0.36 RETURN ON AVERAGE ASSETS 2 All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks NET INTEREST MARGIN All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks LOAN LOSS PROVISION RATIO All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks Compiled by Daigo Gubo SOURCE: Reports of Condition and Income for Insured Commercial Banks NOTES: 1 2 Because all District banks except one have assets of less than $15 billion, banks larger than $15 billion have been excluded from the analysis. All earnings ratios are annualized and use year-to-date average assets or average earnings assets in the denominator. continued on Page 4 Central Banker Fall 2012 | 3 Quarterly Report continued from Page 3 banks are now in a position of running off loan loss reserves in excess of required levels. Asset Quality Better Asset quality measures continue to improve, nationally and in District states. The nonperforming assets ratio—nonperforming loans plus other real estate owned (OREO) to total loans plus OREO—dropped 36 basis points for all U.S. banks to 4.27 percent in the second quarter. One year ago that ratio topped 5 percent. The average nonperforming assets ratio for District states also declined more than 30 basis points in the second quarter to 4.71 percent. Within the District, Indiana banks posted the lowest nonperforming assets ratio in the second quarter TABLE 2 Asset Quality Measures1 2011: 2Q 2012: 1Q 2012: 2Q NONPERFORMING ASSETS RATIO2 All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks 5.15% 5.42 6.09 6.74 3.80 3.61 4.56 4.74 5.96 4.63% 5.03 5.33 6.24 3.49 3.82 4.19 4.73 5.17 4.27% 4.71 5.11 5.74 3.30 3.72 3.91 4.43 4.89 58.37% 56.52 53.94 45.63 74.62 69.01 63.45 72.25 57.21 62.49% 61.02 65.52 50.13 67.05 69.02 74.71 71.53 66.33 66.56% 64.04 68.43 52.59 70.38 71.80 77.89 77.17 67.21 LOAN LOSS COVERAGE RATIO3 All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks Compiled by Daigo Gubo SOURCE: Reports of Condition and Income for Insured Commercial Banks NOTES: 1 2 3 Because all District banks except one have assets of less than $15 billion, banks larger than $15 billion have been excluded from the analysis. Loans 90 days or more past due or in nonaccrual status, plus other real estate owned (OREO), divided by total loans plus OREO. Loan loss reserves divided by nonperforming loans. (3.30 percent), while Illinois banks recorded the highest ratio (5.74 percent). Although problem loans remain stubbornly high, asset quality has improved at Illinois banks, with the nonperforming assets ratio down 50 basis points from the first quarter and 100 basis points from a year ago. Improvement Widespread In general, nonperforming loan rates fell across all asset classes in all District states. The only exceptions to the general decline occurred in Kentucky, where nonperforming construction and land development loans edged up; in Arkansas, where nonperforming commercial and industrial loans rose slightly; and in Tennessee, where nonperforming consumer loans increased. Lower nonperforming loan rates led to large increases in loan loss coverage ratios in the second quarter. U.S. peer banks had set aside about 67 cents for every dollar of nonperforming loans at mid year, up about 4 cents from the previous quarter and more than 8 cents from a year ago. The trend was similar in District states, with the average loan loss coverage ratio increasing about 3 cents between the first and second quarters and up almost 8 cents from a year ago. Among District states, Mississippi banks recorded the highest average coverage ratio (77.89 percent), while Illinois banks recorded the lowest (52.59 percent). Every District state but Illinois posted higher coverage ratios than the national average in the second quarter. Capital Up Tier 1 leverage ratios edged up again in the second quarter. Nationally, the tier 1 leverage ratio averaged 10.1 percent, up 13 basis points from the first quarter and 26 basis points from a year ago. The average for District states in the second quarter increased a more modest 4 basis points to 9.61 percent. Arkansas and Kentucky banks had average leverage ratios that topped 10 percent, while Missouri banks (9.33 percent) and Illinois banks (9.36 percent) posted ratios that trailed the District state and national averages. Michelle Clark Neely is an economist at the Federal Reserve Bank of St. Louis. 