Agricultural Income and Finance Annual Lender Issue

Transcription

1 United States Department of Agriculture AIS-78 Feb. 26, 2002 Electronic Outlook Report from the Economic Research Service Agricultural Income and Finance Annual Lender Issue Jerome Stam, Daniel Milkove, Steven Koenig, Robert Collender, Ted Covey, James Ryan, Charles Barnard, and Robert Hoppe This report is the annual lender issue in the AIS series. It contains a comprehensive analysis of the performance of the four major categories of institutional lenders serving the farm sector commercial banks, Farm Credit System (FCS), Farm Service Agency (FSA), and life insurance companies and their interaction with the farm sector, credit demand and supply, farm debt trends, interest rates, and related topics. Farm Credit Use Expected To Expand Moderately Contents Summary Lender Overview Agricultural Interest Rates Agricultural Banks Farm Credit System Life Insurance Companies Farm Service Agency Farmer Mac Farmland Value Trends Off-Farm Income Farm Debt List of Tables Appendix Tables Contacts Briefing Room Lenders and financial markets The next release is September 26, Approved by the World Agricultural Outlook Board. Low commodity prices continue to depress farm operating incomes, but widespread effects on farm lenders have yet to materialize. All major lender groups, including the FSA, the government lender of last resort, continue to show low levels of delinquencies and other loan problems. The stability of farm loan portfolios is benefiting from large government payments and sizable amounts of off-farm income. Farmers received an annual average of $8.8 billion in direct payments from 1990 to 1997, but this increased to an annual average of $17.7 billion from 1998 to 2002, bolstering credit quality and maintaining farmland values. Total farm business debt at yearend 2001 is forecast at $192.8 billion, up 4.8 percent after increasing 4.3 percent in The expected moderate growth of 1.9 percent in 2002 will be the 10th consecutive annual increase. Agricultural banks remained very profitable through the middle of The annualized rate of return on assets was 1.2 percent, down slightly from 1.3 percent the prior June but matching their strong full year performance of recent years. No agricultural bank failed in 2001, and only five failed between 1994 and The financial condition of the FCS remains solid in Loan volume and at-risk capital continue to grow. Income is strong fueled by good portfolio quality and loan growth. Net interest margins have benefited from the overall fall in interest rates during the past year, allowing FCS lenders to generate enough retained earnings to support loan growth without weakening their capital positions. FSA presence in farm credit markets declined in FSA farm loan program obligations (direct and guaranteed) fell from $3.7 billion in 2000 to $3.2 billion in fiscal 2001, as demand for most loan programs fell. Outstanding volume for the direct and guaranteed farm loan programs fell to around $8 billion each.

2 Summary Demand for Farm Credit Will Moderate, and Farm Lenders Have Adequate Loan Funds Financial institutions serving agriculture continued to experience improved conditions in 2001, and further gains are expected in Farm financial conditions remain stable because of large government payments to farmers and sizable amounts of off-farm income. Net cash farm income, which measures cash available from sales after paying cash operating costs, was $57.5 billion in 2000 and is expected to be the highest on record at $59.5 billion in Despite the rosy income picture, continued low prices for many agricultural commodities, weather problems in some regions, and the uncertain status of government payments have generated concerns about farmers ability to service new or existing loans. New legislation is expected in In the absence of new legislation, under current law, farm lenders will be dealing with a clientele whose net cash income is forecast to decline to $50.9 billion in Should it occur, the impacts of this decline in income would not be evenly distributed across all U.S. farm operations, with corn, wheat, and other cash grains (barley, oats, and rice); soybean; dairy; and hog operations facing possible lower earnings in The position of agricultural lenders reflects the generally healthy state of farmers finances in recent years. All major institutional lender groups, including the Farm Service Agency (FSA), the government lender of last resort, continue to experience low levels of