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WHAT ARE THE CHALLENGES NOW FACING AGRICULTURAL LENDERS? Remarks by Chas. N. Shepardson, Member of Board of Governors, Federal Reserve System, at meeting of American Institute of Cooperation, Fort Collins, Colorado, on August 19, 19^7. Never in the history of agriculture have we seen such an evolution — yes, almost a revolution — s een during and since World War II. in agriculture technology as we have New methods, new materials, and new ^chines have all combined to increase productivity per acre, per animal, ^ ta per man-hour of labor. This, in turn, has brought a scries of impor- ^t changes that are affecting both agriculture and the general economy. First, let us consider the impact of increased productivity per a °re and per animal unit. Since 19U0, per acre production of major crops gone up approximately 30 per cent for wheat, 55 per cent for corn and 65 Per cent for cotton. aa much. 35 Per cent, milk per cow 30 per cent, and eggs per layer 68 per cent. Meat, milk and egg production have increased about Beef production per head of cattle on farms has gone up over the aggregate, production per acre is up about 20 per cent and per animal C e d i n g unit 27 per cent. The increase in human productivity is even more striking. Althoug employment dropped 31.5 per cent from 1?U0 to 1956, production per man l e a s e d 95 per cent with the result that gross farm production for human Use increased 37.5 per cent in the same period. While this increased productivity of labor has been the key to the rising standard of living throughout our economy, it has special - 2significance in the credit problems and policies of farmers and farm lenders, These problems stem from the fact that increased productivity is primarily the result of the substitution of capital for labor. For example, land and animal productivity is being increased by the use of improved seeds, feeds, a nd breeding stock and more and better fertilizers, insecticides, herbicides, ai ~td other agricultural chemicals, together with the increased use of pur- chased power in the form of fuel and electricity. Of course, this increases c *sh operating costs, and per capita operating capital requirements for these items rose from $750 in 19^0 to $2622 in 1956. More and better power and machinery increase the number of land ^ d animal units that a man can handle but they called for an investment of 11,7148 in 1956 compared with $220 in 19b0. The ability to handle more leads to fewer and larger farms and land investment per worker rose S2,H6l to $10,793. In the aggregate, this amounts to an increase in Vestment per worker from $3,631 in 19k0 to $15,163 in 1956, part of which, of course, reflects the rise in prices and depreciation of the dollar durthis period. Naturally, this investment per farm worker varies widely *ith different areas and different types of farm enterprises. It ranges en average of $59,000 for the Corn Belt grain farm to s$35,000 for a ^Iorth Plains cattle ranch, $1)4,000 for a Northeast dairy farm, and $0,000 f ° r a Southern Piedmont cotton farm. There is no indication of any reversal in this trend of rising inv estment per worker. livi ln In fact, continued improvement in the standard of ng, both of the farmer and of the population as a whole, is dependent tto small measure on its continuance. However, this continuing increase - 3in capital requirements calls for more credit and on different terms. Twenty years ago the farmer was concerned with two types of credit. One was long-term real estate credit used most frequently in the acquisition of land or for the consolidation of debts. Traditionally, farmers have feared mortgages on their farms and have sought to get out from under a mortgage debt as fast as possible even at the expense of crippling their operating efficiency. The other was short-term credit used primarily for current cash operating expense incident to crop production or feed lot operations . Such credit was usually self-liquidating at the end of the season. In this situation we had need for two fairly distinct types of Anders. h There was the long-term real estate mortgage lender represented Y such groups as the Federal Land Banks, insurance companies, and individual lenders. Real estate loans were normally made for moderately long periods w ith or without renewal privilege but rarely with any scheduled provision amortization. In the short-term area, we had the PCA's, commercial banks and Merchants. Loans in this area were almost invariably for one year or less and were primarily for current cash operating costs, Except for the pur- chase of feeder livestock, these costs were relatively small. With home- pr °duced power and a minimum expenditure for off-farm supplies and services, a farmer's need for current cash was negligible. Security for such loans v aried from nothing more than a man's note to chattel mortgages on the crop anci all the livestock and equipment on the place. In most cases, however, founts were small and the lender was more concerned with the adequacy of th e security than he was with the soundness of the operation and its