4 | Central Banker www.stlouisfed.org Drought’s Impact continued from Page 1 United States Department of Agriculture (USDA) predicted in spring 2012 that corn yields would be around 166 bushels per acre—a record for corn producers. Given this prediction, many expected corn inventories to grow significantly, putting downward pressure on prices. In fact, as late as June 2012, corn was priced in the mid-$5 range per bushel, well off 2011 prices. The Drought Hits Unfortunately, summer weather conditions did not cooperate. The critical pollination periods for corn and soybeans are generally late June and late July, respectively. But in 2012, excessive heat and dryness was the prevalent weather pattern across most District states, with rain shortfalls reaching 15 inches in some areas. The benefits of a mild winter and early planting were lost. In severely struck areas, many farmers resorted to cutting crops for silage. This weather pattern largely continued through August when the residual rains from Hurricane Isaac provided District states with needed moisture. Crop Forecasts Are Significantly Revised By early July, many analysts and academic institutions began revising their forecasts for the agricultural sector. For example, the USDA revised its corn yield forecast down 26 percent to 123 bushels per acre. Other institutions, such as the University of Missouri’s Food and Agricultural Policy Research Institute, updated their forecasts in August to factor in the impact of the drought.1 The University of Missouri’s revised long-term baseline forecast now reflects the following for the agriculture sector: • Corn prices are now expected to average $8.10 per bushel for the crop harvested in 2012, exceeding last year’s record by about 30 percent. This is expected to result in steep reductions in corn domestic use, exports and carryover stocks. • Soybean prices are now expected to average $16.27 per bushel, up from about $13 per bushel this spring and about 30 percent above last year’s record. This is expected to result in sharply reduced levels of soybean crush and exports. • These higher prices for corn and soybeans are expected to elevate prices for other grains and oilseeds. For example, wheat prices are expected to increase to $8.42 per bushel, in spite of record 2012 U.S. wheat yields. • Ethanol production is now expected to decline by 10 percent for the 2012/13 corn-marketing year. Higher ethanol prices are expected to result in sharply reduced ethanol exports and increased imports, but domestic ethanol consumption is expected to decline by just 2 percent. • The increase in feed prices is expected to result in reduced production of meat and milk, pushing up prices for those products. Consumer food prices are expected to increase by more than 4 percent in 2013. • High prices are expected to keep 2013 corn acreages near its 2012 peak, and soybean and wheat acreage are continued on Page 6 Excessive heat and dryness was the prevalent weather pattern across most District states, with rain shortfalls reaching 15 inches in some areas. The benefits of a mild winter and early planting were lost. Central Banker Fall 2012 | 5 Drought’s Impact continued from Page 5 both expected to increase as well. Cotton acreage, however, is expected to decline in 2013 because of weak cotton returns relative to returns of other competing crops. The University of Missouri is also concerned that if its forecasts materialize and more acreage is planted to compensate for this year’s losses, a return to more normal weather and growing conditions in 2013 could result in a sharp reduction in crop prices because of excess supply. Crop Production in Eighth District States To begin to assess the impact of the drought on agriculture producers in these states and on their lending institutions, we compared yield estimates for several key crops as of September 2012 with actual 2011 yields as reported by the USDA. In general, agriculture producers in the seven states that make up the District harvest more soybeans than corn. Unfortunately, the drought’s biggest impact appears to be on corn and soybean production. The charts at the bottom of Pages 6-9 highlight the estimated changes in yield for four key crops produced in the seven states. These estimates come from the USDA’s September 2012 Crop Production report. The Importance of Crop Insurance Among the 655 community banks headquartered in the Eighth District, 147 of them are considered agricultural banks.3 2 Despite the drought’s impact on the corn and soybean crops, the impact on farmers and on their lenders is expected to be mitigated by the use Corn TABLE 2 Changes in Yield for Corn, 2011–2012 Corn Area Harvested (1,000 acres) 2011 Yield Per Acre (bushels) 2012 2011 2012 Production (1,000 bushels) 2011 Change in Production 2012 520 640 142.0 160.0 73,840 102,400 +38.7% 12,400 12,600 157.0 116.0 1,946,800 1,461,600 -24.9 Indiana 5,750 6,050 146.0 100.0 839,500 605,000 -27.9 Kentucky 1,300 1,490 139.0 65.0 180,700 96,850 -46.4 740 800 128.0 147.0 94,720 117,600 +24.2 3,070 3,350 114.0 75.0 349,980 251,250 -28.2 735 870 131.0 82.0 96,285 71,340 -25.9 District States 24,515 25,800 146.1 104.9 3,581,825 2,706,040 -24.5 U.S. 83,981 87,361 147.2 123.4 12,358,412 10,778,589 -12.8 Arkansas Illinois Mississippi Missouri Tennessee SOURCE: USDA’s September 2012 Crop Production report Of the seven states in the District, Arkansas and Mississippi are the only two that are expected to experience year-overyear increases in corn production. Part of the reason for this seemingly good news is that these two states dedicate less acreage to corn than do other District states such as Illinois and Indiana. In addition, Arkansas benefited from irrigated farmland while Mississippi experienced more favorable weather conditions during 6 | Central Banker www.stlouisfed.org the