AGRICULTURAL INCOME AND FINANCE -- SUMMARY February 26, 1999 February 1999, ERS-AIS-71 Approved by the World Agricultural Outlook Board --------------------------------------------------------------------------- This SUMMARY is published by the Economic Research Service, U.S. Department of Agriculture, Washington, DC 20036-5831. The complete text of the report will be available electronically 3-4 weeks following this summary release. --------------------------------------------------------------------------- Demand for Farm Credit Moderates and Farm Lenders Begin To Show Caution Low prices for many key agricultural commodities and significant weather and disease problems in some regions have created concerns among farmers and their lenders about the ability of some farmers to repay new or existing loans. Many of the concerns focus on farmers' ability to obtain and retain production credit. While net cash farm income has been strong in recent years and is forecast to be above the 1990-98 average in 1999, last year saw increasing variability in farm sector economic performance by region and commodity. While production of many farm commodities remained high, substantial price declines led to lower income for many farmers, particularly those specializing in corn , wheat, soybeans, and hogs. But numerous farm subsectors were profitable in 1998, and dairy, broilers, cattle, vegetables, fruits, nursery, and greenhouse products have a favorable outlook for 1999. Financial institutions serving agriculture continued to experience improved conditions in 1998 and some additional gains are expected in 1999. The position of agricultural lenders reflects the generally healthy state of farmers' finances in recent years. All commercial lender groups continue to experience historically low levels of delinquencies, foreclosures, net loan chargeoffs, and loan restructuring. These aggregate farm lender indicators will remain favorable, barring a sustained increase in farm financial stress. It is unknown how long commodity prices will remain low, but there is little indication of a problem in the national farm lender performance data to date. However, there is a lag before any significant farm financial stress appears in the national data. Total farm business debt at yearend 1998 is estimated at $170.4 billion, up 3.0 percent after increasing 6.0 percent in 1997. The dollar volume of farm loans outstanding expanded for all lender categories, except the Farm Service Agency (FSA). Farm loan volume held by commercial banks and the Farm Credit System (FCS) expanded 4.4 and 3.8 percent, respectively. Commercial banks and the FCS accounted for 60 and 32.5 percent, respectively, of the estimated $4.95-billion increase in farm lending in 1998. Commercial banks have gained farm debt market share for 13 of the past 14 years and now hold 41.1 percent of outstanding farm business debt. FCS market share during the same span dropped for 10 straight years before increasing during 1995-98 to 25.8 percent. Farm business debt is expected to decline 0.5-1 percent in calendar 1999, the first decrease in 7 years following increases during 8 of the previous 9 years. Nonreal and real estate loans are forecast to decrease about 0.4 percent and 1.0 percent, respectively, down from their respective gains of 3.4 and 2.6 percent in 1998. Commercial bank loans are projected to be steady compared with an anticipated 2.2-percent decline in FCS debt. The expected decline in total debt of about $1.2 billion during 1999 will follow an expansion of $31.3 billion or 22.5 percent since yearend 1992. Some $14.3 billion (45.6 percent) of this increase came in 1997-98. But farm debt at yearend 1998 was still 12.2 percent ($23.4 billion) below its 1984 peak. The outlook for 1999 indicates that loan demand will continue to moderate because farmers do not know how long commodity prices and weak export demand will persist. Farmers learned during the farm financial crisis of the 1980's that ill-advised borrowing cannot substitute for adequate cash flow and profits. The forecast decline in farm business debt thus implies fewer new capital investments financed by debt and a relatively low incidence of farms borrowing their way out of cash-flow problems. Adequate working capital and the authorization of $5.8 billion in additional government total assistance under last October's omnibus appropriation bill (P.L. 105-277) are helping to reduce loan balances and hold down new borrowing. About $2.8 billion in additional government direct payments (mostly production flexibility payments) for 1998 and another $2.8 billion in direct payments (mostly disaster payments) for 1999 will be distributed to farmers because of this legislation. The legislation also includes another $200 million in minor farm program assistance. Projections are that total Federal payments received by farmers will be $12.9 billion in 1998 and $10.2 billion in 1999, based on current legislation. Agricultural lenders have grown more cautious in extending agricultural credit. While the current situation does not merit the label of crisis, the farm loan portfolio losses of the early to mid-1980's are a recent memory. Many lenders have moved to improved measures of "repayment capacity" rather than cash flow alone to assess the ability of farmers to handle a given level of debt. ERS research shows that overall farmer use of net repayment capacity is forecast to rise to 57 percent in 1999, up from 55 percent in 1998 and 53 percent in 1997. Currently, the availability of funds is not an issue. In terms of the total supply of credit available to agriculture, lenders currently have more money available than they can profitably lend. What is clear is the current credit situation varies considerably by region, commodity, farm size, and farm type, and that lenders will be dealing with more internal variation in farm sector economic performance. Federal regulators now insist that lenders follow stricter safety and soundness guidelines. Loan