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FARMLAND . . . An Increasingly Valuable Asset Sada L. Clarke “Land is a many-splendored thing. To some, it is soil- how many will it raise? To others, it is a small piece of the earth’s surface, something to be cherished it is space- something and enjoyed like an old masterpiece. on which to build a home, an apartment, -William “Values “Meadow Farm to Be Sold.” This headline, announcing the sale of the Caroline County, Virginia, birthplace of Triple Crown champion Secretariat and other champions such as Hill Prince and Riva Ridge, appeared in the Richmond Times-Dispatch late One of the nation’s most respected last September. horse farms, the Meadow was a 2,6OO-acre land and breeding operation with a reported asking price of $2,650,000. This pencils out to a little more than $1,000 per acre. News stories have since revealed that the Meadow was purchased by a group of Virginia investors shortly after it was put on the market. The actual selling price was not disclosed, but it was said to be very close to the asking price. While the sale price will undoubtedly have a significant impact on the value of land nearby, it by no means sets a precedent. Farmland values per acre in 1974, for example, averaged $1,000 or higher in nearly onetenth of all the counties in Virginia. For Would-Be Landowners Market values such as these are enough to discourage many potential owners of farm real estate, especially those thinking of buying farmland as an investment or those toying with the idea of purchasing a little tract in the country for retirement. Would-be buyers need to remember that the market value of farmland depends on its potential use.’ Generally, the more intensive the use, the higher the price. A nationwide survey of Note: The author wishes to thank Cynthia Vaughan, Senior Research Assistant, for her very able and willing assistance in preparing the statistical material and preliminary drafts of the charts for this article. 1 USDA, Economics, Statistics, and Cooperatives Service, Farm Real Estate Market Developments, CD-83 (Washington, July 1978), Table 37. H. Scofield, and Competition bushels of corn rare as a gem, To still others, a shopping center.” for Land’ the price per acre and probable use of farmland five years after purchase, conducted during the year ended March 1, 1978, revealed that land expected to remain in agriculture sold for an average of $595 per acre. Farmland to be used for forestry went for $373- the lowest price. On the upper end, land sold for commercial and industrial development brought $2,008 per acre, while tracts intended for rural residences went at $1,024. Land is selling at premium prices throughout much of the District and the nation. United States farmland, on the average, was valued at a record $490 per acre on February 1, 1978. On that same date, farm real estate in the Fifth Federal Reserve District sold for an average of $705 per acre-also a record. Average market values ranged from $403 in West Virginia to $1,578 in Maryland. Would-be buyers of a complete farm, rather than part of a farm, will find that farm real estate values per farm have increased at a much faster rate than values per acre. This is due to the steady increase in the average size of farms. Today, for example, the value of a Fifth District farm averages around $101,925, more than double its 1972 value. Values per farm range from $71,300 in West Virginia to $263,000 in Maryland. North Carolina, with a $79,100 value per farm, has the second lowest average. Higher priced farms can be found in South Carolina, where the average is $92,900, and in Virginia where the average value stands at $118,800. The potential buyer will also find wide variations in the average values pending on the type of farm, its size, of its sales. Tallies of the 1974 census instance, that the value of land and FEDERAL RESERVE BANK OF RICHMOND that there are of farms, deand the value revealed, for buildings for 3 Fifth District farms with sales of $2,500 and over averaged $118,921 but ranged from a low of $56,725 for farms with sales under $5,000 to a high of $1,091,059 for farms with sales of $500,000 and over. The value of farmland and buildings per farm increased as the value of farm products sold rose. Similarly, the value of farm real estate on farms with sales of $2,500 and over varied widely by type of farm. In South Carolina, for example, dairy farms, valued at $242,262 per farm, had the highest average, while horticultural specialty farms with a $56,612 price tag had the lowest. South Carolina tobacco farms, producers of the major source of farm income, were valued at an average For the Would-Be of $88,934 per farm. Owner of Farmland The nation’s farmland, on the average, was valued at a record $490 per acre on February 1, 1978. On that same date, farm real estate in the Fifth District sold for an average of $705 an acre, with the market value ranging from $403 in West Virginia to $1,578 in Maryland. Market values of District farms, according to the census, are relatively low when compared to market values nationally. This situation most likely results from the fact that the average size farm in the District is much smaller than the national average. Market values of 48 percent of all District farms were less than $40,000 in 1974, for example, while the values of 29 percent ranged from $40,000 to $99,999. The remaining 23 percent were valued at $100,000 and over. By contrast, only 33 percent of the nation’s farms were valued at less than $40,000, while 37 percent had market values of $100,000 and over. A Backward Glance The movements of District and national farmland values per acre have shown marked similarities since records began back in 1912. During much of this period-up through the midfifties, in fact-farmland prices followed the movements of farm prices and farm income. But in the years that have followed, with the exception of 1972 and 1973, farmland prices have continued to advance despite an irregular downtrend in farm income. Much of the current boom in farmland values began back in 1972 with the huge grain sale to Russia. Farmland became such a favored investment that its market value in the District has jumped an average of 104 percent in the six years since, rising at an average annual rate of 12.6 percent. The largest rise in a single year occurred in 1973 when values zoomed an unprecedented 26 percent. The 4 ECONOMIC REVIEW, only other year that gains in land values to equaling this increase was ence of World War I pushed But following the increase turned downward, finally came close 1919, when the influvalues up 23 percent. of 1919, farmland values hitting bottom with the crash of 1933 when they plummeted almost 20 percent in a single year. Market values of farmland have moved steadily upward since the Great Depression, with only minor interruptions, mostly of one-year duration, occurring in 1938, 1949, and 1953. The rise in farmland values accelerated notably after the start of World estate values more than War II. doubled District by early farm real 1949, re- sponding in part to a sharp gain in farm income. They then fell slightly, largely because of a drop in farm prices and income that accompanied a downturn in overall economic activity. The 1949 dip was of short duration, however. Values of farmland began to advance again with outbreak of war in Korea in June 1950, rising the by March 1953 to a new high some 30 percent above the pre-Korean level. They held at this new level through early 1954. Meanwhile, prices of farm products, which began to decline after reaching an all-time high in February 1951, dropped sharply by early 1954. By mid-1954, farmland values in the District turned upward again despite continued declines in the prices and incomes received by farmers. The escalation in farm real estate prices has continued since, sometimes at a slower, sometimes at a faster, pace. Meanwhile, net farm income, except in 1972 and 1973, has continued on an irregular downward course, moving generally counter to farmland prices. INFLUENCES Market values IN THE LAND of farmland are MARKET controlled by the classic law of supply and demand.2 Both supply and demand factors play strong roles in determining the price. When limited supplies offered for sale coincide with escalating bids from would-be purchasers, the market price climbs. The supply and demand equation is influenced by many factors whose importance varies widely, not only from state to state, but also from county to county, and even within the same Most of these factors reflect the different county. interests competing for farmland on the demand side. Farmers’ demand for land to enlarge their farming operations is one of the strongest factors forcing prices upward. But the demand for land for non2 USDA, Economic Research Service, “High Stakes in the Country,” The Farm Index, Vol. XVI, No. 3 (Washington, March 1977), p. 11. MARCH/APRIL 1979 Chart FARM 1967 = REAL ESTATE: 100 Note: Source: United Farmland and buildings, U. S. Department March INDEX NUMBERS 1 OF AVERAGE States and Fifth District, 1 values for 1940-1975 and February VALUE PER ACRE 1940-1978 1 values for of Agriculture. FEDERAL RESERVE BANK OF RICHMOND 1976-1978. farm uses has also become an increasingly important influence competing in farm real estate markets. A high rate of inflation, anticipated capital appreciation, tax shelters, and the disappointing performance of the stock market nonfarmers into “For Sale” “They’re have been among the factors luring the land-buying rush since 1972. Signs not Scarce making The anymore