summer of 2012. Corn production in these states, given record-high commodity prices, is expected to generally bolster farm income in these areas. Overall, however, corn producers in District states are expected to experience a decline in corn production that is nearly twice the percent decline expected for all corn-producing states nationwide. Expected yield per acre should be well shy of the expected national average. of crop insurance. The USDA’s Risk Management Agency (RMA), created in 1996, manages the Federal Crop Insurance Corp. (FCIC), which was founded in 1938. Since 1998, private insurance companies reinsured by FCIC have sold and serviced all Multiple Peril Crop Insurance (MPCI) authorized under the Federal Crop Insurance Act. A contract of insurance exists between insured farmers and their commercial insurance providers. Premium rates and insurance terms and conditions are established or approved by FCIC. Reinsurance agreements exist between FCIC and the commercial insurance providers. Crop insurance program highlights include: • MPCI covers against loss from many weather conditions including drought, excess moisture, hail, wind, frost, tornado, lightning and flood, as well as other conditions, such as insect infestation, disease, fire and earthquake. • Private crop insurance companies are fully backed by the federal government. Private insurers are stress-tested to verify they have financial reserves adequate to meet 400 percent of the potential loss on their crop insurance book of business. On July 1, 2012, all 16 AIPs (approved insurance providers) passed this stress test. • The service delivery side of the program is handled by each private company but overseen by the USDA’s RMA, which sets the rates that can be charged and determines which crops can be insured. Private firms are obligated to sell insurance to every eligible farmer who requests it and retains a portion of the risk. continued on Page 8 Soybeans TABLE 3 Changes in Yield for Soybeans, 2011–2012 Soybeans Area Harvested (1,000 acres) Yield Per Acre (bushels) Production (1,000 bushels) Change in Production 2011 2012 2011 2012 2011 2012 Arkansas 3,270 3,200 38.0 39.0 124,260 124,800 +0.4% Illinois 8,860 8,350 47.0 37.0 416,420 308,950 -25.8 Indiana 5,290 4,990 45.0 37.0 238,050 184,630 -22.4 Kentucky 1,480 1,380 39.0 34.0 57,720 46,920 -18.7 Mississippi 1,800 2,100 39.0 41.0 70,200 86,100 +22.6 Missouri 5,200 5,150 36.5 28.0 189,800 144,200 -24.0 Tennessee 1,250 1,290 32.0 31.0 40,000 39,990 0.0 District States 27,150 26,460 41.9 35.4 1,136,450 935,590 -17.7 U.S. 73,636 74,635 41.5 35.3 3,056,032 2,634,310 -13.8 SOURCE: USDA’s September 2012 Crop Production report Soybean producers have fared better than corn producers in Eighth District states. Soybean yields are expected to decline only slightly more in District states (18 percent) than nationwide (14 percent). The outlier among the District states is Mississippi, which the USDA expects will experience a sizable percentage gain in soybean production because of the additional acres planted and higher yields per acre in 2012 versus 2011. Central Banker Fall 2012 | 7 Drought’s Impact continued from Page 7 • The USDA subsidizes the crop insurance premium, thus encouraging more farmers to purchase MPCI. The goal is to reduce producers’ dependency on federal crop disaster payments when natural disasters occur. • Agricultural lenders frequently will require highly leveraged borrowers to carry crop insurance and obtain an assignment to the crop insurance proceeds. • Crop insurance is increasingly viewed as providing the cornerstone for active risk management programs for all types of borrowers. Impact on Livestock Production in Eighth District States While crop insurance may help many crop producers partially offset losses caused by various perils, a more material impact could be felt by livestock producers who are forced to pay sharply higher feed bills as a result of the drought. According to the University of Missouri, higher feed costs affect animal products differently. Figure 1 on Page 9 summarizes the dramatic increase in feed costs by animal in dollars per pound. The blue bar represents current conditions, with corn at $8 per bushel, soybean meal at $550 per ton and hay at $200 per ton. The gray bar represents more “normal” input prices, with corn at $5 per bushel, soybean meal at $300 per ton and hay at $150 per ton. Under current conditions, pork producers appear to have experienced the sharpest increase in feed costs. According to the University of Missouri, if these price levels persist in 2013, feed expenses could rise to three times the 1990-2004 average and more than 70 percent above the 20072010 average. Increased feed prices will force livestock producers to adjust to the changed economics in their industry. For example, some producers may choose to partially (or even fully) liquidate their herds as prices escalate. Higher livestock production costs will also be felt by consumers as the market seeks equilibrium. Typically, 15 to 20 percent of total food costs are driven by agriculture commodity