oversight has been enhanced following the farm financial crisis of the 1980's, with tighter regulation for all types of agricultural lenders. Examiners currently see few problems with underwriting practices for agricultural loans. Today, despite low prices, lenders appear confident about the bulk of their farm customers. Most farmers are not heavily leveraged as they were a decade ago. Veteran lenders cite significant differences from the 1980's, including lower interest rates, more owner equity, better credit analysis and monitoring methods, and the financial health of their producers. Lenders will be able to work with most of their customers to restructure debt and provide credit for operating expenses. Interest rates on farm loans are now the lowest since the end of 1994. Annual interest rates on farm loans declined 15 to 30 basis points from 1997 to 1998, with the largest declines occurring in the fourth quarter on large loans (greater than $100,000). Recent reductions in farmer demand for credit, coupled with Federal Reserve cuts in the federal funds rate, have reduced interest rates. Agricultural loan rates and interest expenses are anticipated to continue a gently downward trend through 1999. Agricultural banks remained very profitable through the middle of 1998. Their annualized mid-1998 rate of return on assets was 1.3 percent, in line with their strong performance in recent years. At 12.3 percent, return on equity remained below 1992's rate of 13.1 percent, but this is not a concern because it reflects high capital levels. Nonperforming loans declined a little to 1.1 percent of total loans, and loan loss provisions were only 0.3 percent of total loans. These results indicate that any problems in the farm sector had not yet adversely affected farm bank loan portfolios. Loan losses at agricultural banks will increase if farm sector problems persist over an extended period, but the strong capital position of farm banks will allow most of them to survive. Only one agricultural bank failed in 1998 and only four failed during 1994-98. Average loan-to-deposit ratios for agricultural banks grew to 72.5 percent on September 30, 1998, up from 70.3 percent a year earlier and 57 percent 6 years earlier. The loan-to-deposit ratio has increased from a low of 53.5 percent in June 1987 and the previous high of 68.2 percent recorded in September 1968. In the current financial environment, commercial banks can easily access nondeposit sources of funds, and profitable, well-managed banks often have very high loan-to-deposit ratios. The FCS entered 1999 in strong financial condition. Loan quality and earnings remain strong, and loan volume continues to grow faster than inflation. As of September 30, 1998, early signs existed of a modest, but uneven deterioration of credit quality. Volume growth continued to be led by short- and intermediate-term loans, traditionally dominated by commercial banks. Net income rose 8 percent for the first 9 months of 1998, reflecting increased net interest and noninterest income and a decrease in the provision for loan losses. Despite increased loan volume, earnings have remained sufficient to raise the overall ratio of at-risk capital to assets. Life insurance companies historically have been providers of mortgage credit to the farm sector. Among life insurance companies, total farm lending activity was up 2.3 percent in 1998. Approximately $2.54 billion in new farm mortgage loans was closed in 1998, compared with $1.8 billion in 1997. During 1982-92 total industry farm mortgage holdings actually declined in 8 of the 11 years for an overall drop of 27.9 percent, so the 1992-98 increase of 13.2 percent is significant. Life insurance companies report adequate funds for the deals that meet their quality standards. Their farm lending is forecast to decline 4.8 percent in 1999. FSA's presence in farm credit markets continued to shrink in 1998 as new lending activity sank 6 percent and loan repayment rates rose. Outstanding direct and guaranteed loan volume fell to $15.7 billion at the end of fiscal 1998. Credit quality continued to improve in fiscal 1998, as loan delinquencies and loan writeoffs declined. Demand for FSA credit assistance is expected to rise in fiscal 1999 due to a weaker farm economy. Applications for FSA credit programs were up sharply at the end of 1998. Despite a significant boost in lending authority for operating loans authorized in the omnibus spending bill last fall, FSA anticipates operating loan authority will be exhausted earlier than in past years. To assist indebted farm borrowers, the 1998 omnibus spending bill also made it easier to restructure debts, qualify for FSA assistance, and borrow from the guarantee program in larger amounts. In February 1999, FSA published regulations streamlining its guaranteed lending programs. This could boost program demand, especially for smaller loans. Finally, some administrative initiatives were announced to help borrowers struggling with burdensome debts. One initiative allows borrowers to defer payments to FSA. Sales of mortgages through the Farmer Mac I and Farmer Mac II secondary market for farm mortgages and USDA guaranteed loans rose during 1998 and should continue to rise in 1999. Outstanding Farmer Mac I securitized volume totaled $796 million and Farmer Mac II volume totaled $337 million. Farmer Mac's profitability continues to be enhanced by its large investment portfolio. The annual lender issue of Agricultural Income and Finance Situation and Outlook Report features two special articles. The first compares current farm credit conditions with those leading to the early to mid-1980's farm financial crisis and the second looks at who holds farm debt. Printed copies of the Agricultural Income and Finance Situation and Outlook Report will be available in about 2 weeks. For more information, contact Jerome Stam (202) 694-5365. Full text of the report also will be available on the ERS website at www.econ.ag.gov. END_OF_FILE