delinquencies, foreclosures, net loan chargeoffs, and loan restructurings. These aggregate farm lender indicators will remain favorable barring sustained farm financial stress. Total farm business debt at yearend 2001 is estimated at $193 billion, up 4.8 percent. The dollar volume of farm loans outstanding increased for all lender categories, except the FSA. Farm loan volume held by commercial banks and the Farm Credit System (FCS) increased 3 and 12 percent, respectively. Together, commercial banks and the FCS held 69 percent of all farm debt at the end of Commercial banks have gained market share for 17 of the past 20 years and now hold 41 percent of outstanding farm business debt. FCS market share has increased in 6 of the last 7 years to 28 percent. The expected 2-percent increase in farm business debt in calendar 2002 will be the 10th consecutive increase but reflects declines in the rate of growth of both nonreal estate and real estate loans. The expected increase in total debt of about $3.7 billion during 2002 will follow a expansion of $53.8 billion or 39 percent. Farm debt at yearend 2001 was $1 billion below its 1984 peak in nominal terms. However, the debt-to-asset ratio in 1984 was 22.6 percent, but is forecast to be 16 percent in Farm sector equity growth continues, but at a much slower pace than during the 1990s. The 2002 forecast of a moderate increase in debt suggests modest levels of new capital investments financed by debt and a relatively low incidence of farms borrowing their way out of cash-flow problems. Adequate levels of working capital, emergency government support, and off-farm earnings reduce the need for new borrowing. Congress enacted emergency farm assistance legislation five times between October 1998 and August 2001 to increase farm program spending. Annual direct government payments to farmers averaged $22 billion over the last 3 years but are projected at $10.7 billion for 2002 unless further legislation is enacted. This would be comparable with the annual average of $8.8 billion in direct payments farmers received during These sizable direct payments are helping sustain farmland values and have helped farmers maintain or improve their balance sheets during a period of low commodity prices. In response to the farm loan portfolio losses they experienced in the early to mid-1980s, many lenders have moved to improve measures of repayment capacity to assess the ability of farmers to handle a given level of debt. In the absence of additional emergency legislation, 21 percent of all commercial and intermediate-sized farm businesses are forecast to have debt repayment problems in 2002, up from 18 percent in Farmer use of debt repayment capacity is projected to rise to 68 percent in 2002, up from 60 percent in Large Federal payments contributed to lower use of repayment capacity in Currently, farmers are not being turned away by lenders because of a lack of loanable funds. But the farm sector s heavy reliance on Federal payments may leave individual farmers who are not being helped susceptible to credit problems. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

3 Despite low commodity prices, lenders appear confident about the majority of their farm customers, given the level of anticipated 2002 Federal assistance and the amount of off-farm earnings. Lenders thus will work with most of their customers to restructure debt, if necessary, and provide credit for operating expenses. Annual interest rates on outstanding farm debt dropped about 25 basis points (a basis point is 1/100th of 1 percent) from 2000 to Interest rates on new farm nonreal estate loans made in the fourth quarter of 2001 declined almost 400 basis points from their fourthquarter 2000 levels. Over the same period, interest rates on real estate loans declined by over 200 basis points. These large rate declines, not seen since the early 1980s, were partly a result of the 475 basis-point reduction in the federal funds rate target by the Federal Reserve Board over the course of Unlike the large interest rate reductions in the early 1980s, which came about as inflation declined, the general reduction in rates during 2001 was due to a decrease in real (noninflationary) factors, such as a slowing economy. Agricultural banks remained very profitable through the middle of Their annualized rate of return on assets was 1.2 percent, down slightly from 1.3 percent the prior June but matching their strong full-year performance of recent years. At 11.3 percent, return on equity was the lowest since 1991, but this