prices, so total food inflation will not grow at the same rate as commodity prices. However, agriculture products Rice TABLE 4 Changes in Yield for Rice, 2011–2012 Rice Area Harvested (1,000 acres) 2011 2012 Yield Per Acre (pounds) 2011 2012 Production (1,000 cwt) Change in Production 2011 2012 1,154 1,280 6,770 7,200 78,100 92,160 +18.0% Mississippi 158 123 6,850 6,900 10,823 8,487 -21.6 Missouri 128 177 6,490 6,700 8,308 11,859 +42.7 District States 1,440 1,580 6,752 7,121 97,231 112,506 +15.7 U.S. 2,618 2,677 7,067 7,334 185,009 196,318 +6.1 Arkansas SOURCE: USDA’s September 2012 Crop Production report Arkansas remains a national leader in rice production, accounting for nearly half of all U.S. production. Overall, the U.S. rice crop is small. Strong foreign competition limits exports. Much of the land used in rice production is irrigated, which gave the crop important protection from this summer’s drought. The USDA forecasts a record-high yield of 7,334 pounds per acre nationally, which could result in downward pressure on rice prices. 8 | Central Banker www.stlouisfed.org Impact on Agriculture Bank Performance Ultimately, it will be important to determine how the 2012 drought could impact the performance of the 147 agriculture banks headquartered in the Eighth District. Given that banking performance data are reported only on a quarterly basis, it will be important to track agriculture bank performance over the next few quarters to truly begin to ascertain the impact—which the most recent data do highlight going into the summer drought. Agriculture banks with less than $10 billion in total assets appear well-positioned to handle some of the stresses in the agriculture sector. For example, through the second quarter of 2012, agriculture banks exhibited high profitability (as measured by return on assets) and strong asset quality (as measured by nonperforming loans and other real estate owned FIGURE 1 Feed Costs 1.00 $8 corn / $550 meal / $200 hay $5 corn / $300 meal / $150 hay 0.80 Dollars per Pound with relatively less processing, such as protein, tend to have a higher rate of price pass-through to consumers. Consequently, meat and dairy products have higher correlations between farm prices and consumer food prices than fruits and vegetables do. 0.60 0.40 0.20 0.00 Beef Pork Chicken Milk SOURCE: University of Missouri Food and Agricultural Policy Research Institute, 2012 Drought: Considerations for Animal Agriculture, Aug. 3, 2012 to total loans and other real estate loans). Year-over-year performance of District agriculture banks and their national peers has also been remarkably consistent. This suggests that most agriculture banks, on average, have an appropriate financial buffer to withstand the impacts of the drought this year. (See Table 1 on Page 1.) continued on Page 10 Cotton TABLE 5 Changes in Yield for Cotton, 2011–2012 Cotton Area Harvested (1,000 acres) Yield Per Acre (pounds) 2011 2012 2011 2012 Arkansas 660 580 929 Mississippi 605 460 952 Missouri 367 330 Tennessee 490 District States U.S. Production (1,000 bales) Change in Production 2011 2012 993 1,277 1,200 991 1,200 950 -20.8 969 945 741 650 -12.3 375 796 755 813 590 -27.4 2,122 1,745 911.8 932.5 4,031 3,390 -15.9 9,461 10,443 790 786 15,573 17,109 +9.9 -6.0% SOURCE: USDA’s September 2012 Crop Production report In general, cotton production is expected to be down across all District states because of the fact that less acreage was planted in 2012 than in 2011. Nationwide, cotton production is up, however, which is expected to lead to downward pressure on cotton prices. Prices were already somewhat depressed because of record-high price levels in 2011. Sharply increased world cotton acreage placed downward pressure on prices in 2011. Central Banker Fall 2012 | 9 Drought’s Impact continued from Page 9 Similar to the situation for agriculture banks, recent years of strong farm income will likely provide many farm operators with an appropriate financial buffer to withstand the impacts of the drought. Bankers with good risk management practices are positioned to identify problems by identifying the level of crop insurance in place and ensuring that files contain appropriate documentation. It would not be surprising to see some ancillary businesses, such as equipment dealers, experience near-term sales declines because of a more cautionary spending approach on the part of farmers. Given the rise in feed costs, lenders with high exposure to livestock production may encounter greater challenges over the next few months. The situation is somewhat different for livestock producers, as higher feed costs and the loss of hay from destroyed pastureland are impacting their cost of doing business. Some producers have already culled their herds in response to these higher input costs, which will likely increase the prices paid by consumers. Even if drought conditions ease by the next growing season, decisions made today, particularly in regard to herd size, may have a more lasting effect. Ultimately, the impact on agriculture banks will become more apparent over the next few