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INTERMEDIATE TERM CREDIT - THE NEED AND THE CHALLENGE Remarks by Chas. N. Shepardson, Member, Board of Governors, Federal Reserve System, at the Eighth Annual Colorado Farm and Ranch Credit Conference, The Shirley-Savoy Hotel, at Denver, Colorado, on March 29, 1956. This country has just finished one of the most prosperous years in history. C Gross national product, industrial production and personal in- °me u ere all at record levels while consumer prices generally maintained an e V e n ancl keel. In spite of drought and flood in some areas, production of crops livestock was also at record levels. With bounteous production and a *6h level of consumer purchasing power, this should have been a top year for ^culture. Wllile Instead, we saw agricultural commodity prices continue to decline ^ n - f a r m commodity prices rose at an offsetting rate. The drop in farm Pl>i °es more than offset the bounteous production with the result that farm continued to decline in contrast to a material increase in non-farm in coiue. Naturally, this has given rise to widespread discussion about the farn * problem and the all too-frequent assumption that government can and should the answer to solve it. Certainly, government has a part to play. Many , conditions that plague us now are the result of government actions in of t , P&st. Some of them were necessary in the public interest, especially the ti'h auction incentives during the war. wisdom from their beginning. Uncw r w Some, however well intended, were of Some of those which were justified a r conditions may be of doubtful wisdom now. They constitute govern- Problems and sooner or later they will be solved by government. - 2But there are many things that agriculture can and must do for itself and many things in which commercial banking has both the opportunity and respon- sibility to play a part. Your presence at a conference of this kind is evi- n c e of your awareness of this fact and your interest in it. I want to con- gratulate the Colorado Bankers Association on sponsoring such a program and ^ alma mater, the Colorado A. and M . College, on cooperating in it. W a n t I also to express my appreciation of the opportunity to participate in these H u s s i o n s with you. First, let us review briefly the present situation of agriculture, prices advanced throughout 1955 in most sections of the country and now Sua 'a(3 at or slightly above their peak level of 1952. Farm mortgage debt in- c a s e d during 1955 but the increase was more than offset by rising land values S ° t l l a t real estate debt amounts to slightly less than 9 per cent of market Van, XQ compared with 20 per cent .in 1940 and even higher levels in earlier While non-real estate debt also rose during 1955, total farm debt a tin x CSnt ^presents only about 11 per cent of total assets compared with 19 per in 1940. • To the extent that rising debt reflects added investment in produc- ti V e resources, it may be indicative of increasing productive efficiency. To tent that it represents operating losses, it is a matter of grave con- ex • Unfortunately, available data do not show which of these two predomin- ate ' W Q do know, however, that the total of farmers' equities continued to ^ise > amounting to three and one-half times as much in 1955 as in 19/+0, and tw agricultural credit is still in a relatively strong position in most sectiOftg the country. 7 - 3Increased productivity per acre and per man-hour by means of advances ln agricultural science and technology has resulted, in the past fifteen years, in n a p0 35 per cent increase in output de-spite a 28 per cent decrease in farm PUlation. str This high and increasing level of productive efficiency, the °ng equity position of farm operators, and the continuing high level of c °*isuiuer purchasing power are all indicators of strength in the agricultural plc ture. tnan Offsetting factors include the burdensome and mounting surpluses of y farm commodities, unsound land use, losses of foreign markets, falling and rising costs, all of which have resulted in a reduced net income farming. These latter problems are receiving the attention of the Congress t h e UQ * present time and I would not venture to guess what the outcome will In the meantime, let us consider some of the credit problems growing out Of changes of the last few years. The high level of our national economy at the present time is largely dii e t o t h e our increasing productivity, resulting from the substitution of capital form of equipment, facilities and technical "know-how" for physical This is true in agriculture as well as in other segments of the econ- ^ Today the farmer must have technical "know-how" as well as integrity must have access to adequate capital as well as willingness to work. ihi e P increased farm productivity to which I have referred has made not only ° Ss ibl e but necessary the enlargement of the family farm unit if the opera- t0t> i s to make the most efficient use of modern technology and machinery. * ^ s u l t , the capital requirements have become staggering in terms of our ^ ^ standards for farm credit. As -uThe value of production resources on typical commercial family0 Perated farms, in 1955, ranged from an average of $25,000 for dairy farms to th an average of over £>100,000 for some grain producing farms. Including ® large number of small farms in the South, the national average amounted to about i24,000 per farm in 1955, compared with an average of ^6,000 in i g con t i n u i n g to increase. These figures refer to the physical capital used in farming — the lan <*, buildings, livestock and equipment. They do not take account of the of a modern dwelling and modern household