value is still high, and other information suggests that the decline was due to building capital levels rather than reflecting weak profits. Nonperforming loans increased to just 1.1 percent of total loans, from 1.0 percent the prior June, and loan loss provisions were only 0.3 percent of total loans. These results indicate that several years of problems in the farm sector have not seriously affected farm bank loan portfolios. No agricultural bank failed in 2001, and only five failed between 1994 and The financial condition of the FCS remains solid as it enters Loan volume and at-risk capital continue to grow. Income is fueled by strong portfolio quality, loan growth, and the reduced taxation of income from interest on real estate loans originated by Agricultural Credit Associations through Federal Land Credit Association subsidiaries. Loan portfolio growth is related to fairly even growth in shorter and longer term loans to farmers and from the purchase of participations in FCS eligible loans originated by other lenders, including commercial banks. Portfolio quality remains strong with nonaccrual plus accrual loans more than 90 days overdue accounting for just over 1 percent of total loans as of September 30, Net interest margins have benefited from the overall fall in interest rates during the past year, allowing FCS lenders to generate enough retained earnings to keep their capital positions strong. Life insurance companies historically have been providers of mortgage credit to the farm sector. Among life insurance companies, total farm loans outstanding were up 1.5 percent in Approximately $2 billion in new farm mortgage loans was closed in 2001, compared with $1.6 billion in From 1981 to 1992, total industry farm mortgage holdings actually declined in 8 of the 11 years for an overall drop of 27.9 percent, so the increase totaling 36.9 percent over 9 consecutive years is significant. Life insurance companies report adequate funds for deals that meet their quality standards. Their farm lending is forecast to increase 1.6 percent in FSA presence in farm credit markets declined in FSA s direct and guaranteed loan programs now account for only 8.5 percent of total farm debt compared with 15.8 percent 10 years earlier. Outstanding guaranteed farm loan volume fell for the first time in 20 years due to weaker demand and better repayments. Farm loan obligations (direct and guaranteed) fell from $3.7 billion in fiscal 2000 to $3.2 billion in fiscal Loan quality continued to improve for both the direct and guaranteed loan programs. Despite the decline in new lending, FSA continued to increase its lending to beginning and socially disadvantaged borrowers during the year. Also, FSA farm borrowers were benefitting from historically low farm loan interest rates in 2001 and Direct operating loans in early 2002 were being made at 4.75 percent, the lowest in at least 25 years. Guaranteed operating loans with 4-percent interest rate assistance are being made at even lower rates by participating lenders. Farmer Mac reported record purchase and guarantee volume of $1.5 billion in The large increase in new volume pushed outstanding volume over the $4 billion mark. Much of the increase in new lending came from the guarantee of FCS loans. The quality of Farmer Mac loans weakened slightly during 2001, and the government-sponsored enterprise faces new riskbased capital standards starting in the spring of Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

4 Lender Overview Lenders Served a Farm Sector Continuing To Experience Low Commodity Prices in 2001 The financial condition of agricultural lenders was stable in 2001, and no major decline is forecast for These lenders serve a farm sector whose aggregate financial indicators continued to show strength in 2001 (figs. 1-6). Each of the four major institutional farm lender categories commercial banks, the Farm Credit System (FCS), the Farm Service Agency (FSA), and life insurance companies continue to experience few problems with their farm loan portfolios by historical standards. Generally favorable conditions experienced by the farm economy over the period contributed to the strengthening financial condition of farm lenders. But beginning in the latter half of 1998, declining farm commodity prices left farmers and by extension their lenders heavily dependent on Federal assistance. Net cash farm income, which measures cash available from sales after paying cash operating costs, was $57.5 billion in 2000, and is forecast to be $59.5 billion in Existing