old timer land”3 who must said have been thinking about the small supply and the scarcity of listings. The number of farms today is limited. But the number for sale is even more limited. Reportedly, only around 2 percent of the nation’s total acreage in farms typically changes hands each year. This situation sets the stage for stiff competition and higher bidding in the event of a sudden increase in demand for farmland.4 Voluntary and estate sales are generally assumed to reflect the supply of farmland put on the market in a given period.5 On this basis, the supply of farmland offered for sale has been trending downward since the midforties, although a temporary increase did occur during the 1972-1975 period of high net farm incomes. By 1978, voluntary and estate sales were only about one-fifth as large as they were during the record year 1944. This downturn in the supply of land for sale has been one of the prime factors influencing farmland values, especially in recent years. Farmers Still Leading Buyers Farmers who want to enlarge their farming operations continue to be the number one purchasers of farmland, despite the growing competition from land-hungry nonfarm buyers. Farm expansion, the largest single reason for buying farmland, is definitely on the uptrend. Last year, for instance, almost 60 percent of all farmland transfers- up from less than 30 percent in 1954 -were made to enlarge existing farms. Parcels or. tracts sold for enlargement purposes usually bring better prices than those sold as complete farms. But since the turnover rate for farmland is generally low, farmers who want to expand will usually pay the price to meet their competition. When a neighboring farm is put on the auction block, it isn’t at all un3 Bill Humphries, “They’re Not Making Anymore Land,” News and Observer (Raleigh, October 9, 1960), Sec. III, p. 1. 4 USDA, Economics, Statistics, and Cooperatives Service, “Real Estate,” Farmers’ Newsletter, G-3 (Washington, August 1978), p. 2. 5 Marvin Duncan, “Farm Real Estate Values-Some Important Determinants,” Monthly Review, Federal Reserve Bank of Kansas City (Kansas City, March 1977), pp. 6-7 6 ECONOMIC REVIEW, common for farmers living close by to be the strongest bidders. They know that with the aid of presentday machinery and equipment, they can increase their volume of business and spread overhead costs over the additional acres, thus reducing average costs per unit of output. Many farmers linas’ flue-cured in the heart of the Virginia-Carotobacco-growing area have sought more land for still another reason: to increase their acreage allotments. Buying land that carries a tobacco allotment is the only realistic way to accomplish this since an allotment is tied to the land and not to the landowner. Such farmland is in strong demand and consequently it carries a much higher price tag than acreage which has no allotment. “They’re not making anymore land.” -Author Unknown Growth in part-time farming has also contributed to the increasing demand for farmland.6 Part-time farmers in 1975, for example, bought 12 percent of all farm tracts sold nationally compared with only 6 percent in 1954. Because those farming part-time usually buy fewer acres than full-time farmers, they generally pay more per acre than do the full-time operators. In other words, the smaller the farm tract purchased, the higher the price per acre. During the year ended last March 1, for example, farm real estate transfers that were smaller than 100 acres typically commanded more than twice the price of the overall national average.7 The generally higher price of land bought by part-time farmers is also due to factors other than the “volume discount effect” cited. Part-time farms, for instance, are more likely to be located near cities, and the average price is higher because of the location. Off-Farm Income Significant Farm families’ nonfarm income has become an important factor in the land market, enabling many of them to bid for the dwindling supply of land that is for sale (see Chart 2). Such earnings have shown a steady growth for many years, providing a supplement to farmers’ net farm income and increasing their ability to invest and to service real estate debt.8 The situation is especially true for farm operator families with farm 6 USDA, Farm 83, Table 22. Real Estate Market Developments, CD,- 7 USDA, Farm 83, Table 38. Real Estate Market Developments, CD- 8 USDA, Farm 83, p. 7. Real Estate Market Developments, CD- MARCH/APRIL 1979 sales under $10,000, for their average off-farm income is generally equal to, or far exceeds, their average debt.9 9 Readers may be interested in knowing that the U. S. Department of Agriculture’s classification of farms by value of sales lists three classes with farm sales under $10,000. Farm operator families in the $5,000 to $9,999 class had an average off-farm income in 1977 of $12,179, around 120 percent of their average debt of $10,195. Those with sales of $2,500 to $4,999 received an average off-farm income of $14,559, far in excess of their debt which averaged $6,727. The average farm family with sales valued at less than $2,500,. however, had off-farm earnings of $15,077 compared with debt of only $3,905. While these small farmers received the largest off-farm income, they also owed the least debt. Economics, Statistics, and Cooperatives Service: Farm nonfarm earnings per farm By the midsixties, family equaled the family’s net farm income. But today’s farm families, on the average, earn more from their sources of off-farm income than from their Of each $100 of income received farming operations. by farm families in 1977, for instance, $61 came from nonfarm sources. On the average, their total income from farm and nonfarm sources amounted to a little more than $19,000. Of this sum, around $7,400 was Income Statistics, Statistical Bulletin No. 609 (Washing- ton, July 1978), Table 8D; Balance Sheet of the Farming Sector, 1978, Supplement No. 1 to Agriculture Information Bulletin No. 416 (Washington, October 1978), Table 33. FEDERAL RESERVE BANK OF RICHMOND 7 net farm income and the remaining $11,600 was income from sources off the farm. While nearly all farm families have some off-farm income, such earnings are most important on small farms. Stated another way, nonfarm income generally becomes a larger share of total farm family income as the value of a farm’s sales declines. Farm operator families whose farm sales in 1977 totaled $100,000 and over, for example, earned 20 cents of every dollar of their total income from nonfarm sources. Those with farm sales of $10,000 to $19,999 had off-farm earnings amounting to 66 cents of each dollar of total income. But families with farm sales cents of every dollar of their total earnings. As noted earlier, net farm income, with the exception of 1972 and 1973 was generally moved counter to farmland values from the midfifties to the present. While net farm income has trended irregularly downward, values of farmland have continued to advance, a relationship that many see as a paradox. Meanwhile, off-farm income of farm operator families has continued upward, climbing at almost the same pace as farmland values until very recent years. The offfarm earning supplements to net farm income have contributed to the ability of some farmers, particularly those on small and part-time farms, to compete below for and 8 $5,000 depended on off-farm income for ECONOMIC 91 REVIEW, MARCH/APRIL purchase 1979 additional farmland. When these data are adjusted for inflation, the influence of nonfarm income on farmers’ capacity to purchase land is even more evident. Real market values of farmland in early 1978 were more than double the 1960 level. Real net farm income in 1977, however, was 11 percent below the level in 1960. contrast, farmers’ real nonfarm earnings rose percent during the same period (see Chart 3). Farmland a Good Investment10 For much By 66 of the history of this country, many individuals who are not interested in farming have chosen to invest in farmland. Such investments have proven to be an effective hedge against inflation for more than 40 years. Many also view farmland as a safe and desirable Farmland prices, in fact, have long-term investment. outstripped consumer prices throughout the last 20 years. During that period, there has generally been a 2 percent average annual rate of increase in farmland values for every 1 percent average annual rate of gain in the Consumer Price Index. “Real estate investments have yielded long-term returns equal to, or better than, other long-term investment alternatives.” -Robert D. Reinsel Measured against the gross national product price deflator, the most comprehensive price index, few alternative investment opportunities since 1960 have been as profitable and as safe a hedge against inflation as has United States farmland. Farm real estate values have risen faster than this general price index each year. They have also increased much faster than Standard and Poor’s average of 500 common stocks. During this period, farmland values climbed to more than four and one-half times the 1960 level, while the GNP price deflator more than doubled and 10 References for this section include: Jack Bickers, “Why the Southern Land Boom May Be Just Beginning,” Progressive Farmer, Vol. 93, No. 7, July 1978, p. 15; Marvin Duncan, “Farm Real Estate: Who Buys and How,” Monthly Review, Federal Reserve Bank of Kansas City (June 1977), p. 6; Robert G. Healy and James L. Short, “New Forces in the Market for Rural Land,” The Appraisal Journal, Vol. XLVI, No. 2 (April 1978). pp. 190-192: Howard W. Hjort, Statement