repaypotential. Loans were scattered among long and short-term institutional - h - lenders, merchants and private individuals, with each concerned about the security of his own loan but rarely with anyone in position to make an overall appraisal of the entire operation. Today, the situation has changed. Out of the U.8 million farms in the country, approximately 2 million commercial farms turn out close to 90 per cent of our agricultural production. Without minimizing the social contribution of the part-time and residential farms and their credit needs, ^ is to these commercial farms that the country must look for its food and fiber, and it is on these farms that the greatest need for adequate and appropriate credit has developed. What are these needs? Wi First, let us look at the long-term area. th the increasing size of farms and the rising cost of land, the invest- ment in land itself for some operations may be more than the average man can Reasonably expect to accumulate during his lifetime. This means that he may need for a mortgage loan that can be amortized down to a conservative level and the balance carried on a continuing basis for a relatively long L i k e any other business, a farm that is adequately staffed, stocked and ati equipped, and that has the necessary working capital for efficient oper- °n, has a far better earning potential and hence is a better credit risk tha n the one in which too much of the available resources are tied up in land or plant with the result that operations are handicapped through lack 0f ^ to equipment or resources to take advantage of fortuitous opportunities that arise. This is even more important in farming, with its susceptibility "the hazards of nature, than in almost any other business. Masons, it would seem important that farmers For these avoid tying up too much of - $ - their resources in land or committing themselves to amortization payments that take so much of current income as to cripple their operating budget. Since mortgage loans are limited initially to a safe percentage of a conservative evaluation, it would seem that amortization payments, each °ne of which further enhances the security, might well be held to minimum founts perhaps with options for prepayments. of We should never lose sight the fact that mortgage payments are in effect forced savings and that we attempt to enforce too much saving at the expense of current living sooner or later drive the young farmer, on whom we depend for the future, °ut of business. Next, let us look at the short-term area. lAJhen the farmer shifted f rom horsepower to mechanical power, he immediately undertook a big cash ex Pense for fuel and maintenance of his power equipment. The advance in Production technology involving the increased use of commercial feeds, fertilizers, insecticides and other agricultural chemicals, together with improved seeds, adds to productive efficiency but it also adds to the cash e *Pense and the need for short-term credit. As the volume of this credit Ureases, it becomes more and more important that it be geared to an established line of credit based on the over-all earning potential of the borrower. introduction of high speed power equipment introduces a time factor that ^ e s it possible to minimize many of the hazards of nature that formerly c 3 ° t the farmer heavily in the form of damaged crops. For example, an insect "testation that formerly would have destroyed a crop before a farmer could to it with horse-drawn equipment can now be saved p0s sibly even with high speed tractors. with an airplane or Important time can be saved and a - 6serious loss averted by the prompt replanting of a crop destroyed by rain or frost. This can frequently be done with day and night tractor operations where a horse operation, with its fatigue limitation, would be too slow to ^ake it worthwhile. But time is of the essence and the farmer must be in Position to know that he can cover the added expense without having to take time out to make new credit arrangements. In other words, he needs a line credit that he can count on to meet day-to-day developments. Obviously, the establishment of such a line of credit must be predicated on a knowledge the borrower's total financial picture, as I shall discuss later. In addition to the changes in these long and short-term needs, a netT need has developed in recent years in the intermediate-term area. This c overs loans for items that have a continuing usefulness over a period of y °ars and that cannot reasonably be expected to be paid for out of one year's operation. b The recent Federal Reserve survey of farm loans at commercial ^ks showed that loans of this type constituted 37.6 per cent of all loans, ^counted for one-third of the dollar amount outstanding, and were owed by 0t)e -half of the borrowers. These loans may be divided into four principal categories — equipment and machinery, foundation livestock, land and building ^Provements, and consumer durables. Developments in mechanization have resulted in increased man-hour pr °ductivity but they have also resulted in more complicated and expensive ^chinery which should be