legislation, which does not contain supplemental assistance for 2002, leaves net cash income at $50.9 billion, some $8.6 billion below the average. As the law now stands, the projected decline in farm sector net cash income for 2002 will not be equally distributed over all farm operations, but will disproportionately impact those who specialize in the production of wheat, corn, other cash grains (barley, oats, and rice), soybeans, dairy, and hogs. Net farm income, which assesses the net value of calendar-year production, including the portion placed in storage, is forecast to increase from $46.4 billion in 2000 to $49.3 billion in 2001 (which included $9.1 billion in emergency assistance passed last summer), but drop by 17.6 percent to $40.6 billion for 2002, barring additional Federal assistance. This net farm income forecast for 2002, if realized, would be the lowest since Cash receipts from sales of farm commodities in 2001 totaled $201.9 billion, up $2.4 billion from 2000, with crop sales increasing $2.1 billion and livestock sales growing $0.3 billion. Cash receipts from farm marketings averaged $190.5 billion for and are forecast at $204.3 billion in The value of farm production forecast for 2002 was exceeded only in 1997 when a confluence of favorable harvests, prices, and exports occurred. Since the latter half of 1998, large worldwide harvests of major field crops and weak export markets have dampened market prices. Commodity prices will likely rise in 2002, but remain below the 10-year average. After four consecutive years of substantial increases, livestock receipts, despite being only slightly above 2001, will be $8.5 billion above crop receipts in Crop sales averaged $96.9 billion in , compared with the 2002 forecast of $97.9 billion. Livestock receipts averaged $93.6 billion in and are forecast at $106.4 billion in Even with a forecast drop in net farm income, much of the financial viability of the farm economy continues to rest on its sound balance sheet. The value of farm assets increased 67.9 percent from the low in 1986 to $1.22 trillion in Farm equity increased 80.3 percent during the same period and was $1.02 trillion at the end of Farm-sector equity is expected to increase for the 16th consecutive year (by about 1 percent), even though prices for major grains remain relatively low. Farm debt increased 4.8 percent in 2001 and is forecast to grow at 1.9 percent in Emergency Legislation Bolsters Farm Sector and Its Lenders Congress elected to address low farm income prices and weather problems affecting selected commodities with additional financial support in 1998 through Under the 1996 Farm Act (P.L ), the farm sector received a combined total of $16.1 billion in production flexibility payments (which replaced most commodity programs) in the three calendar years , then $4 billion in calendar 2001, and is forecast to receive $3.9 billion in calendar The omnibus appropriations bill (P.L ), enacted in October 1998, included an additional $5.8 billion in total assistance for agriculture for fiscal 1998, including $5.4 billion in direct payments to the farm production sector for disaster and income support. The supplemental payments under P.L added to previously authorized production flexibility payments and larger loan deficiency payments due to falling prices for major field crops substantially boosted Federal assistance to the farm sector. About $2.8 billion in additional government direct payments Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

5 The farm sector s aggregate financial indicators continued to show strength in 2001 largely due to generally favorable growing conditions and sizable government payments. Total farm business debt increased $53.8 billion or 38.7 percent during , and this growth increased from 3.1 percent annually to 4.7 percent annually Total farm assets exceeded $1.22 trillion in 2001 as farm equity (assets minus debt) increased for the 15th straight year to $1.02 trillion (up 80.3 percent during the span). The sector debt load relative to net cash income is up slightly and the debt-to-asset ratio is steady. The total rate of return on assets has been in the percent range since Figure 1 Total farm business debt almost matches previous peak registered in 1984 $ billion 250 Figure 2 Annual change in farm debt positive since 1993 and highest since 1997 $ billion Farm debt Figure 3 Farm sector balance sheet shows equity growth $ billion Debt Equity Assets Figure 5 Real net farm and real net cash incomes increase slightly during Billion 1996 dollars Figure 4 Farmers' debt load is just above 3 times their net cash income Ratio of debt to income 6 Farm debt Net cash income Figure 6 Farm sector rate of return on assets remains normal and debt/asset ratio is steady Percent 30 Debt/asset ratio Net cash Net farm Total rate of return on assets Source: Economic Research Service, USDA. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