Before the House Agriculture Committee, Subcommittee on Family Farms, Rural Development and Special Studies (Washington, June 20, 1978), pp. 1-10; E. C. Pasour, Jr., “Farm Real Estate Prices in the United States and North Carolina,” Tar Heel Economist, North Carolina State University (Raleigh, November 1976), p. 2; Robert D. “Land Rents, Values, and Earnings (Paper presented at the meeting of the American Agricultural Economics Association, Edmonton, Canada, August 1973), pp. 11-12; Ted Vaden, “Duke U. Buys 1,222 Acres in North Wake,” News and Observer (Raleigh, September 6, 1978), p. 1. Standard and Poor’s 500 common stock average rose only 71 percent. These comparisons clearly indicate that the average investor in farmland since 1960 has done much better than the average investor in the stock market (see Chart 4). Last fall, Duke University, in an unusual investment initiative for an educational institution, joined the ranks of nonfarm investors when they bought a 1,222-acre tract of prime development land along the Neuse River in northern Wake County. Although the price was not disclosed, the the tract includes 9,000 feet of While noting that “. . . inflation to diversify their investments . . announcement said riverfront property. was forcing schools . ,” the Duke presi- dent was also quoted as saying, “. . . the Wake County purchase, we think, gives us an opportunity to make more money on our investment than stocks and bonds."11 Duke itself does not plan to develop the propertyquite unlike the real estate venture by Campbell College at nearby Buies Creek in 1975. At that time, Campbell opened a 371-acre residential development, including a golf course, tennis courts, and a swimming pool. Since United States farmland has become such an attractive investment, foreigners have joined the ranks of nonfarm investors in recent years in buying large tracts of the nation’s farm real estate. Whether these foreign interests are oil-rich Arabs, Italian grain magnates, German industrialists, bankers from the Netherlands, or tycoons from Argentina, these eager buyers may well have helped to drive the price of land up. Most popular spot for foreign investors is California, but they are also reported to be purchasing land in the Midwest and Southeast, including this five-state area. Among the few foreign transactions known to have taken place in the Fifth District is the Italian-owned Open Grounds Farm, Inc., located in Carteret County, North Carolina. This 42,000-acre tract of farmland, timberland, and marsh, is currently being used to produce cattle and feed crops. Foreign investments in this country’s farmland have received a great deal of publicity, partly because foreign buyers have made large, lump sum payments. Moreover, their investments have raised a number of economic and political questions, as well as some emotions. The best information now available indicates that the amount of United States farmland owned by foreigners is only around 1 percent. Recent reports from the Department of Agriculture conclude that thus far the amount of farmland presently owned 11 Vaden, News and Observer, FEDERAL RESERVE BANK OF RICHMOND p. 1. 9 by foreign investors the nation’s farmers has had no significant or on the agricultural impact on economy. Population Pressures Boost Values12 The competing demands for farmland stemming from population pressures come in many different forms and usually have a considerable impact on local farmland prices. The “back-to-the-country” trend, suburbanization, purchases for second homes or retirement homes, development of recreational facilities, and industrialization are all reflections of these pressures. That significant evident the market for rural pressures from in both the District the “back-to-the-country” land is undergoing the population and the nation. trend. Since some is clearly Consider 1970, for the 12 USDA, Economics, Statistics, and Cooperatives Service, “Population Shuffle,” The Farm Index, Vol. XVII, No. 6 (Washington, June 1978), pp. 4-6; Healy and Short, The Appraisal Journal, pp. 195-197. 10 ECONOMIC REVIEW, first time in decades, the population of nonmetropolitan counties has grown faster than that of the This phenomenon, which has metropolitan areas. occurred in both the District and the nation, is un precedented. Districtwide, statistics show that between 1970 and 1975 population in the nonmetro counties rose by 6.6 percent, as against 5.1 percent in the metro areas. Net inmigration in the nonmetropolitan counties totaled around 214,100, compared. with some 127,600 in the metropolitan areas. Generally, the fastest nonmetro growth has occurred in But the nonmetro counties bordering metro areas. population gain has not been limited to the spillover from the cities-to suburbanization, that is. Rural population evenly distributed. losing population. from metro But where to nonmetro to the demand MARCH/APRIL growth has by no means been Some counties, in fact, are still 1979 areas, for farmland, population the shuffle as has the has shifted has added population dispersal Where from the this demand central cities has been to strong, the market NET GAINS suburbs. have soared. This situation is amply illustrated in the accompanying table showing net gains in population and increases in farmland values in specified nonmetro and metro counties (see Charts 5 and 6). IN POPULATION INCREASES IN FARMLAND values Specified Counties, Fifth District, widespread system of good roads, makes long- 1969-1974 Net Migration 1970-1974 Percent County and State Gains in Farmland Values 1969-1974 Percent Some population pressures have resulted from the increased job opportunities in rural areas as well as the availability of jobs in the suburbs. Moreover, the desire for the amenities of rural life, coupled with a AND VALUES Nonmetropolitan Calvert, Counties 16.1 Md. 71.3 6.1 142.7 distance commuting both desirable and practicable for many. The strong wave of movement to the country and the resulting boom in farmland prices is Worcester, Albemarle, Va. 16.0 81.5 well illustrated Louisa, 16.6 125.0 10.8 137.1 22.0 177.2 vania, Virginia. percent between sharply, rising by the nonmetro county of Spotsyl- There, with net inmigration at 22 1970 and 1974, land values jumped 177 percent during the five years ending in 1974. Many who migrated to Spotsylvania were former residents of the nation’s capital and its environs and continue to commute to their jobs by bus (see Table and Chart 6). Much of the pressure for rural land has come increasingly from people who are buying land for second homes or for retirement homes. Generally, many of these people have chosen such places as the North Carolina highlands or sandhills. Coastal areas, reservoirs, lakes, and the foothills are other favorite locations. Moreover, some urbanites, in response to rising farmland prices, have bought rural acreage far ahead of actual need to make sure they have their “place in the country” when retirement time rolls around. Demand for rural land to be used in recreational pursuits has also been on the upswing. Such developments can and often do take good land out of agricultural use forever. But with today’s leisureoriented society, growing pressure for recreational facilities is not surprising. Ski centers with their lodges and slopes and accompanying real estate complexes, l8-hole golf courses, tennis on mountain and valley courts as well as in the lowlands, lands owned or leased by hunting clubs, “theme” parks, and facilities oriented to campers are but some of the recreational developments now occupying a great deal of acreage that once was farmland. The resort complex in Watauga County, North Carolina- a nonmetro county-provides an excellent example of how this type demand has influenced land values (see Table and Chart 6). Other Nonfarm Influences The demand structure for farmland has changed significantly over the years as many new uses and demands have been Md. Va. Orange, Va. Spotsylvania, Va. 13.4 127.6 15.1 102.7 W. Va. 8.5 126.7 W. Va. Stafford, 8.0 100.6 8.9 118.6 8.8 111.2 12.2 102.6 10.5 108.1 8.4 153.4 17.7 83.0 Va. Warren, Va. Barbour, Berkeley, Hampshire, W. Va. Jefferson, W. Va. Jackson, Macon, N. C. N. C. Polk, N. C. Watauga, N. C. 14.3 Metropolitan 66.7 55.7 101.2 11.3 S. C. 5.0 12.5 Horry, S. C. Orangeburg, 79.8 21.8 106.2 16.7 177.3 12.6 103.2 23.9 102.3 Counties Carroll, Md. Harford, Md. Chesterfield, Va. Gloucester, Va. Montgomery, New Va. Kent, Va. Powhatan, Va. 32.1 142.9 Brunswick, N. C. 26.0 106.6 33.8 106.8 12.1 85.5 Currituck, Orange, N. C. N. C. Dorchester, Lexington, S. C. S. C. Pickens, S. C. Source: 23.1 90.5 19.6 76.2 10.1 140.7 U. S. Bureau of the Census. FEDERAL RESERVE BANK OF RICHMOND 11 Chart 5 FARM REAL ESTATE: AVERAGE VALUE PER ACRE Fifth District by Counties, Cities of the Standard Source: Metropolitan U. S. Bureau of the Census. Statistical Area. 1974 Chart 6 FARM REAL ESTATE: CHANGE IN AVERAGE Fifth District by Counties, *Data not published in 1969 for counties with less than Cities of the Standard Source: Metropolitan U. S. Bureau of the Census. Statistical Area. 10 farms VALUE PER ACRE 1969-1974 to avoid possible disclosure of information for individual farms. added to the normal demands for land for farming purposes. When these demands for farmland result in strong competition between agricultural and nonagricultural The rises. uses, the conversion value of such land typically of farmland to nonfarm uses, such as commercial-industrial developments, shopping centers, highways, airports, and the like, not only increases the value of that land but also has a