months as drought insurance claims are submitted and final payments determined. Gary Corner is a senior examiner at the Federal Reserve Bank of St. Louis. The author thanks Daigo Gubo for his assistance. ENDNOTES Summary of the Drought’s Impact Despite historic drought conditions, crop producers and lenders in Eighth District states appear likely to exit the year in satisfactory financial condition. Additionally, crop producers in some states have actually been able to maintain their yields throughout the drought and may even experience a windfall as a result given record-high prices, particularly for corn and soybeans. Since the majority of crop producers also have crop insurance, it appears likely that many crop producers will be able to offset a portion of any lost revenue. >> M O R E O N L I N E Agricultural Finance Monitor http://research.stlouisfed.org/publications/afm/ Kansas City Fed 2009 Ag Credit Survey Study www.kansascityfed.org/PUBLICAT/ECONREV/ pdf/09q4Briggeman.pdf 10 | Central Banker www.stlouisfed.org 1 www.fapri.missouri.edu/outreach/publications/ 2012/FAPRI_MU_Report_06_12.pdf 2 Community banks are defined as those having $10 billion or less in total assets. 3 These are community banks with agriculture real estate and production loans making up 25 percent or more of total loans. Central View continued from Page 2 correlation between reported lender expectations in its surveys and future loan repayment rates and collateral requirements. The inaugural St. Louis Fed survey was conducted June 15 to June 29, 2012, and was based on the responses of 88 agricultural banks located within the boundaries of the District. The next survey, which is now under way and will be released in mid-November, includes two additional questions about the percentage of loans covered by crop insurance and the expected impact of drought on farm incomes. Are Covered Bonds an Alternative to Asset-Backed Securities? U .S. retail investors were permitted to purchase covered bonds for the first time during the spring when the SEC allowed the Royal Bank of Canada to register and publicly sell covered bonds in the U.S. market. Previously, only “qualified institutional investors” were permitted to purchase covered bonds. Meanwhile, separate bills now in the House of Representatives and Senate seek to establish a legal framework for covered bond issuance by U.S. banks. Why is there now a legislative effort to establish a covered bond market in the United States? Covered bonds have attracted the attention of U.S. lawmakers in the aftermath of the financial crisis primarily as an alternative to assetbacked securities (ABS), which have been widely blamed for providing perverse incentives to loan originators and fueling the recent housing bubble. Securitization, or the process of creating ABS by packaging assets together (such as loans) and selling their payment streams, potentially engenders a principal-agent problem. The principal-agent problem occurs when one party (the agent) is charged with making decisions on behalf of a second party (the principal) but the agent is not fully incentivized to act in the principal’s best interest. Senior research associate Brett Fawley and economist Luciana Juvenal of the St. Louis Fed explore covered bonds in an Economic Synopses published earlier this year. They explain covered bonds, the motives for legislating a market for them, and the pros and cons of covered bonds versus ABS. >> M O R E O N L I N E November Dialogue To Look at the Emerging Giants of India and China The St. Louis Fed’s popular “Dialogue with the Fed” discussion series for the general public continues on Nov. 13 with “Emerging Giants: Perspectives on India and China.” This dialogue will be hosted by B. Ravikumar, vice president, and YiLi Chien, senior economist, both with the St. Louis Fed’s Research division. Cletus Coughlin, senior vice president and policy adviser to the Bank’s president, will moderate the question-and-answer session after the presentation. A reception with light refreshments will start at 6:15 p.m. with the presentation beginning at 7 p.m. Register now at www.stlouisfed.org/dialogue Watch the Series Online Did you miss any of the previous sessions? Visit www.stlouisfed.org/dialogue to see the videos and presentations from: OCT. 1, 2012 “Robo-signing, the London Whale and Libor Rate-Rigging: Are the Largest Banks Too Complex for Their Own Good?” MAY 30, 2012 “Deuda Soberana: Una Tragedia Griega Moderna” MAY 8, 2012 “Sovereign Debt: A Modern Greek Tragedy” NOV. 21, 2011 “Understanding the Unemployment Picture” OCT. 18, 2011 “Bringing the Federal Deficit Under Control” SEPT. 12, 2011 “Lessons Learned from the Financial Crisis” A full report on the Oct. 1 and Nov. 13 Dialogue sessions will appear in the winter 2012 issue of Central Banker. “Coming to America: Covered Bonds?” by Brett Fawley and Luciana Juvenal http://research.stlouisfed.org/ publications/es/article/9362 Central Banker Fall 2012 | 11 FIRST-CLASS US POSTAGE PAID PERMIT NO 444 ST LOUIS, MO Central Banker Online S E E T H E O N L I N E V E R S I O N O F T H E FA L L 2012 