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ì]r $ r y O STATEMENT ON / FARM FINANCIAL CONDITIONS AND THEIR IMPACT ON AGRICULTURAL B A N K S , P TO rullio LLÀJk-** SUBCOMMITTEE ON FINANCIAL INSTITUTIONS SUPERVISION, REGULATION AND INSURANCE » BY y LYNN NEJEZCHLEB FINANCIAL ECONOMIST FEDERAL DEPOSIT INSURANCE CORPORATION 10:00/a.m. Wednesday, March 20, 1985* Room 2128, Rayburn House Office Building Mr. Chairman, and members of the subcommittee, I am honored to have this opportunity to testify on the subject of the farm credit situation. statement concerns two major areas: 1) the exposure of My of commercial banks to problems within the agricultural industry and 2) the current condition of agricultural banks. However, before addressing these areas I think it is important to say a few words about the nature of the agricultural problem and the financial condition of agricultural producers, since they will ultimately have some impact on financial institutions. Current agricultural problems are often depicted in terms of a large and small farm context. We often hear the problem portrayed in terms of the smaller, less efficient sized farms being unable to compete with larger farms, who are able to utilize" the latest and biggest technology. But this phenomenon has been going on for quite some time, and while it is true that it has resulted in the disappearance of a large portion of the farm population over the years, it has not resulted in the kind of financial difficulties we are witnessing today. In reality, economies of size or technological change have very little to do with current financial problems. During optimism the 1970s, concerning the the agricultural outlook for community agricultural developed producers. an increased Agricultural exports during the 1970s grew at record rates while real farm income averaged well above the previous two decades. relatively limited production In a world of high population growth and capabilities, it agriculture would continue to reap large benefits. was believed that U.S. Marginal land was brought 2 - - into production and land prices were bid up at rates well above the overall rate of inflation. During the 1980s, however, agricultural exports did not continue their upward spiral, and in fact, relative to other leveled off. currencies, The increased value of the dollar increased production abroad, commodity price supports at home, and foreign debt problems were all factors which contributed to the worsening production export continued picture. at record At the rates, substantially from their bargain rates same and of time, real the domestic interest 1970s, agricultural rates making increased increased debt loads substantially more burdensome. These developments have had their major impact on cash grain farms of the Midwest and Northern Plains have certainly been affected. farms are not experiencing farms are experiencing, states, although other farm types and areas While national statistics indicate that large the degree of financial stress that medium size these data are probably biased since cash grain farms of the Midwest and Northern Plains states are under-represented in the largest farm size group. about financial load, not farm According to agricultural economists who are knowledgeable conditions size, is of the agricultural critical producers factor in the in determining Midwest, the debt degree of financial stress experienced by any given producer. In essence, many debt contracts based on the optimism of the 1970s are no longer viable given interest rate and export market developments thus far in the 1980s. family-size A recent commercial USDA farms, study owing indicates over that 46 percent about of one-third all farm of all debt, had -3financial problems ranging from difficulty servicing debts to technical insolvency. A complicating development institutions is the recent decline for both producers and in farm real estate values. declines have occurred in the Midwest and Northern Plains financial The largest states, with some states exhibiting declines in farm real estate values of as much as 28 percent from their 1981 peak values. Indications are that further declines are in the offing, although in many areas land values have fallen to the point where an investment at current prices (with a substantial portion of the purchase price borrowed) would bring a positive return to some investors. At the same time, farm real estate markets are currently thin, and given the current pessimistic outlook in rural areas, it is not clear that cease their downward trend at a point should. this Because financial of problems where possibility, that we not pursue it land values will necessarily economic is policies returns important which in suggest they dealing with inadvertently create additional downward pressure on farm real estate values. Commercial Bank Exposure to Agricultural Problems Commercial banks are an important financial services to agricultural producers. farm debt outstanding $166 billi on. billion, reporting lending of credit and other As of the 3rd quarter of 1984, institutions totalled just over Commercial banks held almost one-third of this total, or $51.9 80 percent institutional at provider of which was not lender to secured by real estate. agriculture is the Cooperative Farm The largest Credit System, ^USDA, "The Current Financial Condition of Farmers and Farm Lenders," Agriculture Information Bulletin Number 490, March 1985. -4which provided just over 40 percent of all farm debt last year. Commercial banks, the Cooperative Farm Credit System, and the Farmers Home