carry-over effect on the value of surrounding land. The trend towards industrial parks has added sigForwardnificantly to the demand for farmland. With the generally early sixties. market of the past several decades, ucts-since the strong farmland the value of farm real estate in this five-state area totaled an unprecedented $26.9 billion by 1978, up from $11.5 billion in 1970 and $2.3 billion in 1940 just prior Rising to World farmland ing asset values. War II. prices, therefore, lead to increasAs the growth in asset values has not only improved the asset position of landowners’ balance sheets, it has resulted in substantial gains in proprietors’ equities, enabling them to expand their borrowings and to use the higher priced farmland as as sites for new plants but also for future expansion. Today’s modern, well-engineered plants require siz- collateral. But with the rapidly rising land prices of recent years, farmers who have recently invested able acreage. Since industry more for land than farmers, large looking industrial establishments want is often pressure land willing to pay from industry can be significant in some areas. With the economic development that has occurred in the Fifth District over the past couple of decades, in rural as well as in urban areas, it seems safe to say that industrial demand for land has played a major role in the escalation of farmland prices. Development of the interstate highway system has also had a major impact on farmland prices. One mile of interstate highway requires nearly 40 acres, while a single interchange may take another 10 acres.13 The dual lanes of asphalt or concrete such as I-95, cutting across the Fifth District and extending north and south up and down the East Coast, became wands of magic that sent farmland prices skyrocketing. On the average, land values per acre along the North Carolina segment zoomed from a low of $1,684 in 1955 to a high of $26,611 in 1963.14 And owners of farm property adjacent to interchanges reaped even bigger windfalls. The strong demand for land exerted by the interstate highway program aptly illustrates that location value is often more important as a price-making factor in the land market than productive value. items have been finding it increasingly difficult to meet debt payments out of net farm income. sums in farmland their AND been forthcoming, validity In some in certain a recent discussion of the Board Reserve System Net farm income, farm assets Farm real estate, a farmer’s major production asset, has dominated the capital structure of agriculThe value of farmland, in ture for many decades. fact, has comprised from three-fourths to four-fifths of the total market value of all farm production assets -those assets used in the production of farm prod“Values and Competition for 13 William H. Scofield, Land,” The Yearbook of Agriculture, 1963, USDA (Washington: Government Printing Office, 1963), p. 64. 14 Dick Brown, “Land Values Soar as Interstate Routes Expand,” News and Observer (Raleigh, May 19, 1968), Sunday Reading Sec., p. 1. 14 ECONOMIC REVIEW, undoubtedly geographic Melichar areas The amount labor have income must assets. Melichar proportion be regarded ment of Agriculture sharply past estimates analyses.16 not only labor to and manage- value of farm oper- in recent decades, of total net farm as a return then pointed Emanuel of the Federal is a return and probable more in others. subject, many he noted, and thus an increasing than of this challenged fallen having of Governors but also to operators’ ators’ EARNINGS capital Over the years, many attempts have been made to explain rising farmland prices. The traditional hypothesis states that farm income is the basic factor influencing farmland va1ues.15 But as noted in the historical perspective above, this hypothesis fell into disrepute in the midfifties when farmland prices continued to rise without an accompanying increase in net farm income. By and large, this apparent paradox continued through 1977, puzzling land appraisers, prospective land buyers, and farm lenders alike. This departure from the historic relationships between farmland prices and farm income has stimulated many analysts to search for possible explanaMany different factors or explanations have tions. ment. FARM ASSET VALUES and other out that to production U. S. Depart- show that such annual 15 John Brake, “A Perspective on Future Capital and Credit Needs of Agriculture” (Remarks prepared for the meeting of the National Agricultural Credit Committee, Chicago, Illinois, September 24, 1973), p. 2. 16 See Farm sented Spring 1978), Between Emanuel Melichar, “The Relationship Income and Asset Values, 1950-1977” (Paper preat the Seminar on Food and Agricultural Policy, Hill Center, Wayzata, Minnesota, March 27, pp. 1-13. MARCH/APRIL 1979 Chart 7 RATES OF RETURN TO FARM Percent United 1950 Sources: 1955 U. S. Department States, 1960 of Agriculture PRODUCTION ASSETS 1950-1977 1965 1970 and Board of Governors 1975 of the Federal 1980 Reserve System. residual returns to production assets rose faster than the value of those assets over the period 1954-1971.17 The rate of return to assets thus increased even though land prices were rising-an observation quite contrary to the commonly held view (see Chart 7). While the rising trend in returns to production assets has gone unnoticed by most observers, many have noted that the major purchasers of farmland have been the large farmers who, for the most part, have above-average rates of return. These farmers, mostly those with sales of $100,000 and over, have been prominent in buying farmland for farm expansion, and it is believed that their purchases have had a marked influence in determining the price of farmland. Indeed, it appears that these farmers have been setting the tone of the rural land market. Therefore, as Melichar has pointed out, it seems logical that “. . . farm real estate might be priced at the return achieved by these [large] farms capitalized at their cost of borrowing funds.”18 17 Melichar, “The and Asset Values, 18 Melichar, “The and Asset Values, Relationship Between 1950-1977,” p. 8. Farm Income FEDERAL RESERVE BANK OF RICHMOND Relationship Between 1950-1977,” p. 12. Farm Income 15 FINANCING Someone REQUIREMENTS has said, and rightly farmers ditions, RISE so, that “. . . the farm lending of money is the keystone of most land purchases.”19 While rising farmland prices lead to increasing asset values, create greater financing as indicated above, requirements. has been portion 19 USDA, of farm due, however, they also transfers to the increasing comprised The Farm Index, 1950 Source: 16 apply 1955 U. S. Department only transfers comprised Chart 8). nanced the addi- the amount of cash of farm real estate transused has been climbing 89 percent of with borrowed funds, the total Strong transfers it should come (see With now fias no 21 Paul L. Holm and William H. Scofield, “The Market for Farm Real Estate,” The Yearbook of Agriculture, 1958, USDA (Washington: Government Printing Office, 1958), p. 205. to credit- 1965 1970 of Agriculture. ECONOMIC to buy Demand for Borrowed Funds roughly nine out of ten farmland by 1960 borrowing steadily. While credit financing was involved in 54 percent of all farmland transfers in 1951, the proportion was up sharply by 1978 when credit-financed March 1977, p. 13. 20 Data used in this paragraph financed farmland transfers. when Moreover, the proportion fers for which credit was pro- of purchases as security tional land, oftentimes reducing required for a downpayment. The amount of money borrowed in relation to the purchase price of farmland, for example, trended upward steadily from a low of 54 percent in 1951 to a high of 78 percent in 1973.20 Moreover, the debt-topurchase-price ratio has averaged around 76 percent in the years since. Some of the increase in the amount of debt relative to the purchase price of farmland to enlarge their farms.21 Under such conthe prospective buyer can use his existing REVIEW, MARCH/APRIL 1979 1975 1980 surprise District’s that farm real estate indebtedness of the farmers at the beginning of 1978 hit $3,083 million, a record January 1 high and more than 11 times the $277 million outstanding on the same date in 1940. Over this 38-year period, the volume of farm-mortgage credit outstanding grew at an average annual rate of 6.5 percent-almost as fast as the 6.7 percent yearly increase in the total value of farm Greatest expansion in the use of farm real estate. real estate credit has occurred since 1972, with District farmers boosting their outstanding debt at an annual rate of 13.0 percent-faster even than the yearly rates of gain in farmland value per acre and in the total value of all farmland. Moreover, the rate was somewhat higher than the 11.9 percent rate increase in farm-mortgage indebtedness nationally. of Because of the burgeoning demand for farmmortgage credit, the sources of credit have become increasingly important in paving the way for transfers of farmland. The availability of credit is, unquestionably, the one ingredient that affects nearly all purchases of farmland, regardless of location.