C E N T R A L B A N K E R AT W W W. S T LO U I S F E D. O R G/C B F O R R E G U L ATO RY S P OT L I G H T S A N D R E C E N T S T. LO U I S F E D R E S E A RC H . ISSUE 2 | 2012 Perspectives on Household Balance Sheets Unsteady Progress: Income Trends in the Federal Reserve’s Survey of Consumer Finances By William Emmons, assistant vice president and economist, and Bryan Noeth, policy analyst, Federal Reserve Bank of St. Louis T he Federal Reserve’s 2010 Survey of Consumer Finances revealed a decline in the income of many Americans between 2007 and 2010.1 Among the middle decile (10 percent) of all families, the average pre-tax family income in 2010 was $45,951, falling 5.6 percent from the 2007 level of $48,669.2 (All figures are expressed in terms of 2010 purchasing power.) Detailed comparisons of income and wealth trends over both short and long periods for a number of subgroups lead us to conclude that some types of families are doing noticeably better than others.3 For example, the average older family (headed by someone 55 or older) in the middle ten percent of such families had a pre-tax income 3.5 percent higher in 2010 than a similar family had in 2007. In stark contrast, the average younger family (headed by someone under 40) had a pre-tax income 12.6 percent lower in 2010 than in 2007. Meanwhile, a family headed by someone between the ages of 40 and 54 had pre-tax income that was about 8.3 percent lower in 2010 than such a family in 2007. HOUSEHOLD FINANCIAL STABILITY —A Research Initiative This analysis of the Federal Reserve’s Survey of Consumer Finances is but one aspect of a recently launched research initiative now under way at the Federal Reserve Bank of St. Louis. Through research, publications, web-based data tools and public events, the HFS initiative aims to help rebuild the balance sheets of struggling American households. For more information, see the Household Financial Stability site at www.stlouisfed. org/hfs NE W S T. LO UIS FED PUB LI C ATI O N NEW BANKING AND ECONOMIC RESEARCH • Too Big To Fail: Pros and Cons of Breaking Up Big Banks Read short essays related to research on understanding and strengthening the balance sheets of American households. The online publication is part of the St. Louis Fed Community Development’s Household Financial Stability initiative, which includes research, web-based data tools and public events. Short- and Longer-Term Income Trends Table 1 provides information on typical pre-tax family incomes at various times for (continued on Page 2) TABLE 1 • Understanding Poverty Measures and the Call to Update Them • Household Financial Stability: Who Suffered the Most from the Crisis? Average family income of the middle decile of families ranked by income in 2010 dollars C D E 1992-95 average 2007 2010 Percent Change 2007-2010 Percent Change 1992-95 average to 2010 $41,990 $48,669 $45,951 –5.6 9.4 A 1 All families B 2 Historically disadvantaged minority (African-American or Hispanic origin) 25,557 34,917 32,306 –7.5 26.4 3 White, Asian or other minority 46,569 54,815 52,221 –4.7 12.1 4 Young (family head under 40) 40,787 39,834 –12.6 –2.3 5 Middle-aged (between 40 and 54) 59,416 64,763 59,373 –8.3 –0.1 6 Old (55 or older) 29,613 40,686 42,090 3.5 42.1 45,583 7 No college degree 32,245 36,363 34,121 –6.2 5.8 8 College degree (two-year or four-year degree) 66,303 82,844 73,502 –11.3 10.9 83,177 97,051 99,334 2.4 19.4 66,564 88,131 74,558 –15.4 12.0 Addendum: • Monetary Policy and the Expected Adjustment Path of Key Variables • Why America Spends While the World Saves • Prime and Subprime Hybrid Mortgages R U L E S A N D R E G U L AT I O N S • Recent Fed Actions Concerning the Dodd-Frank Act printed on recycled paper using 10% post-consumer waste 9 Middle-aged and college degree and white, Asian or other minority 1 0 Old and college degree and white, Asian or other minority SOURCE: Federal Reserve Survey of Consumer Finances and authors’ calculations. 1 >> Read or download In the Balance and see subscription options at: www.stlouisfed.org/ publications/itb/ C E N T R A L B A N K E R | FA L L 2 0 1 2 https://www.stlouisfed.org/publications/central-banker/fall-2012/recent-fed-actions-concerning-the-doddfrank-act Recent Fed Actions Concerning the Dodd-Frank Act The Fed issued final or proposed rules on the following Dodd-Frank Act initiatives during the previous four months. Final Rules Risk-based capital guidelines related to market risk capital rules — Effective Jan 1., 2013, the joint final rule revises risk-based capital guidelines to better capture positions for which the market risk capital rules are appropriate; reduce procyclicality; enhance the rules’ sensitivity to risks that are not adequately captured under current methodologies; and increase transparency through enhanced disclosures. The final rule does not include all of the methodologies adopted by the Basel Committee for calculating the standardized specific risk capital requirements for debt and securitization positions due to their reliance on credit ratings, which is impermissible under the Dodd-Frank Act. Instead, the