Administration provide the bulk of institutional lending to agriculture. Non-institutional lenders (or individuals) provided roughly another $50 billion to agriculture last year. Chart 1 depicts the degree of farm loan concentration among commercial banks. For example, banks with farm loan-to-total loan ratios greater than 50 percent represent a little over 12 percent of all commercial banks (about 1775 banks) and hold about 24 percent of the total volume of farm loans held by all commercial banks (or about $12.5 billion). As the numbers above suggest, these banks are typically small, having an average asset size of just over $20 million. Nevertheless, they represent a large number of banks that appear to be highly susceptible to the ongoing agricultural stress. Over 28 percent of all commercial banks (roughly 4150 banks), holding over 50 percent of all farm loans (almost loan-to-total loan ratios greater than 25 percent $27 billion), (see Chart 1). banks with farm loan-to-total loan ratios of 25 to 50 percent banks) hold about $14.5 billion in farm loans. Here, as have farm Of these, (roughly 2375 in the previous group, the banks are typically small, with average assets of about $32 million. In more general terms, continued agricultural the potential exposure of commercial banks to problems seems small when comparing the volume assets of banks which are more highly concentrated in agricultural those less concentrated. For example, banks with farm of loans to loan—to—total loan ratios of less than 10 percent hold nearly 89 percent of all domestic bankassets, while banks with farm ratios little less than 6 percent of all greater than such assets. 25 percent Nevertheless, hold only a the absolute -5volume of assets involved in banks which are more agriculturally oriented is not inconsequential. Assets at so called agricultural banks (where 25 pecent or more of their loan portfolio is in farm loans) total about $114 billion. Furthermore, a significant number of banks with farm loan ratios between 10 and 25 percent may well have designated as farm loans, health of the substantial amounts of loans that are but which are directly or indirectly tied agricultural economy. A further complicating factor not to the is the geographic concentration of farm loans among commercial banks. As banks recent to experience would agricultural landscape. stress suggest, varies the susceptibility considerably across of commercial the geographic Not only have agricultural producers in the Midwest and Northern Plains states experienced greater stress than other regions, but commercial banks in many of those areas are more dependent on the farm economy. Chart 2 depicts the potential exposure of the fifteen states with the largest volume of farm loans. where both States shown in the northeast quadrant of Chart 2 are those the dollar volume of farm loans commercial banks to farm stress are high. and the Similarly, susceptibility Chart of 3 presents data for banks located in nonmetropolitan areas. Of course most states that appear in Chart 2 also appear in Chart Removing the metropolitan influence serves to further illustrate the 3. high degree to which many banks in these states are reliant on the farm economy. In addition to high farm loan-to-total loan ratios, banks located in nonmetropolitan areas within these 15 states hold farm loans equal to roughly one-half (or $26 billion) of all farm loans held by U.S. banks. the extent agricultural that other economy, loans the in more metropolitan areas exposure In several of are Further, related these Midwest and to to the Plains states may be considerably larger than the farm loan data alone would suggest. 6 - - Current Condition of Agricultural Banks Agricultural past two years. represented on bank performance Two years ago, the FDIC's has been on a downward problem bank of problem banks in June of 1983 were Chart 4). however, 1984, the agricultural banks were significantly under list. Although constitute roughly 28 percent of all commercial banks, By June of trend over agricultural the agricultural banks only about 22 percent banks percentage of (see Table problem 1 and commercial banks designated as agricultural had increased to over 34 percent, and by the end of 1984 agricultural problem banks problem list. constituted about 36 percent of the However, more recent data — including the last half of 1984 and the first two months of 1985 — indicate that the rate of increase in the number of agricultural problem banks has slowed considerably from the first half of 1984. Looking at problem bank data by geographic region is also illustrative of agricultural banking trends. The bulk of agricultural banks, as well as banks indirectly tied to agriculture, are located in the Midwest and Northern Plains states. Of the total increase in problem banks during 1984, about 75 percent increase of the can be accounted for by eleven contiguous states located across the Midwest and Northern Plains regions. These remembered trends that outperforming are somewhat agricultural other banks, disturbing. banks to a have position gone Nevertheless, from a of moderately it position poorer should of be clearly performance. For example, while major increases in problem banks occurred in the 11 state area just referred to, the problem bank rate (i ,e., problem banks as a percent of total banks in those states) at the end of 1984 in these same states was equal to 6.2 percent, compared to 5.5 percent for the nation. Similarly, the -7problem bank rate for agricultural banks was compared to 5.2 percent for 6.9 percent at year-end non-agricultural