equipment, which are almost an Essential part of farm equipment if we expect to hold our capable, ambi- tiou s young farmers and their families on the farm. tho operating capital necessary to meet current cash expenses, which are also ^ e a s i n g from year to year. to Neither do they include ^10,000. These two items may well add another &3,000 Usually this large capital investment on a farm must be obtained controlled by one individual. The whole technological revolution in agriculture of the last fifyears, as well as the rise in price structure of the economy, is reflected ln these figures. With the increases that have occurred, the amount of capi- deeded per worker in agriculture now exceeds the amount required in manUf?ic turing and other off-farm activity. Before the war, the average farm in this country had an investment in Machinery and equipment of about U 0 0 . Today the machinery inventory aver- v3,loo, and on a typical commercial farm, outside the South, the necessary ac h i n e r y and equipment may be valued at 010,000 or more. Even in terms of - 5Con stant dollar values, the current investment per farm in machinery and shipment is nearly four times that of 1940. Production expenses per farm in 1955 also averaged about four times the l % 0 level, or $4,500 compared with $1,050. ^errns With increased overhead in capital investment and increased operating costs, the need for in- leased efficiency and increased output per operating unit is obvious. th-is In connection, it is interesting to note that the biggest increase in oper- alj n s expense is in the cost of depreciation on -machinery and equipment, ^ther emphasizing the importance of volume per unit. These changes sym- the change in farming from a largely self-contained, manual operation a highly complicated commercial business. To a much greater extent than in the past, credit, properly used, must y»°e one of the tools by which farmers acquire and operate today's effiiervt enterprises. We should expect that average debts per borrower will be ^Uoh i • w g e r than we have been accustomed to think of in the past, particularly f beginning farmers or for farmers on units being converted to new types arm operations. This increased borrowing involves three types of credit, namely - (l) 1 °ng-term mortgage credit, primarily for the acquisition of land, (2) er ftediate-term credit for the acquisition of equipment, facilities, breeding u v estock and major land improvements or shifts of enterprises from which Returns accrue over a period of years, and (3) short-term production credit. With rising land costs and the need for larger holdings to provide eff i c i e n t operating unit, the problem of land acquisition is becoming in^ i n g l y difficult, especially for the beginning farmer. There would seem - 6to b e real need for more accurate appraisal of land values based on long-range pr °ductive capacity. land Some farmers are in difficulty today because of marginal bought at inflated values based on a few abnormally good years. othe On the r hand, loan values on good land are frequently held unrealistically low. L °an limits might also be raised on amortized loans which provide for variable ainor ti 2 ation payments based on earning capacity of the operation. Short-term production credit has normally been adequate and, while the ne Us e d for operating capital is constantly increasing, the good operator can Ually secure his needs, although not always at as favorable terms as night be ^sired. The relatively new and increasingly important need is for more intor- ^ i a t e term credit. This need always becomes greater at times of declining ^ i o e s and rising costs when farmers find themselves unable to finance such ^ n d i t u r e s from one year's net earnings. Pres It is especially pressing at the * * t time. We have noted the rapid rate of farm mechanization. la a y6ar Farm machinery semi-permanent type of investment which produces income over a number of s. jugt a g t h G i n c o m e received over a period of years, similarly a lo a n t o Qai?s » purchase such machinery should properly be repaid over a period of Machinery is only one of several important investment needs that are Either f i x e d ca p i t a l , as land, nor current operating capital, such as crop * pei i3e, With the high cost of land, farmers are striving more than ever to their present land holdings more productive. 3 Many soil conservation meas- and irrigation systems also require and merit longer term credit than is y available. - 7A similar situation is found in the case of the farmer who needs to ch *mge h i s f a r m i n g operation to a new type better suited to market conditions, to the resources of the farm, or to his particular interests and aptitudes. He]? e there is a need for a form of intermediate credit which permits matching loan advances to the steps in the conversion process and the terms of ^Payment to the expected flow of income. In making intermediate term loans, it is imperative that a realistic and careful appraisal be made of the situation, including not only the integ- industriousness and collateral of the borrower but also his capability the soundness of his plan of operations. The strong probability that the a(3d e - <* investment will produce a more profitable return on the entire operation sh °uld be a key factor in granting the desired extension of intermediate term As mentioned before, modern farming is a highly complicated underinvolving a wide variety of technical and business problems. Unless th e Coin borrower has the training or is vailing to seek and use the advice of Petent specialists, he is not apt to be a good risk regardless of his colf o r no business transaction is a desirable one unless it