6 (mostly marketing loss payments) for 1998 and another $2.8 billion (mostly from disaster payments) for 1999 were distributed to farmers because of P.L The Agriculture Appropriations Act (P.L ) signed into law in October 1999 contained an additional $8.7 billion in emergency farm assistance for fiscal Also, P.L , enacted in November 1999, added $186 million in production loss payments and $10 million to livestock producers. The Agricultural Risk Protection Act (P.L ) was enacted on June 20, 2000, authorizing $15.1 billion in additional Federal assistance to farmers. An estimated $6.7 billion was in the form of direct payments to farmers, with $6.3 billion disbursed in calendar Additional emergency farm funding covering a broad range of items was provided in the U. S. Department of Agriculture Appropriations Act (P.L ) enacted in October This act provided $3.5 billion in disaster assistance, including $1.3 billion for crop loss payments, $667 million for dairy market loss payments, $450 million for livestock assistance, and $158 million for apple and cranberry growers. The Crop Year 2001 Agricultural Economic Act (P.L ), approved in August 2001, included $5.5 billion in economic assistance to farmers. The omnibus USDA Appropriations Act (P.L ), enacted in November 2001, contained $75 million in emergency assistance for apple producers. Government payments during , with additional emergency assistance, have been sufficient to maintain net farm income near or above the average. In total, when added to previous legislative authorities, the 2000 and 2001 legislation brought the total direct payments for farmers to $22.9 billion in 2000 and $21.1 billion in The government direct payout is forecast at $10.7 billion in 2002, down 49.3 percent from 2001, assuming no additional government payments. The total direct payment of $88.6 billion is helping bolster agricultural credit quality and maintain farmland values. Farmers received an annual average of $8.8 billion in direct payments for the period, jumping to $17.7 billion per year for In real terms (based on a gross domestic product chaintype index), the direct payments received by farmers in 2000 were the second highest annual payout on record, with 1987 being the highest (fig. 7). Both Congress and the Administration have discussed additional payments for However, total payments will likely be less this year than was distributed in Emergency assistance originating from special legislation comprised $9.1 billion in government payments during Higher crop prices will result in nearly $1.3 billion less in loan deficiency payments, which were also a significant component of total payments in Commercial Banks Lead The distribution of the farm sector s estimated $192.8 billion in farm business debt among the six lender categories on December 31, 2001, is summarized in table 1. Commercial banks account for 40.8 percent of all farm debt outstanding, making them the leading agricultural lender, followed by the FCS, a Government-sponsored enterprise, with 28.1 percent. Individuals and others (merchant and dealer credit, land purchase credit contracts) held an estimated 21 percent, Figure 7 Direct Federal Government farm program payments to farmers, $ billion 25 Real direct Government payments, 1996 dollars Direct Government payments Source: Economic Research Service, USDA. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

7 with the remaining categories holding lesser market shares. Total farm debt outstanding at the end of 2001 represented an increase of $55 billion, or 39.9 percent, from its low in 1989 (app. table 1). At yearend 2001, the value of $192.8 billion total farm debt outstanding was only $1 billion in nominal dollars below the previous all-time high recorded in Total farm real estate debt outstanding, at $103.1 billion is nearly identical to the nominal peak of $103.2 billion recorded in 1983 (app. table 2). Total nonreal estate debt outstanding at $89.8 billion in 2001 now exceeds the 1983 high of $87.9 billion by 2.1 percent (app. table 3). Details of changes in market share and related issues are given in the Farm Debt section