‘” And closely tied to credit availability, of course, is the average interest rate charged on farm real estate loans, or the cost of borrowing. Generally, when credit availability for farm-mortgage loans tightens, the move is reflected in higher interest rates. But higher interest rates do not always signify tighter credit conditions. Last year, for example, farmers in general did not find it difficult to arrange loans, but interest rates-like most everything else-moved higher. The Principal Lenders Who is providing the large sums of money required to finance purchases of By far the major today’s high-priced farmland ? share of funds for financing new farm capital has traditionally been provided by farmers themselves.23 But in recent years as their capital needs have expanded sharply, creasingly Fifth District tutional land on banks, relative individuals, providing 22 USDA, farmer lenders ministration, farmers generally The that today’s finds are, according commercial and importance life more to volume, banks, Farmers insurance of seller has declined slightly have funds. borrowed financing, one-fifth outstanding, sellers source of loan funds major Meanwhile, commercial banks’ share of farm real estate credit held at around one-fifth of the total from 1960 through the early seventies. Financing by banks has been declining since and now stands at 14 percent-far below their relative position among the institutional lenders during the late forties and fifties when banks played the leading role in financing farmers’ long-term credit needs. District banks, however, continue to play a relatively more important role in the farm-mortgage field than banks nationwide. Life insurance companies and the Farmers Home Administration have not been as active in extending credit to District farmers as have commercial banks and the Federal land banks. Life insurance companies’ relative position in farm real estate lending has followed a downward trend since 1960, with their share dropping to 5 percent by 1978. While the profinancing supplied by the portion of long-term FmHA has followed an up-and-down pattern for the past several decades, it has also trended downward since the early seventies and now accounts for around 8 percent of the total outstanding. ininsti- the Federal Home mostly AdThe by But by still of the credit The Farm Index, March 1977, p. 12. 23 Alvin S. Tostlebe, Capital in Agriculture: Its Formation and Financing since 1870, A Study by the National Bureau of Economic Research (Princeton, N. J.: Princeton University Press, 1957), p. 19. continue as the second for buying farmland. Competition between lending agencies intensified in the postwar years, and major shifts occurred in the shares of outstanding farm-mortgage loans held by the principal lender groups. Districtwide, the greatest competition was between the Federal land banks and commercial banks. The Federal land banks have steadily increased their share of total farm-mortgage credit since the midfifties, becoming the major institutional lender in 1960 and increasing their hold on this position almost every year since. Half the farm real estate loan volume outstanding for the past couple of years, in fact, has been provided by the Federal land banks. IN SUMMARY modern-day companies. over the years. than relied volume largest Farmland is, indeed, an increasingly valuable asset. With the generally strong farmland market of the past several decades, the value of farm real estate in this five-state area totaled an unprecedented $26.9 billion in 1978, up from $11.5 billion in 1970 and $2.3 billion in 1940 just prior to World War II. While rising farmland prices have led to increasing asset values, they have also created greater fiRoughly nine out of ten nancing requirements. farmland transfers are now financed with borrowed funds. Moreover, borrowed funds make up around three-fourths of the purchase price of each transfer. Outstanding farm-mortgage debt in the District has FEDERAL RESERVE BANK OF RICHMOND 17 thus grown significantly, hitting a record $3.1 billion at the beginning of 1978. Half this loan volume was held by the Federal land banks. Land is presently selling of the current boom in the 1972 with Market years values at premium in farmland huge have sale more prices. values began of grain than Much to doubled back Russia. in the six since. Both supply and demand factors play strong roles in determining the price of farmland. The supply of farms for sale is limited, which sets the stage for stiff competition and Many creases. on the demand higher factors side, bidding influence however. into two categories-either by nonfarmers. when demand buyers in- of farmland Generally, fall by farmers demand they or Farmers who want to enlarge their farming operations are still the leading buyers. Their demand is one of the strongest factors forcing prices upward. Growth in part-time farming has also become an important factor in the land market, as has the nonfarm income of full-time farmers and their families. Land purchased for nonfarm uses has become an increasingly important influence competing in farm real estate markets. Among the factors that have lured nonfarmers into the land-buying rush since 1972, these stand out: population pressures, including the “back-to-the-country” trend, purchases for second homes or retirement homes, and development of recreational facilities; conversion of farmland to nonfarm uses, such as commercial-industrial developments, shopping centers, highways, and the like; the disappointing performance of the stock market; and investment in farmland as a hedge against inflation. The would-be buyer, seriously considering getting into the land market, would do well to remember: l The market value of farmland depends on its potential use. Generally, the the use, the higher the price. l The smaller the farm tract higher the price per acre. purchased, l Market values of different farms vary widely. l Location value a price-making l 18 more Few alternative investment opportunities since 1960 have been as profitable and as safe a hedge against inflation as has farmland. is oftentimes factor than sizes and intensive types the of more important as productive value. ECONOMIC REVIEW, References Bickers, Jack. “Why the Southern Land Boom May Be Progressive Farmer. Vol. 93, Just Beginning.” No. 7. July 1978. pp. 16-17. Blazar, Sheldon. “Farmland Investment Determinants.” Farm and Land Realtor. Vol. XXIX, No. 9. National Association of Realtors. Chicago, October 1977. p. 6. Brake, John. “A Perspective on Future Capital and Credit Needs of Agriculture.” Remarks prepared for the meeting of the National Agricultural Credit Committee, Chicago, Illinois, September 24, 1973. Duncan, Marvin. “Farm Real Estate: Who Buys and How.” Monthly Review. Federal Reserve Bank of Kansas City. June 1977. pp. 3-9. “Farm Real Estate Values-Some Important Determinants.” Monthly Review. Federal Reserve Bank of Kansas City. March 1977. pp. 3-12. Healy, Robert G., and Short, James L. “New Forces in the Market for Rural Land.” The Appraisal Journal. Vol. XLVI, No. 2. April 1978. pp. 185-199. Hjort, Howard W. Statement before the House Agriculture Committee, Subcommittee on Family Farms, Rural Development and Special Studies, Washington, June 20, 1978. Holm, Paul L., and Scofield, William H. “The Market for Farm Real Estate.” The Yearbook of Agriculture, 1958. USDA. Washington : Government Printing Office, 1958. Melichar, Emanuel. “The Relationship Between Farm Income and Asset Values, 1950-1977.” Paper presented at the Seminar on Food and Agricultural Policy, Spring Hill Center, Wayzata, Minnesota, March 27, 1978. News and Observer, October September 6, 1978. 9, 1960; May 19, 1968; Pasour,. E. C., Jr. “Farm Real Estate Prices in the United States and North Carolina.” Tar Heel Economist. North Carolina State University. Raleigh, November 1976. p. 2. Reinsel, Robert D. “Land Rents, Values, and Earnings.” Paper presented at the meeting of the American Agricultural Economics Association, Edmonton, Canada, August 1973. Richmond Times-Dispatch, September 15, 1978 27, November 7, Scofield, William H. “Values and Competition for Land.” The Yearbook of Agriculture, 1963. USDA. Washington: Government Printing Office, 1963. Tostlebe, Alvin S. Capital in Agriculture: Its Formation and Financing since 1870. A Study by the National Bureau of Economic Research. Princeton, N. J.: Princeton University Press, 1957. USDA. Economics, Statistics, and Cooperatives Service. Farm Real Estate Market Developments. CD-83. Washington, July 1978. pp. 3-50. . Economic Research Service. “High Stakes in the Country.” The Farm Index. Vol. XVI, No. 3. Washington, March 1977. pp. 11-13. Economics, Statistics, and Cooperatives Service. “Population Shuffle.” The Farm Index. Vol. XVII, No. 6. Washington, June 1978. pp. 4-6. “Real Estate.” Farmers’ Newsletter. Washington, August 1978. pp. l-4. MARCH/APRIL 1979 G-3. PROFITABILITY OF MINORITY BANKS IN 1977 James F. Tucker A significant development in the American banking industry during the post-World War II era has been the interest shown by certain ethnic groups in the ownership and operation of commercial banks. So-called minority banks have drawn special attention from both the government and private businesses. The executive and legislative branches of the Federal government, along with the Federal bank supervisory agencies, have favored minority banks with a number of special programs, rules, regulations, and studies aimed at strengthening the operation of these banks. Private industrial firms and the major trade association of the banking industry also have been active in designing special programs to assist minority banks. For purposes of the discussion that follows, minority banks are considered to be those commercial banks in which 50 percent or more of the common stock is owned and controlled by any of the following racial groups: (1) Black; (2) HispanicAmerican; (3) Asian-American; (4) American Indian; (5) Eskimo, Aleut; and (6) Multiracial. A recent amendment to the Federal Reserve System’s rules