promises to e d u a l l y profitable to both parties. In appraising the borrower's proposed plan, there are several points t 0 v. e en considered. First, is the unit large enough or can it be made large °uSh without prohibitive cost to provide an adequate living for the operator ^ ^ hi s family and still leave enough margin to repay the loan over a reasonnumber of years? f l a t e d use? Second, is the land adapted or adaptable to the con- Much of our present farm problem comes from the misuse of land, In 11 s Pite of years of concentrated emphasis on soil conservation and proper larici use, we still have vast acreages with a low or hazardous crop potential ^ a t should be returned to grass or timber. Is the borrower's schedule of anticipated income realistic in maklil S due allowance for weather cycles and market fluctuations? The present ^fficulty of many wheat farmers and cattlemen is in no small measure due to thft Ie unwarranted optimism generated by the unusually good weather and abnor- ^ y high prices during the war and early post-war period. t Q r m c A sound plan for redit should make provision for years of uncontrollable adversity but should also require offsetting prepayments in years of higher than antic^Pated returns. anci It should also take account of the possible effect of quotas acreage allotments and have sufficient flexibility of alternative enter- ^ i s e s to meet such conditions. Unea tbjQ V o f The.farm farmoperation plan should living ahead. document, outbethe broad outthe for bo thea period It laying must not regarded by u °rrower as a useless paper which he signs to get the loan and then ^ P t l y forgets. 1 A properly prepared plan is a joint product in which the rover and lender are both vitally interested and which will, in fact, be err On a e d to frequently. . It should be subject to appraisal periodically, based actual achievements, and should be flexible enough to be modified by mutual «ment if conditions require such change. It is much better that these guards be written down specifically and accepted by both parties so the W e r , as well as the lender, knows exactly what is expected. The borrower is th, nu s assured that the financing will be available in the amounts and on the terina nPromised if he meets the terms of the agreement. - 9Banks with competent agricultural representatives should be in excellent position to make such loans and they appear to be increasingly interr e d in this development. t u r a l Other banks which are not staffed with agricul- specialists may find it somewhat more difficult. City banks can be of much assistance to their correspondent banks in tlo an J helping them to develop this phase of their farm lending service. In addi- n to the technical assistance which the city banks can provide, they have increasing opportunity and responsibility to participate in the larger ° a n s for which the local banks' resources are not adequate. A sound farm and loan agreement make a highly desirable, if not absolutely essential, a s i s appraising such participations. It is of doubtful value to the individual or the community to assist hirfl Sub in contiruing on an inadequate unit which shows little promise of being stanti a lly improved and where the applicant runs the risk of seeing his R e t i m e savings and possibly the land itself gradually dissipated. Those C o v e r s who cannot develop an economically profitable unit, either because 0f lack of physical and financial resources or because of insufficient man- u a l capacity, should be encouraged to supplement their farm earnings with ^ai't-time, off-farm jobs or, in some cases, even to consider full-time, off^ employment. This latter move often results in the individual improving °wn position and at the same time allows the land to be ^ g e r and more efficient units. c recombined into With the present cost price situation in agri- ^ t u r e j everything possible should be done to promote greater efficiency. -10In this connection, we should not overlook the credit needs of the Part-time farm operators. 0r If a person has a reasonably secure, off-farm job °an get one and he operates his farm on a part-time basis, his loan repayability may well be based on his job earnings as well as on the earnings from his farm. his Thus, it may be possible to help him on a sound basis whereas farm earnings alone would not justify the loan. The management potential of the prospective borrower — a major con- a e r a t i o n in today's complex farm operations — can be appraised to some ext9ri t on the basis of his past performance. Some appraisal can also be arrived based on the knowledge and judgment that he exhibits in mapping his farm Plui1 ' and such moves should be undertaken gradually and with sufficient flexibility So Addition of or conversion to a new enterprise always entails some risk that the plan can be slowed down or speeded up as developments warrant. At first, this farm planning may seem onerous and costly. However, the experience gained in processing earlier plans will serve as a basis for ths more expeditious handling of subsequent cases. Many of the problems Countered in preparing one plan will be common to others. ^ c u l t u r a l workers can be of help. Federal and State They can help formulate the basic data ^ e d , such as land-use classification, crop yields, price prospects, crop and livestock production goals, and similar considerations. S01 fo They may be able *e cases to work with a prospective borrower in preparing a specific plan * his f a r m > t o b e submitted with the loan application. Since a prospective borrower must scrutinize his projected income ^Pense picture carefully when a farm plan is prepared, he is less likely - 11 to Purchase a machine