final rule includes alternative methodologies for calculating standardized specific risk capital requirements for debt and securitization positions. Debit interchange transaction fee allowance for fraud-prevention costs — On July 27, the Board approved a final rule amending the provisions in Regulation II (Debit Card Interchange Fees and Routing) that permit a debit card issuer subject to the interchange fee standards to receive a fraud-prevention adjustment. The final rule revises provisions that are currently in effect as part of the interim final rule, which the Board of Governors announced on Dec. 16, 2010, and became effective on Oct. 1, 2012. Risk management standards for financial market utilities (FMUs) designated as systemically important by FSOC —This final rule implements two provisions of the Dodd-Frank Act related to supervision of FMUs designated as systematically important by the Financial Stability Oversight Council. Specifically, the rule establishes risk-management standards for designated FMUs supervised by the Federal Reserve and requirements for advance notice of a proposed material change to its rules, procedures or operations. The rule became effective on Sept. 14, 2012. Two final rules with stress-testing requirements for certain BHCs, state member banks and SLHCs — The Federal Reserve will begin conducting supervisory stress tests under the final rules this fall for the 19 bank holding companies that participated in the 2009 Supervisory Capital Assessment Program and subsequent Comprehensive Capital Analysis and Reviews. The final rules also require these companies and their state member bank subsidiaries to conduct their own Dodd-Frank Act company-run stress tests this fall, with the results to be publicly disclosed in March 2013. In general, other companies subject to this stress testing will be required to comply with the final rule beginning in October 2013. Companies with between $10 billion and $50 billion in total assets that begin conducting their first company-run stress test in the fall of 2013 will not have to publicly disclose the results of that first stress test. The Fed will release the scenarios for this year's supervisory and company-run stress tests no later than Nov. 15, 2012. As required by the Dodd-Frank Act, the scenarios will describe hypothetical baseline, adverse and severely adverse conditions, with paths for key macroeconomic and financial variables. To help firms prepare to estimate their losses and revenues under the scenarios, the Federal Reserve also released historical data for variables likely to be used in the scenarios. A revised version of these historical data, reflecting the latest information, will be published along with the scenarios. Proposed Since June Appraisal standards and disclosures for higher-risk mortgages — Several federal agencies (the Fed, CFPB, FDIC, NCUA and OCC) have proposed amendments to Regulation Z appraisal standards and disclosures for higher-risk mortgages. Under the Dodd-Frank Act, mortgage loans are higher-risk if they are secured by a consumer's home and have interest rates above a certain threshold. For higher-risk mortgage loans, the proposed rule would require creditors to use a licensed or certified appraiser who prepares a written report based on a physical inspection of the interior of the property. The proposed rule also would require creditors to disclose to applicants information about the purpose of the appraisal and provide consumers with a free copy of any appraisal report. Creditors would have to obtain an additional appraisal at no cost to the consumer for a home-purchase higherrisk mortgage loan if the seller acquired the property for a lower price during the past six months. This requirement would address fraudulent property flipping by seeking to ensure that the value of the property being used as collateral for the loan legitimately increased. Capital Requirements The Fed, FDIC and OCC issued joint proposals in June for revising the current regulatory capital standards. The agencies also offered a regulatory capital estimation tool so that organizations can estimate the potential effects the on their capital ratios of the two proposals given below. The estimation tools are for banks, savings associations, bank holding companies, and savings and loan holding companies. Keep in mind that the tool should not be relied on as an indicator of an institution’s actual regulatory capital ratios and that it is not part of the NPRs nor of any final rule(s) that the agencies may adopt. Revisions to risk-based and leverage capital requirements consistent with Basel III, including tier 1 capital requirements, a supplementary leverage ratio, and limits on capital distributions and certain discretionary bonus payments — Consistent with the international capital standards in Basel III, this proposal includes a more restrictive definition of regulatory capital, higher minimum regulatory capital requirements, and a capital conservation and a countercyclical capital buffer. The proposal would place limits on capital distributions and certain