amortized over a period reasonably related to its pJ? °ductive life. 0f Tractors, harvesters of various types and other major piece* equipment certainly have as long a lif automobiles. and more productive value than If 2$ per cent down payments and 30 or even 36 month terms - 7or * cars can be justified — and they are becoming increasingly common — it Would seem that dairy equipment, tractors, and more especially crop harvest s , which are used only a few weeks or months at most each year, might well be financed on similar terms. Yet the survey to which I fust referred showed of the loans on farm equipment representing 20 per cent of the total lo ahs outstanding, 60 per cent had maturities of 12 months or less and 90 per Cer *t of two years or less. Production of livestock and livestock products is already a major enterprise in this country. fo Furthermore, the most encouraging prospect * increased consumption of agricultural produce is in the form of livestock an <i livestock products. the ls This means that we should anticipate and encourage diversion of more land to livestock production. But here again the fanner faced with an investment in breeding animals that can pay out only over a pe ^iod of years. For example, the average productive life of either a beef ° r dairy cow should be something over four years. However, the bank loan sur- showed that 8? per cent of these loans, most of which were cattle loans, maturities of 12 months or less. You cannot starve a profit out of a cow. many dairy and beef cattle men, either from lack of judgment or pressure ^ e lender, have curtailed needed feed and care in order to meet onerous ain 0rti2ation payments and thereby sacrificed profitable production. The third type of intermediate-term credit need is for land and Elding improvements. Here again expenditures are large and benefits accrue °Vei? a period of time. There has been more general recognition of this situa- ti0n V lenders as illustrated by the fact that loans for this purpose averlarger than for any other purpose except acquisition of land and that - 8they were written for longer terns. Forty-eight per cent had maturities of 18 months or more and 36 per cent had maturities of h years or more. These longer maturities may he further explained by the fact that 63 per cent of the dollar amount was secured by real estate mortgages whereas twothirds of all other loans for intermediate term investments were secured by chattel mortgages. With the increasing interest in irrigation, drainage, and clearing and leveling of land, together with building modernization for functional efficiency, there is going to be a growing need for this type of credit. this connection, it would seem that, as a result of such improvements, "tore consideration might be given to reappraisal of the farm valuations as a base for mortgage credit. Certainly, land that has been leveled and pre- pared for irrigation or that has been cleared, terraced and sodded to good Pasture or that has modern, efficient buildings for handling the farm operat ions has a greater productive value than before and should provide an im- proved base for credit. In fact, fuller and more prompt recognition of such ^Proved productivity as a base for more credit would greatly increase the °Pportunity for a man with limited resources to acquire an unimproved or r ^ d o w n farm and build it into a profitable productive unit. The fourth category of intermediate-term investments covers con- f e r durables. bil In general, this includes household equipment and automo- es which contribute primarily to the living comfort and convenience of the farm family but which may add little to the productive efficiency of the operation. Loans for such purposes should be based on the net income resources of the farm family rather than on the amount they will contribute - 9to the productive capacity of the farm business. It should be borne in mind, however, that living conditions make up an essential part of the compensation for farm labor, either family or hired, and that some investment in household conveniences may be an essential part of the cost of farm labor. Obviously, with these changing needs in the long and short-term areas and with the introduction of this new need for intermediate-term investments, farming has become big business and its credit needs must be handled on more and more of a business basis both by borrowers and lenders, fortunately, lenders generally have been aware of this and commendable progr ess is being made. However, there are several things that would seem to justify further consideration. One is the recognition of the fact that a farm operation is an integrated business. te Vihile there is need for long, intermediate, and short- rm credit and possibly from different lenders, the amounts involved require th at they be based on the earning and repayment potential of the operation as a whole and not on single crop or livestock enterprises or, as has so ^requently been the case, on the adequacy of the collateral. This is espe- °ially true of the intermediate and short-term credit and to an increasing G *tent of long-term mortgage