or some other item that he does not actually need for heater efficiency. and In fact, there is reason to believe that some farmers ranchers over-invested in stock or equipment during good years beyond the opacity or need of their operation over a long-time average. Bankers can perf ltu o r m an important service to farmers by helping them to limit their expend- r e s to those items which are most likely to improve their efficiency and in coiue. It should not be implied from these remarks that banks are not meetthese credit needs, particularly in the intermediate term area. h Some ave been doing an excellent job in this field for several years. Others, are equally interested in serving their farm customers, have felt they y n restrained from making such loans due to some regulatory restriction. this connection, the Federal Reserve Board has stated in a letter to all 6cJe ral Reserve examiners that there is no Federal law or regulation which eve llr n t s commercial banks from making intermediate term loans for agricul- al purposes and that such loans, made on a sound credit basis, are not to Corv 3idered as undesirable. Some bankers have attempted to meet this situation with annual re~ QVa l s of short-term loans. It is entirely possible that such loans may have b °riticized by examiners if the terms of the note were not being met even tho u £h the lender and the borrower both understood that renev/als might be Sa l3 r y over a period of years before the loan could be liquidated. It is ° Possible that some bankers may not have realized the needs or potential rtunity for profitable service in this field. - 12 We have little knowledge of the over-all extent of intermediate ter &i lending to farmers and we need to know more. Some day our loan statistics ^ y have a three-way break to include intermediate term loans, in addition to the Present two-way break on mortgage loans and short-term loans. The Federal Reserve System is planning a study of agricultural lending by commercial banks ^ e near future. ban It is hoped we will learn from the study the extent of k Participation in intermediate term lending and some of the characteris- ti0 3 and conditions of such lending. Heretofore, farm financing has been a rather scattered and haphazard ^ H a k i n g , distributed among private mortgage holders, merchants, nonbanking inst U u t i o n s , and commercial banks with little consideration to the over-all needs or capabilities of the entire operation. The farm plan and loan agree- ^ t suggested above would seem to provide an excellent vehicle for a package pr °gram to cover the entire farming operation. There is an increasing and need for long-time and even continuing use of borrowed capital. * 'f arm plan and an open-end mortgage might be the basis for a continuing 0peri a line of credit," which would do much to put commercial farming on a par commercial business so far as financing is concerned. I would like to add one other point. bal We are in a period of delicate ance so far as the stability of the economy is concerned. P °aable income is at a record level. SlTt bui Upv Consumer dis- Consumer demands, together with invest- expenditures by businesses, by State and local governments, and by home l d e r s , are pressing on productive capacity in many areas with corresponding ard pressures on prices of industrial materials and products. This is a Iftnf. j e r of concern to all of us and, more particularly so, to the farmer who is - 13 Cau §ht between rising costs and a level of prices for his produce which has kittle immediate prospect of improvement as long as the market is under the Resent burden of agricultural surpluses. While everyone might like a little inflation in his own business, I ^ink all of us realize the long-run importance of maintaining the value of the do Uar. This is becoming of increasing importance with our increased reliance insurance, pension plans and similar fixed income devices. eyce In the face of ssive demand on existing production and inflationary price pressures in the industrial area, we must find a way to curb these pressures without unduly ^ s 1 * i c t i n g the flow of credit into the creation of added production facilities. This calls for real discretion and unselfish statesmanship on the P a n of lenders to see that available credit, which is adequate for a continued hlgh ievel of economic activity and growth, is allocated to the best long-run of the community. This means a prudent restraint on extensions of credit speculative or consumption purposes — even though more remunerative — to ^ e end that adequate credit may be available for the expansion or impro^e- ent of the more essential production facilities. 111 a n Cre agricultural area such as this, that lenders adjust their allocations of <3it i n iniat It is especially important, s u c h a w a y a g t 0 Q needs of farmers. a s 3 u r 0 the availability of credit to meet the legit- Only in this way can we hope to come out with a strong, w o u s farm economy when the present imbalance of farm production to demand is Erected. In closing, let me say that agriculture is still in a strong credit P °Pition. While we have some serious problems of rising surpluses and falling - U - P r i ces, aggravated in some areas by drought, there is reason to hope that S0rae Q M e d i a l legislation may be developed in the foreseeable future. In the antime, I am sure that commercial bankers will continue to strive to meet the i 6 a,j legitimate and meritorious credit needs of good farmers and that you will sist and encourage them to develop better management techniques, improve their e f f i c i e n C y and adapt their production unit to the changing demands of ^ domestic and export markets.
@FedFRASER