and regulations allows a bank to qualify as a minority bank if : (a) more than 50 percent of its stock is owned by women ; (b) a majority of its board consists of women; and (c) women hold a significant number of its management positions. Minority banks have existed in this country for many years and some can show an impressive record of sustained success. A number of black banks, for example, have operated profitably since early in this century, and eight such banks survived the “bank holiday” of 1933. Until recently, neither banking students nor bank supervisory agencies gave any particular attention to black or other ethnic banks, although in the 1930’s J. B. Blayton, a noted black accountant, businessman, and college professor, reported on the successful operations of black banks in a number of studies of black business firms.l In recent years, a steady flow of research has begun to focus on the operations of black banks and the growing number of banks owned and operated 1 See e.g., J. B. Blayton, Bankers Magazine, “The Negro Vol. 4, December in Banking,” 1936, p. 511. by groups designated as minorities. Most of this research compares the operations and financial performance of minority banks with those of nonminority banks. A previous issue of this Review, however, carried another type article which undertook to evaluate minority banks by comparing the highearning banks in this group with the others.2 The paragraphs that follow extend that article by examining the general profitability of minority banks during 1977 and by comparing the financial performance of minority banks in that year and 1976. The data used were derived from Reports of Condition and Reports of Income filed by each insured commercial bank with its Federal bank supervisor. The study is limited to minority banks at least three years old. The reason for excluding less-than-three-yearold banks is that, in the first three years of their existence, new minority banks, according to an FDIC sponsored study, can typically expect to experience losses from current operations.3 PROFIT LEVELS, 1976-1977 Consistent with the trend for the entire banking industry, minority banks as a group realized increased profits in 1977. The number of profitable minority banks rose by 16.6 percent compared with an increase of 6.1 percent in the number of profitable banks in the industry generally. On the other hand, there was also an increase in the number of unprofitable minority banks in 1977, while the number of unprofitable banks in the industry as a whole declined. For this study, there were ten more minority banks in 1977 than in 1976. This fact, however, made the gain in the number of profitable minority banks in 1977 all the more impressive since the ten additional banks were just emerging from the less-than-three-year-old category, which contains a high percentage of unprofitable banks, according to the previously mentioned FDIC study. 2 Bruce J. Summers and James F. Tucker, Characteristics of High-Earning nomic Review, Federal Reserve 62, No. 6 (November/December “Performance Minority Banks,” EcoBank of Richmond, Vol. 1976), pp. 3-12. 3 John T. Boorman, New Minority-Owned Commercial Banks, A Comparative Analysis (Washington, D. C.: Federal Deposit Insurance Corporation, 1973), p. 34. FEDERAL RESERVE BANK OF RICHMOND 19 Minority three years banks that had been in operation or longer numbered 70 in 1977. for Of from 11 to 15, while their net income rose from $1.4 million to $1.8 million. Average net income per bank these, 49 showed a net income (i.e., profit) for the year, while 21 experienced net losses. In 1976 there were 60 such banks, 42 of which showed net income was up sharply for the largest in 1976 to $581,000 in 1977. $25-$50 million class, average banks, from $168,000 But for those in the per bank income was for that year, while 18 experienced net losses. The percentage of the total number showing positive net down to $118,000. income was practically the same, 70 percent for each year. By size group, as shown in Table I, slightly more than half the banks with assets under $10 less favorable. As a group, million category, numbering million realized a net income in 1977, down from 62 percent in 1976. Seventy percent of those with assets in the $10-$25 million range were profitable in 1977, as against 75 percent in 1976. Of those in the $25-$50 million group, 80 percent were profitable in 1977 compared with 82 percent in 1976. All banks with assets over $50 million were profitable in 1977, whereas only 50 percent of this group showed a profit in 1976. The year-to-year changes in these percentages, and especially the reductions in the percentage of smaller banks that were profitable, were no doubt affected by such factors as the operating experience of the ten additional banks in 1977 and the failure of some of the banks to correct a number of long-standing problems. Total net income of the 70 banks in 1977 exceeded $5 million, compared with just under $1.5 million for the 60 banks in 1976. The increase in 1977 was accounted for not by the inclusion of the ten additional banks in that year but rather by the growth and the greatly improved profitability of the larger banks. As shown in Table I, the number of banks with assets in excess of $50 million grew from four, with net income of $672,000 in 1976, to seven, with net income of over $4 million in 1977, thus accounting for the bulk of the year-to-year gain. Banks in the $25-$50 million category increased in number Table BANKS AND AGGREGATE PROFITS IN 1976 AND Total Number of Banks Number of Profitable Banks 1977 Aggregate Profits (in thousands of dollars) 1976 1976 1977 1976 1977 21 21 13 11 10-25 24 27 18 19 312 25-50 11 15 9 12 1,364 1,770 4 7 2 7 672 4,067 60 70 42 49 1,424 5,174 Under Over Total 20 10 50 from smaller banks $124,000 the income picture was those in the under 21 in both 1976 much $10 and 1977, suffered losses in both years. Losses in 1977 totaled $609,000 or $29,000 per bank on the average. This was, however, an improvement over 1976, when losses came to $924,000 or an average loss of $44,000 per bank. The 27 banks in the $10-$25 million category lost a total of $54,000 in 1977. This compares unfavorably with the positive net income of $312,000 recorded by 24 banks in this category in 1976. Net Operating Income While the magnitude of the increase in net income for the aggregate of minority banks in 1977 was substantial, the sources of the increase were perhaps equally important. As shown in Table II, the average minority bank in every size class except the $25-$50 million category actually incurred a loss on current operations during 1976. For the banks as a group, however, gains from securities transactions more than offset this operating loss and produced an overall net profit. In 1977, the situation was much different. The average minority bank in every size class except the under$10 million category earned a net income on operations. Even the average bank in the under-$10 million category showed an improvement in operating net income over 1976, as the average loss fell from $56,000 to $30,000. Thus the average bank in every size category turned in a better operating performance in 1977 than in 1976, although in dollar terms the bulk of improvement was concentrated at the larger banks. I NUMBER OF PROFITABLE MINORITY Size of Banks by Assets (in millions of dollars) a shade, For -924 ECONOMIC 1977 -609 -54 REVIEW, Profitability Measures Two commonly used measures for evaluating the earnings performance of commercial banks are the ratios of net income to average equity capital (return on equity) and net income to average total assets (return on assets). The former indicates the yield on the stockholder’s investment, while the latter is a measure of the effectiveness with which management employs the bank’s assets. Both measures reflect increased profitability of minority banks taken as a group in 1977. For the average minority bank, the return on equity for 1977 was 5.2 percent, compared with 1.7 percent in 1976. The return on assets for 1977 was 0.3 percent as MARCH/APRIL 1979 Table II INCOME AND EXPENSES OF THE AVERAGE MINORITY BANK BY ASSET-SIZE, 1976 AND (Amounts in thousands of dollars) Size Groups in Item Under 10 1977 10-25 Millions of Dollars 25-50 Average, Over 50 All Banks 1976 OPERATING 1976 1977 1976 1977 1976 1977 1976 1977 316 325 705 681 1,316 1,345 3,738 3,138 883 962 8.95 5 4 24 12 49 17 159 150 31 25 - 19.35 38 36 101 81 135 150 198 300 92 104 13.04 25.92 % Change INCOME: Interest and Fees on Loans Interest 1977 on Balances Income on Federal Sold, etc. with Banks Funds Interest and Dividends on: U. S. Treasury Securities 76 69 143 157 252 243 482 706 162 204 Obligations of Other U. S. Government Agencies 45 39 130 115 297 198 402 373 149 136 -8.72 Obligations of States and Political Subdivisions 11 9 22 16 165 58 429 327 71 54 -23.94 2 4 15 15 78 26 10 60 22 19 -13.64 Service Charges on Domestic Deposit Accounts 44 42 75 61 154 151 153 220 84 91 8.33 Other 28 35 31 35 61 47 163 139 44 48 9.09 14 7 19 12 19 27 80 50 22 17 578 570 1,266 1,185 2,526 2,262 5,813 5,463 1,560 1,659 176 164 330 286 723 606 1,016 1,132 394 403 2.28 2,739 2,307 586 607 3.58 15 87.50 All Other Service Charges, All Other Total Securities Income Operating OPERATING etc. Income and Employee Interest on Deposits Benefits interest on Other Money 193 187 433 404 888 768 1 2 14 27 4 5 18 27 8 1 Expense on Federal Purchased 1 1 4 13 6 2 2 5 39 22 25 40 13 11 167 186 76 77 1.32 11.36 Funds Borrowed Interest on Subordinated Notes and Debentures 2 Other Expenses Income Before Tax