discretionary bonuses. Also, the proposal includes a leverage ratio that, if applicable, incorporates certain off-balance sheet assets in the denominator. Standardized approach for calculating risk-weighted assets — This proposes revisions to the general risk-based capital requirements for determining risk-weighted assets (that is, the calculation of the denominator of a banking organization's risk-based capital ratios). The standardized approach proposal incorporates certain capital standards of Basel II and proposes alternatives to credit ratings for calculating risk-weighted assets for certain assets. This proposal also includes a greater number of exposure categories for purposes of calculating total risk-weighted assets, provides for greater recognition of financial collateral, and permits a wider range of eligible guarantors. C E N T R A L B A N K E R | FA L L 2 0 1 2 https://www.stlouisfed.org/publications/central-banker/fall-2012/recent-st-louis-fed-banking-and-economic-research Recent St. Louis Fed Banking and Economic Research Too Big To Fail: The Pros and Cons of Breaking Up Big Banks St. Louis Fed economist David C. Wheelock breaks down the arguments for and against breaking up the biggest banks—those that are considered “too big to fail”—including whether reduction in size would increase costs of providing banking services, in the October 2012 Regional Economist. Understanding Poverty Measures and the Call to Update Them Does the increase in the poverty rate mean more Americans fall short of a desired standard of living? Or does the increase mean more people lack the resources necessary for basic needs? To be able to answer these questions, the authors argue for a better understanding of the poverty threshold in this Regional Economist article. Household Financial Stability: Who Suffered the Most from the Crisis? Economist William Emmons and research analyst Bryan Noeth of the St. Louis Fed look into which demographics were hit hardest during the financial crisis and recession. In this Regional Economist article, the authors use three demographic dimensions of population diversity (race and/or ethnicity, age and collegedegree status) to study household financial outcomes. Monetary Policy and the Expected Adjustment Path of Key Variables In an Economic Synopses essay, St. Louis Fed President James Bullard discusses the notion that the Fed is “missing on both sides of its dual mandate,” which often implies that current monetary policy is far away from an ideal or optimal policy. However, Bullard argues, the notion that one can easily infer something about the sub-optimality of policy by observing current levels of inflation and unemployment is imprecise. In fact, observing that the Fed is “missing on both sides of the mandate” says little or nothing about the appropriateness of current policy. Beyond Our Means: Why America Spends While the World Saves This Bridges article explores why American savings are so low when compared with European and East Asian nations. Those nations promote saving and attempt to protect their citizens from over-indebtedness, while Americans save little, spend much and borrow excessively. Prime and Subprime Hybrid Mortgages The financial crisis shed light on several financial products introduced in the years before the crisis. One such product was the hybrid adjustable-rate mortgage or the hybrid ARM. Although similar in many ways, subprime hybrids were really different from prime hybrids, as explored in this Economic Synopses. C E N T R A L B A N K E R | FA L L 2 0 1 2 https://www.stlouisfed.org/publications/central-banker/fall-2012/november-dialogue-to-look-at-the-emerging-giants-of-china-andindia November Dialogue To Look at the Emerging Giants of China and India November Dialogue To Look at the Emerging Giants of China and India The St. Louis Fed’s popular “Dialogue with the Fed” discussion series for the general public continues on Nov. 13 November with “Emerging Giants: Perspectives on India and China.” This dialogue will be hosted by B. Ravikumar, vice president, and YiLi Chien, senior economist, with the St. Louis Fed’s Research division. Cletus Coughlin, senior vice president and policy adviser to the Bank’s president, will moderate the question-and-answer session following the presentation. A reception with light refreshments will start at 6:15 p.m. with the presentation beginning at 7 p.m. Register now Watch the Series Online Did you miss any of the previous sessions? Visit www.stlouisfed.org/dialogue or follow the links to see the videos and presentations from: Oct. 1, 2012 — “Robo-signing, the London Whale and Libor Rate-Rigging: Are the Largest Banks Too Complex for Their Own Good?” May 30, 2012 — “Deuda Soberana: Una Tragedia Griega Moderna” May 8, 2012 — “Sovereign Debt: A Modern Greek Tragedy” Nov. 21, 2011 — “Understanding the Unemployment Picture” Oct. 18, 2011 — “Bringing the Federal Deficit Under Control” Sept. 12, 2011 — “Lessons Learned from the Financial Crisis” A full report on the Oct. 1 and Nov. 13 Dialogue sessions will appear in the winter 2012 issue of Central Banker.