credit as it is used more and more for inter- mediate purposes. Thi3, in turn, calls for more business planning in projecting deeded expansion and .improvements and more careful projections of earnings; ex Pected to result from such investments. It calls for analysis of the 0v er-all financial resources and credit requirements of the operation, in- k i n g the need for reserves against unpredictable hazards. I realize, of - 10 course, the difficulty of such planning, particularly because of the hazards to which farming is subject. On the other hand, I believe the hazards can be more adequately met than has frequently been the case in the past. example, credit life insurance has untimely death of the operator. For done much to remove the hazard of the In fact, the whole gamut of insurance cover- ages available today has done much to eliminate or reduce many of the old hazards. Of course, this is an added expense but with the amounts involved today few farmers can afford to carry this risk themselves. Other business has long since recognized this fact. Fluctuations in market prices certainly create a problem in estimating income, yet greater attention to available market information regardin 8 supply and demand and projected production could do much to overcome this difficulty. Certainly, weather hazards are unpredictable bat the man who bases his ave if yield estimates on a few favorable years without regard to the long-run rage of weather in the area is incurring unnecessary risks, particularly he adjusts his operations and standard of living upward to unusual and ^sustainable levels. of Our recent drought experience provides ample evidence this. Standards for the establishment of adequate reserves against these hoards need to be developed as well as planned provisions for prepayments 111 Sood years against the deferments that must be and usually are granted ln had years. Ski 0f Unfortunately, many farmers lack the business training and U to do this kind of planning. Here is the great challenge to lenders. course, such planning, analysis and loan supervision cost money. This - 11 is another argument for a one-step credit service. Such analysis and super- vision can be more effectively and economically rendered by one lender for the entire credit program of the borrower than by several lenders, each covering only one phase of the operation. Such costs should be set up as service charges separate from the basic interest rate and should be sold as 3 service that is worth the price. In this connection, I am reminded of the story in a recent paper b y <J. L. Robinson, Agricultural Economist for the Federal Extension Service, a bout the farmer who called on his lender to see if he could arrange for credit to buy some machinery. a greed to make the loan. After analyzing the situation, the lender Seeing the farmer sometime later and having heard n °thing further about the loan, he remarked, "I suppose you decided not to bu r The farmer replied, "Yes, I bought it but I financed it with the dealer. I wanted to save my credit with you... to J that outfit you wanted." f all back on if I need it." This illustrates the thinking of too many borrowers and the need f °r understanding that the prudent lender is going to base his loan commit- ^ t s on the borrower's total credit picture in any event or else he is going to th charge a rate that protects him. at the farmer paid the dealer In this case, for instance, it developed per cent against the 7 per cent offered V the lender. The Farmers Home Administration has provided an excellent example 0f a program to cover a farmer's total credit needs. Since FHA loans are W t e d to clients who are ineligible for normal commercial credit, superv ision costs have been high but the number of clients who have graduated to - 12 regular commercial credit is indicative of what can be done with proper Planning and credit supervision. Many banks are now providing total credit needs of their farm customers although most of the intermediate and longer term needs are on a tentative renewal basis with few planned commitments that the borrower Can count on. This may be all right for the protection of the lender but ^ is inadequate for the needs of the borrower who must be able to see ahead °n his plans and operations. This need in other business has been recog- nized for some time and intermediate-term loans for business and industry, hased on approved plans and projections and subject to review and superVl sion by the lender as to performance, have been in use for several years. Pa rm lenders must find the way and devise the safeguards necessary to meet ^ e farm credit needs in this area. Failure to do so may result in pressure f °r further direct government lending through FHA or some similar agency. The recent extension of PCA terms up to 5> years in proper cases s a step in meeting this need and the further broadening of Land Bank credit f °r general farm purposes is another. a The use of open end mortgages offers Possible method of establishing lines of credit without the trouble and e *Pense of repeated examinations and recordings of mortgages or other col- lat