and Securities Gains (Loss)* Income Gains * May 38 38 74 75 123 110 44 49 46 122 127 112 82 995 260 159 106 881 782 296 305 5,976 4,849 1,577 1,574 -33.33 141 263 229 456 447 634 600 1,283 1,177 2,420 2,126 8 107 137 -162 615 -18 85 572.22 17 8 36 -197 119 -7 26 471.43 99 100 35 496 -10 59 690.00 20 18 133 34 31 9 119 118 168 530 20 67 235.00 Items, 51 4 7 75.00 581 24 74 208.23 60 70 -30 of Banks not add to totals -32 -30 8 -43 Net -17 15 -51 (Losses) Net Income Number 24 -4 Taxes Net Income Before Extraordinary Items Net 125 -55 Income Before Securities Gains or Losses Extraordinary 61 -15.38 137 Expense Operating Applicable 34 117 0.00 Equipment Provision for Possible Loon losses Total 8 75 67 Expense 1 36 22 Occupancy Furniture and Expenses Securities 6.35 EXPENSES: Salaries Net -22.73 1 -29 -1 -44 21 -9 38 6 3 -6 7 -29 21 13 24 4 -2 27 5 124 118 168 11 15 4 7 3.04 -0.19 -70.96 16.67 due to rounding. FEDERAL RESERVE BANK OF RICHMOND 21 against 0.1 percent for 1976. Moreover, the number of minority banks realizing a return on equity of 10 percent or more was 23 in 1977, compared with only 11 in 1976. Return on assets also showed an improvement for minority banks as a group. The ratio of net income to total assets rose from 0.1 percent in 1976 to 0.3 percent in 1977. There was, however, a decline in the number on assets clined of 1.0 percent from eight of banks that realized or more. This in 1976 to six in 1977 a return number de- (Chart 1). From these data it seems clear that a substantial number of minority banks that realized a return of 10 percent or better failed to earn as much as 1 percent on total assets. To some financial analysts this would suggest that such banks are either undercapitalized or are carrying too many low-yielding assets. Aggregate data for the 70 banks do, in fact, indicate that growth in equity capital for the group has lagged behind growth in other parts of their financial structure. From 1976 to 1977, for example, total equity capital for the group increased 3.1 percent while total assets rose 12.4 percent, net loans 9.8 percent, and total deposits 14.1 percent (Table III). The ratio of total equity capital to total assets 22 ECONOMIC over the same period fell from 8.8 percent to 8.1 percent. It should be noted, however, that in the same period this ratio declined from 9.2 percent to 9.0 percent for nonminority banks as well. Sources of Profits Previous studies have suggested that the relatively high expense structure of minority banks was the principal reason for the difference in their financial performance and that of nonminority banks of similar size.4 One study, comparing minority banks with each other, illustrated in detail that the crucial factor determining a given bank’s position in a profitability ranking is the extent to which it is able to control expenses.5 Thus experience suggests that effective measures to restrict the growth of operating expenses could become an important source of improved profitability. In fact, effective cost control appears to have been a major source of increased profits in 1977. 4 See John T. Boorman, “The Prospects for MinorityOwned Commercial Banks: A Comparative Performance Analysis,” Journal of Bank Research (Winter 1974), pp. 263-279. 5 Summers REVIEW, MARCH/APRIL and Tucker, 1979 op. cit., pp. 9-10. Table SELECTED ASSETS AND III LIABILITIES OF THE AVERAGE MINORITY (As of December (Amounts in thousands 1976 10-25 1977 31) of dollars) Size Groups Under 10 Item BANK BY ASSET-SIZE, 1976 AND in Millions of Dollars 25-50 Over 50 Average, All Banks 1977 1976 1977 1976 1977 1976 1977 1976 1977 684 1,041 1,933 1,648 3,755 3,937 9,092 7,791 2,307 2,571 11.40 1,143 1,098 2,763 2,143 4,104 3,787 7,520 13,338 2,759 3,301 19.64 Other U. S. Government Agencies 686 646 1,568 1,845 3,871 2,745 4,630 5,480 1,885 2,042 8.33 States and Political Subdivisions 169 215 424 404 2,384 1,258 9,017 5,692 1,267 1,059 25 42 193 208 884 196 838 253 219 13.44 % Change ASSETS: Cash and Due From Banks Total Securities Held: U. S. Treasury All Others Federal Funds Sold, etc. -16.42 Assets Total Assets 1,768 2,019 1,820 3,156 7,138 8,593 1,651 2,514 52.27 7,323 7,123 15,255 14,640 42,276 37,568 9,679 10,631 9.83 316 411 405 1,345 1,243 2,837 1,907 986 708 3.21 88 Assets 664 3,300 244 Net Fixed 382 3,241 loans, All Other 74 95 229 246 478 438 1,667 1,262 321 344 7.16 16,612 16,043 6,663 7,516 33,896 31,402 84,251 82,470 20,808 23,389 12.40 13.00 LIABILITIES: Demand Deposits, IPC 1,595 1,812 3,886 3,797 9,777 8,701 16,420 17,768 5,000 5,650 2,854 2,635 6,717 6,021 14,977 12,371 40,191 39,677 9,111 9,732 6.81 Deposits of U. S. Government 354 800 1,009 1,885 1,906 2,126 2,885 4,728 1,069 1,896 77.36 Deposits of States and Political Subdivisions 984 1,278 2,632 2,632 3,329 4,286 9,329 8,283 2,629 3,145 43 32 140 24 66 5,625 3,272 461 352 Time and Savings Deposits Deposits of Commercial Other Deposits Total Banks Deposits Demand 81 Time and Savings Federal Deposits Funds Purchased, Mortgage 236 14,687 14,598 2,812 5,919 3,758 3,843 8,768 65 396 61 245 26 5 Indebtedness All Other etc. 295 6,655 2,154 Deposits 97 5,911 liabilities Total Liabilities Subordinated Debentures EQUITY 74 Notes 6,017 Preferred 15,342 2,284 1,995 367 494 34.60 76,734 75,723 18,638 21,269 14.11 7,179 8,623 20.62 11,459 12,646 30,428 28,323 6,413 13,272 12,279 24,363 26,743 8,185 17,156 16,044 52,372 48,980 96 230 729 231 139 -39.83 -17.53 17 313 13 448 322 121 66 97 80 174 273 558 1,495 992 274 304 14,881 31,380 29,220 78,662 138 530 282 338 511 19,240 77,510 21,792 10.36 10.94 13.26 and 48 27 128 188 173 -7.98 20 Undivided Total liabilities and Equity Capital of Banks 52 143 28 203 50 51 630 541 601 708 1,690 1,204 608 605 .49 251 393 399 915 798 3,163 2,457 618 646 4.53 76 31 244 347 398 586 88 115 1 83 20 17 6 -39 Profits Equity Capital 43 414 233 Reserves for Contingencies, 17 378 Stock-Par Stock-Par Surplus Number 6,801 808 19.62 -23.64 CAPITAL: Common Total 13 373 30 etc. -99 2.00 30.68 6 5 598 589 1,143 1,024 1,986 1,900 5,251 4,449 1,381 1,424 3.11 6,663 7,416 16,612 16,043 33,896 31,402 84,251 82,470 20,808 23,808 12.40 21 21 24 27 11 15 FEDERAL RESERVE BANK OF RICHMOND 4 7 60 -64.71 70 23 Table IV KEY OPERATING RATIOS, AVERAGE MINORITY BANK, 1976 AND Size Groups Item Average in Millions Under 10 Total 1977 of Dollars 10-25 25-50 Over 50 1976 Percent of Average 1977 1976 1977 1976 1977 1976 1977 1976 1977 Total Assets: Operating Income 7.5 7.1 8.7 7.7 7.6 7.4 7.5 7.2 6.9 6.6 Operating Expense 7.6 6.7 9.5 8.1 7.7 7.3 7.1 6.8 7.1 5.9 Percent of Average Financial Assets: Gross Interest Earned 8.0 7.6 6.6 8.1 8.1 7.8 8.1 7.9 7.7 7.1 Gross Interest Expense 3.5 3.2 2.6 3.1 3.2 3.2 3.3 3.1 3.9 3.3 Margin 4.5 4.4 4.0 5.1 5.9 4.6 4.8 4.8 3.8 3.8 Net Interest The data in Table IV indicate that, for the banks as a group, the improvement in the expense structure in 1977 was a considerably more important factor increasing net income or profits of these banks than the improvement in operating income. In fact, even though total net income of minority banks was greater in 1977 than in 1976, the ratio of operating income to average total assets declined in 1977. On the other hand, even with increased deposits, loans, and investments, the ratio of operating expense to average total assets declined from 7.6 percent in 1976 to 6.7 percent in 1977. In short, the drop in the operating expense to asset ratio more than matched the drop in the corresponding operating income to asset ratio, thereby resulting in an improvement in net income for the banks as a group. While the drop in the operating expense to asset ratio was indeed important, perhaps even more significant was the decline in the ratio of noninterest expense to average total assets, which fell from 4.7 percent to 3.9 percent (Table V). The decline in this latter ratio was greatest dropping for the over $50 million asset-size from 3.6 percent to 2.5 percent. banks, Salary Expense A key expense that minority banks were able to improve upon in 1977 was the outlay for salaries and employee benefits. The improvement in this expense item is reflected in the reduction in the ratio of salaries and employee benefits to average total assets for the banks as a group (see Table V). Increased attention to recruiting and training, along with better utilization of personnel appear to have been the principal factors in this improvement. Salaries and employee benefits tend to be relatively high expense items at minority banks. One reason for this is that more personnel are needed to service a given dollar deposit total when the average size of each deposit is small. Most minority banks levy service charges but the relatively high salaries that these banks must pay to secure qualified personnel are an offset to revenues from this source. Table V RATIO OF NONINTEREST EXPENSES TO AVERAGE TOTAL ASSETS AT MINORITY BANKS DURING 1976 AND Size Groups Noninterest Expense Average Total in Millions Under 10 Net and Occupancy Furniture and Provision for Other Total 24 Benefits Equipment Possible Loan losses Expenses 1977 1976 1977 1976 1.9 1.7 2.6 2.2 0.4 Employee 0.3 0.5 0.4 0.2 0.2 0.3 0.8 0.4 1.4 1.3 4.7 3.9 6.4 ECONOMIC of Dollars 10-25 1976 Salaries 1977 25-50 Over 50 1977 1976 2.0 1.8 2.0 1.9 1.2 1.9 0.5 0.4 0.4 0.4 0.2 0.2 0.3 0.2 0.2 0.2 0.2 0.1 0.1 1.0 0.6 0.7 0.8 0.3 0.3 1.1 0.3 2.0 1.9 1.6 1.4 1.3 1.4 1.4 1.3 5.4 5.0 4.6 4.2 4.2 3.6 2.5 REVIEW, MARCH/APRIL 1979 1977 1976 1977 Moreover, at many minority banks, a large fraction of the clientele is likely to be made up of small business 1976, even though the former period was marked the deepest recession