banks. At the 1984, present time, these differences are not what one would characterize as large. Additional data on the relative performance of agricultural banks are presented in Charts 5-12. These data were calculated from year-end Reports on banks with total assets of less than $100 million. banks with assets less than $100 million include about 97 agricultural banks. When looking at profitability measures Charts see 5 statistics. small & 6), we Over banks have the the last gone same trend two from years that was a clearly superior banks status Agricultural percent of all (as depicted depicted by agricultural Call problem relative in bank to other to a position where profits are moderately below their counterparts. Of the major factors in bank profitability overhead and noninterest income, and net loan losses), losses at for their agricultural banks (see Chart lower interest margins profitability over at agricultural lower profitability, the banks (net interest margin, increases in net loan 7-10) appear to be the major reason past are two years. partially While lower responsible for problems with interest margins have been with income rather than interest expense, their interest indicating that nonperforming loans may be the source of lower interest margins as well. for lower interest margins, net Regardless of the reasons the increase in net loan losses at agricultural banks was sufficiently large — going from just under 1 percent of average loans during 1983 to 1.37 percent during 1984 — to have accounted for the major portion of the drop in profitability during 1984. Despite increases in loan losses and declining profitability over the past few years, agricultural banks have been able to maintain their - traditionally higher capital ratios 8 - (see Chart 11). In fact, the aggregate capital-to-asset ratio for agricultural banks was higher at year-end 1984 than at any other time during the previous 4 year period, and continues to be well above other small banks. loss provisions The fact that agricultural banks have set aside loan substantially in excess of their loan loss experience (see Chart 12) during the past few years, has been partially responsible for their improved capital ratios. Essentially, agricultural banks have been accepting lower current profits in order to maintain their capital ratios. Conclusion. commercial banks In that summary, are there closely are tied a to relatively large agriculture. number Roughly of 4,150 commercial banks with farm loan-to-total loan ratios greater than 25 percent hold almost $27 billion in agricultural loans. At the same time, these banks possess slightly less than 6 percent of all domestic bank assets, farm loans at all commercial banks comprise loans held by commercial banks. Thus, and total only about 4.3 percent of all continued agricultural stress while will, no doubt, pose some problems for these institutions, it is unlikely that it will pose significant problems for the deposit insurance fund. Recent trends in agricultural problem bank statistics, as well profitability and loan loss trends at agricultural banks are disturbing. the same below stable. time, other the small profitability banks, Nevertheless, and given of their the agricultural aggregate financial banks capital prospects is At only marginally ratio for as the has remained agricultural industry, as well as recent loan loss trends, agricultural banks will likely face some trying times ahead. Chart 1 Farm Loan Concentration Among Commercial Banks Percent Bks. with Farm Loan Ratios (percent) Note: Farm loan ratio is farm loans-tototal loans. Greater than Chart 2 Farm Loan Exposure by State Total Farm Loans (Billions of Dollars) Chart 3 Farm Loan Exposure by State (Nonmetropolitan Areas Only) Total Farm Loans (Billions of Dollars) 10 15 20 25 30 35 40 45 50 Farm Loans as a Percent of Total Loans 55 60 Problem Commercial Banks by Type of Bank June ‘ 83 Dec. '83 June '84 Dec. ‘ 84 Feb . '85 Ag. Banks 106 ( 22.0) 146 ( 24.2) 231 ( 34.4) 288 ( 36.1) 313 ( 36.7) Other Banks 375 ( 78.0) 457 (75.8) 440 ( 65.6) 512 ( 63.9) 540 ( 63.3) Total 481 (100.0) 603 (100.0) 671 (100.0) 800 (100.0) 853 (100.0) J 1 Table 2 Commercial Bank Failures by Type of Bank 1984 Jan.-Jun 1984 Jul.-Dec. 1982 1983 7 ( 21.2) 6 ( 13.6) 8 ( 19.1) 17 ( 50.0) Other Banks 26 ( 78.8) 38 ( 86.4) 34 ( 80.9) 17 ( 50.0) Total 33 (100.0) 44 (100.0) 42 (100.0) 34 (100.0) Ag. Banks Chart 4 Problem Banks by Type of Bank (Commercial Banks Only) Number of Banks Agricultural Banks Note: Agricultural bank distinction is not used prior to June 1983. Chart 5 Return on Average Assets Percent Note: Only includes banks with assets less than $100 million Chart 6 Return on Average Equity Percent Non Ag. Banks Ag. Banks Note: Only includes banks with assets less than $100 million Chart 7 Net Interest Margin (Tax Equivalent Basis) Percent Non A g . Banks Ag. Banks Note: Only includes banks with assets less than $100 million Chart 8 Overhead as a percent of Average Assets Percent Note: Only includes banks with assets less than $100 million Chart 9 Non-interest income as a percent of Average Assets Percent 0.5 1980 1981 Mote: Only includes banks with assets less than $100 million 1982 1983 Chant 10 Net Loan Losses as a percent of Average Loans Note: Only induces banks with assets less than $100 million Chart 11 Capital-to-Asset Ratio Percent Note: Only includes banks with assets less than $100 million Chart 12 Loan Loss Provisions as a percent of Net Loan Losses Percent Note: Only includes banks with assets less than $100 million
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