later in this report. Farm business debt by lender for , percent change by year, and market share percentage data are reported in the appendix for total debt (app. table 1), real estate debt (app. table 2), and nonreal estate debt (app. table 3). Lenders Financial Position Continues Strong The position of commercial agricultural lenders in 2001 reflected the generally healthy state of farmers finances in recent years. To date, borrowers from agricultural lenders have generally been able to withstand the low commodity prices and weatherrelated problems due to their strong financial positions and an increase in payments received from the Federal Government beginning in As a result, commercial farm lending institutions have been able to continue to build capital and maintain favorable credit quality levels in their loan portfolios. All major institutional lender groups continued to experience historically low levels of delinquencies, foreclosures, and net loan charge-offs. Information on delinquent farm loans by lender during 1980 to 2001 is presented in table 2. The FSA had the highest delinquency rates in both dollars and share of the portfolio, which are expected in its role as the government lender of last resort. The total value of delinquent loans peaked for commercial banks in 1985 and for the FCS and life insurance companies in 1986 (tables 2 and 3). Delinquencies as a percentage of outstanding farm loans peaked in 1986 for all lenders except FSA which peaked in The delinquency rates have been low for all institutional farm lenders in the 1990s. Even the FSA direct farm loan portfolio has shown constant improvement during the last decade and stood at $1.6 billion in delinquent loans in mid- 2001, down from $12.5 billion in 1988 (table 2). A key concern of farm lenders is the amount of loan losses they must absorb. Losses for commercial banks, FCS, and FSA for are shown in table 3. Commercial bank and FCS farm loan charge-offs have been low since 1989, while FSA levels have been trending down since Even FSA as the lender of last resort charged off only $333 million in farm loans in fiscal 2001 compared with $3.2 billion in fiscal During , agricultural loan charge-offs by the three lender categories commercial banks, FCS, and FSA totaled $13.7 billion. Any farm financial stress must be sustained to make a significant impact on aggregate national farm lender indicators such as loan delinquency rates. A number of agricultural lender performance measures are lagging indicators of farm financial stress. Prices for several major farm commodities are forecast to remain near their lows in 2001 and 2002, but there is no Table 1--Distribution of farm business debt, by lender, December 31, / Type of debt Lender Real estate Nonreal estate Total Percentage of total Commercial banks Farm Credit System Farm Service Agency Life insurance companies Individuals and others Commodity Credit Corporation / Total / Preliminary. Due to rounding, subcategories may not add to totals. 2/ This excludes CCC crop loans, which are estimated at $5 billion at the end of calendar Sources: American Council of Life Insurance, Board of Governors of the Federal Reserve System, The Farm Credit Council, and the Farm Service Agency. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

8 significant indication of a problem in the national farm lender performance data to date. The overall performance of farm lenders is vastly superior to that experienced during the farm financial crisis of the 1980s (app. table 6). In 1986, farm lenders held over $3.7 billion in property due to loan defaults or foreclosures; in 2001 the amount was only $207 million. The agricultural situation currently facing lenders differs from that of the early to mid-1980s in that the problem is widespread low crop prices rather than overextended farm borrowers. For example, the ratio of farm debt to net cash farm income was only 3.2 in 2001, compared with the high of 5.8 in 1981 (fig. 4). Total farm interest payments were 19.2 percent of net cash income in 2001 compared to 37.7 percent in 1981 (fig. 8). The increase in farm debt in recent years has been restrained compared with the 1970s, with only a 39.8-percent increase during , compared with a 274-percent increase during FSA s direct farm loans outstanding as a share of total farm sector debt have dropped from a high of 16.3 percent in 1987 to 3.8 percent in 2001, as many financially vulnerable farmers retired or otherwise left the sector. Farm lenders have undergone considerable restructuring