eral. To provide the type of service I have suggested, lenders must be Staf fed with or have access to the services of men with a broad background ^ ^raining and experience both in credit and in the credit needs of modern a rrning> • es Many banks are establishing agricultural departments to meet this In some cases city banks with few direct farm loans of their own are tablishing such departments to service the needs of their small country - 13 correspondents who are unable to provide this service themselves. Unfortunately, the progress so far is still inadequate to meet the needs of the country. The Farm Credit System seems to have gone farther than the banks ^ this respect. I would raise a question, however, as to whether many of the local PCA's and Farm Loan Associations are adequately staffed with properly trained men or whether they are placing too much reliance on availability of th eir local boards. In connection with the problem of staffing and also the cost of ^alyzing and servicing loan requests, I would raise a question as to the Possibility of closer coordination of the several units of the Farm Credit Astern. The opinion is frequently advanced that long and short-term credit two different things requiring different men with different training, ^is may be true within limits but with the increasing size, complexity and ^terdependence of farm credit needs today and the need for each lender to the whole picture, closer coordination is inevitable. Certainly, it seem that two cooperative farm lending organizations, serving overl i n g needs of essentially the same farmers, might well consider the greater Use Sta of common quarters and joint staff, thus permitting more efficient use of *f and clerical personnel and more ready access to credit files of common Merest to both agencies. tion Vis * Commendable progress has been made in this direc- I am convinced, however, that the rising cost of the technical super- ion required to service these new credit needs will necessitate further ste Ps in this direction. - xu - The attracting and holding of competent agricultural credit men also presents the problem of providing for the future growth and progress of such men. tion. b This is a problem for the personnel division of every organiza- Perhaps the secretaries or managers of local PCA's and NFLA's might e moved from smaller to larger associations as their ability and experience ^arrant and possibly to the district offices. agricultural agents in many states. a This is common with county No institution can afford not to have sound management training and promotion program if it expects to attract ^ hold the type of management personnel essential to the growth and devel- opment of any sound business today. This applies to cooperative as well as Private business. Another big need of farm lenders is more current and comprehensive research and statistical information on the changing credit needs of agriculture. ty This might include better current information on the magnitude and Pe of need in different areas and different sectors of the farm economy; the establishment of more adequate norms for reserves against loss in differ- eri t sectors based on loss experiences and their causes; and certainly studies as to the implications of the growing importance of vertical integration in SGv eral phases of agriculture. I have already talked too long and I have not mentioned the chal- *enges to the Bank for Cooperatives. While much that I have mentioned is of interest to them, this problem of vertical integration would seem to be ° ne of special significance. If cooperative hatcheries, feed companies and pr °cessing plants move into this area of financing producer operations as Sorne appear to be doing to meet the competition of private concerns, their -15 credit problems in this area will provide a real challenge to the Bank for Cooperatives. In fact, this development has broad implications for the entire agricultural economy. In conclusion, let me add one thing. I have talked at some length about the growing need for more adequate farm credit. I would Emphasize that this need for adequacy is more in suitability of terms than in amount. credit. Coupled with this is the need for more wisdom in the use of In some cases an increased line of credit is surely justified. Credit invested to improve income over the cost of the credit advanced is Profitable to both borroitfer and lender. to a losing operation that cannot be put on a paying basis is a loss to all concerned. In such cases the amount of credit extended might better be r educed or even withheld entirely. Se On the other hand, credit extended The lender may be able to protect him- lf through liquidation of his security but the borrower who continues to Pour credit into a losing business will eventually lose his equity at which p °int the lender loses a customer. >fy- challenge to all farm lenders, then, is to provide and encour- a ^e the more intelligent use of credit on terms appropriate to the needs an d to sell the borrower on the idea that supervision requisite to the ser- v i n g of such credit is worth what it costs.
@FedFRASER