during the post-World War owners era and of moderately households more personnel established Loan time expenses provisions most more the at minority for possible As provision than any outlay expense charge-offs reported and income. loan losses percent loan V). declined between the provi- as a typical it is related to net on of provision greater ratio (see Chart 2). In most of the studies and observations to date on the performance of minority banks, analysts have concluded that the high volume of loan losses has kept these banks from achieving the earnings level enjoyed by nonminority banks of comparable size. A study of the 1970 operations of minority banks, for example, found that “the provision for loan losses consumes three times as much income at minority banks than at either new or established white banks.”6 Another ence in study concluded that the substantial profitability between minority-owned nonminority-owned banks was “attributed differand to the very high loan losses suffered at the minority banks.”7 Thus, by reducing losses from loans in 1977, minority banks succeeded in mitigating a long-standing problem in their current operations and in drawing for possible decreased in 1977. than cash- influence has a direct net loans the total losses Although salaries, with expense is not viewed (average 1977, the of average noninterest The ratio was much 1972-75 during was perhaps possible therefore to average in con- losses loan other like of associated in 1976 to 1.07 percent provement period banks a percentage for losses made expenses 1976 and 1977 (see Table sion for loan of customers progress in curtailing dramatic. assets, those or to require banks. Of all improvement individuals needs are likely than nonminority Losses trolling low income whose banking by II from 1.27 This im- that between for these years) the and 6 Donald L. Kohn, “Minority Owned Banks,” Monthly Review, Federal Reserve Bank of Kansas City (February 1972), p. 19. 7 John T. Boorman, New Minority-Owned Banks: A Comparative Analysis. FEDERAL RESERVE BANK OF RICHMOND Commercial Table VI NONINTEREST EXPENSES AT MINORITY DURING 1976 AND Noninterest Average Total (in thousands of dollars) Expense BANKS 1977 Net and Benefits Occupancy Furniture 403 2.3 77 1.3 44 49 159 106 Other 296 405 Expenses Equipment 394 Provision for Possible Loon Losses Total and 1977 76 Employee 969 closer to the rest of the industry’s one of its key operating expenses. 9.0 percent in 1977 compared 1976 (Table VIII). For Percentage Change 1976 Salaries rising sharply, earnings benefited. interest and fees on loans to average the 70 banks, percent above loans suggests loans The ratio of net loans was with 8.6 percent in 1977 rose in almost the 1976 level. This increase that minority bankers might 10 in net. be ex- periencing more success in developing loans, not only in their traditional markets, but also in nontraditional markets-particularly in the suburbs. 11.4 Income -33.3 940 experience 3.0 -3.1 with Other Noninterest Expenses A reduction in the relative burden of other noninterest expenses was also noticeable at minority banks in 1977. The ratio of net occupancy to average total assets dropped from 0.4 percent in 1976 to 0.3 percent in 1977, and the ratio of “other expenses” dropped from 1.4 percent to 1.3 percent (Table V). For the 70 banks taken in the aggregate, total outlays for noninterest expenses were 3.1 percent less in 1977 than in 1976 (Table VI). The need to lower the overhead at these banks has been emphasized in several studies.8 No doubt the decline in loan losses helped to bring about the relative reduction of “other expenses,” since in the past these other expenses have been closely associated with monitoring problem loans. Changes in the Revenue Mix In addition to the rather successful control of operating expenses at minority banks during 1977, a change in the distri- and and interest Yields Interest and dividends bulk of minority from interest bank and fees on securities income in 1977. and fees on loans on loans provided Gross the: income in 1977 increased by almost 9 percent over 1976, while gross income from interest and dividends on securities increased by only 2.4 percent. Of the four categories of securities held by most banks, only U. S. Treasury securities produced a larger gross income in 1977 than in 1976 Also, the percentage increase in (see Table II). income from U. S. Treasury securities was greater than that from any other single source. U. S. Treasury and Government agency securities constituted the largest element in the investment portfolio of minority banks in both 1976 and 1977. Holdings of these securities rose substantially in 1977 and in that year dominated investment portfolios to an even greater extent than in 1976. As a matter of Table VII DISTRIBUTION OF REVENUE AT THE AVERAGE MINORITY BANK IN 1976 AND 1977 As a Percent of Total Operating Income Item 8 See e.g.., Summers and Tucker, op. cit., p. 10. This study points in particular to high occupancy expense as a major factor depressing earnings of these banks. 26 ECONOMIC REVIEW, 1977 56.6 58.0 2.0 1.5 5.9 6.3 26.0 24.9 10.4 12.3 9.6 8.2 Obligations of States and Political Subdivisions 4.6 3.3 All Other 1.4 1.1 Service Charges on Domestic Deposit Accounts 5.4 5.5 Other bution of revenue over its several sources was an important factor contributing to profitability. For the 70 banks in the aggregate, an increased proportion of operating income came from interest fees earned on loans and less from earnings on government securities in 1977. Income from interest and fees on loans amounted to 58.0 percent of total operating income in 1977 as compared with 56.6 percent in 1976 (Table VII). As was the case for the banking industry generally, minority banks’ portfolios shifted toward loans in 1977, and, with loan rates 1976 2.8 2.9 1.4 1.0 Interest and Fees on Loans Interest on Balances Income on Federal Interest and Dividends -Total U. S. Treasury Obligations Agencies Charges, Income 1979 etc. Securities U. S. Government Securities Total Operating MARCH/APRIL Banks Funds Sold, of Other Service All Other with Income etc. 100.0 100.0 Table Vlll RATES OF RETURN ON FULLY CONSOLIDATED PORTFOLIOS OF THE AVERAGE MINORITY BANK IN 1976 AND 1977 ltem than Percent 1976 Obligations Agencies of Other 6.2 U. S. Government 7.9 6.7 Obligations of States and Political Subdivisions 5.6 5.1 All Other 8.7 8.7 8.6 9.0 8.1 8.0 Securities Loans - Gross Total Securities and Gross Loans the rate for 1976.9 6.2 5.9 U. S. Treasury securities market possessed might be noted, however, rates, the rate of return on loans for all insured comonly 20 basis points higher 1977 6.5 Securities- Total intimate knowledge of the by nonminority banks. It that despite rising interest total securities and gross mercial banks in 1977 was fact, holdings clined during of municipals and other securities dethe year. The large increase in Treasury securities may have been associated not only with yield differentials, but also with increases in public deposits requiring a pledge of such securities (Table III). Although the rate of return on gross loans at the average minority bank increased during 1977, the overall return on total securities and gross loans remained at about the same level as in 1976 (Table VIII). This was not too different from developments in the banking industry as a whole. The margin of difference in the overall rate of return between minority banks and the industry, .87 percent, was accounted for by the increase of 124 basis points earned by the industry on “all other securities.” This difference may result from the longer experience and more SUMMARY Taken as a group, minority banks experienced a substantial improvement in profitability in 1977. Both the number of profitable banks and net income for the group increased, although a large portion of the increased net income was accounted for by a relatively small number of the larger banks. Unlike the situation in 1976 when the net income came solely from securities transactions, almost all of the income in 1977 was derived from current operations. Improved expense performance as well as increased gross revenues figured importantly in the better profitability picture in 1977. Perhaps the most outstanding development in the 1977 operations of these banks was the reduction in noninterest expenses compared with the previous year. As a group, the banks were especially successful in reducing the loan loss expense. High loan losses have been the major obstacle to increased profitability at these banks in the past. The marked reduction in such losses during 1977 suggests that minority banks are devoting more resources to such functions as credit investigation and are placing the adherence to sound banking principles ahead of other considerations, such as community economic development. 9 Barbara N. Opper, “Insured Commercial Bank Income in 1977,” Federal Reserve Bulletin, Vol. 64, No. 6 (June 1978), p. 442. The ECONOMIC REVIEW is produced by the Research Department of the Federal Reserve Bank of Richmond. Subscriptions are available to the public without charge. Address inquiries to Bank and Public Relations, Federal Reserve Bank of Richmond, P. O. Box 27622, Richmond, Virginia 23261. Articles may be reproduced if source is given. Please provide the Bank’s Research Department with a copy of any publication in which an article is used. Also note that microfilm copies of the ECONOMIC REVIEW are available for purchase from University Microfilms, Ann Arbor, Michigan 48106. The identification number is 5080. I I FEDERAL RESERVE BANK OF RICHMOND 27