and consolidation since 1980, and have thus spread their risk over a more diversified and geographically dispersed borrower clientele. Moreover, some less than optimum farm loan portfolios have been moved under the auspices of the FSA loan program. Farm lenders also learned the risks of lending on the basis of collateral in the 1980s and have instituted better loan analysis tools based on cash flow and other criteria. Farm lender regulation is much improved over the 1970s. In a nutshell, most financial problems faced by producers during the period were caused by a combination of low prices and locally poor weather conditions. Lenders likely will find that these farmers will not gain much relief in the form of higher commodity prices in With market Table 2--Delinquent farm loan volume, by lender, Commercial Farm Credit Life insurance Farm Service Yearend 1/ banks 2/ 3/ System 4/ companies 5/ Agency 6/ Billion dollars (Percentage of outstanding loans) 1980 NA NA 0.3 (0.5) 0.3 (2.0) 3.6 (18.2) 1981 NA NA 0.4 (0.5) 0.5 (3.7) 5.8 (24.1) (2.5) 0.7 (1.1) 0.8 (6.4) 9.5 (37.9) (3.8) 1.3 (1.8) 1.0 (8.3) 11.0 (43.9) (3.1) 1.8 (2.5) 1.2 (9.6) 12.1 (45.9) (6.6) 5.0 (8.0) 1.7 (15.1) 11.9 (41.5) (6.4) 7.0 (13.8) 1.8 (17.0) 12.0 (42.9) (5.1) 5.2 (11.8) 1.3 (14.3) 11.8 (45.8) (3.5) 3.3 (8.0) 0.8 (8.9) 12.5 (49.8) (2.5) 2.5 (6.1) 0.4 (4.7) 11.1 (47.8) (2.0) 2.5 (6.1) 0.4 (4.2) 8.1 (41.3) (2.0) 2.2 (5.4) 0.4 (3.8) 7.3 (41.7) (1.9) 1.9 (4.6) 0.3 (3.3) 6.6 (42.5) (1.5) 1.5 (3.6) 0.2 (2.2) 5.8 (41.0) (1.2) 1.1 (2.7) 0.2 (2.6) 4.4 (34.8) (1.2) 0.8 (1.8) 0.2 (2.7) 4.5 (39.0) (1.4) 0.6 (1.3) 0.1 (0.9) 3.5 (32.6) (1.2) 0.5 (1.1) 0.1 (1.0) 2.6 (26.8) (1.3) 0.8 (1.5) 0.2 (1.4) 2.3 (24.9) (1.5) 0.7 (1.3) 0.1 (0.8) 2.0 (22.2) (1.4) 0.5 (0.8) 0.2 (1.3) 1.8 (20.2) Midyear / 0.7 (1.5) 0.6 (1.0) 0.3 (1.9) 1.6 (19.0) NA=Not available. 1/ End of fiscal year (Sept. 30) for the Farm Service Agency (FSA) and end of the calendar year (Dec. 31) for the other lenders. 2/ Delinquencies were reported by institutions holding most of the farm loans in this lender group. Data shown are computed just for these reporting banks. 3/ Farm nonreal estate loans past due 90 days or more or in nonaccrual status, from the Reports of Condition submitted by insured commercial banks. 4/ Data shown are nonaccrual loans, which include accrued interest receivable and exclude loans of the Banks for Cooperatives, Agricultural Credit Banks, and affiliated associations. 5/ Loans with interest in arrears more than 90 days. 6/ A loan is delinquent if a payment is more than 30 days past due. Data shown are for September 30; thus, they avoid the yearend seasonal peak in very short-term delinquencies and so are more comparable with those shown for other lenders. The FSA data reflect the total outstanding amount of the direct loans that are delinquent (as do the data shown for other lenders), rather than the smaller amount of delinquent payments that is often reported as FSA delinquencies. 7/ June 30 except for FSA. Sources: American Council of Life Insurance, Board of Governors of the Federal Reserve System, The Farm Credit Council, and the Farm Service Agency. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

9 prices for most farm commodities mired in a deep slump, some erosion in agriculture s financial foundation is underway. Recent farm assistance packages, which included supplemental aid, disaster assistance, and greater subsidies for crop insurance, are shoring up farmer loan repayments to lenders and are keeping up farmland values that provide collateral for many agricultural loans. Farmers Use of Repayment Capacity Continues to Rise Given anticipated 2002 price and income levels, and uncertainty concerning the timing of price improvements in cash markets for many agricultural commodities, farmers are expected to become more restrained in taking on new debt, while lenders are anticipated to be more conservative in extending credit. Despite this financial conservatism, farm debt rose more than 4 percent in both 2000 and 2001, with an additional moderating increase projected in Debt management is crucial during periods of potentially decreasing farm incomes. Net cash income, which measures the amount of funds available to meet expenses as they come due during the year, is forecast at $50.9 billion for 2002 (assuming no additional government assistance). This represents an $8.6-billion decline from 2001 and would be $5.2 billion below the average. This reduction in farm operator income, if it occurs, would translate into a potential rise in difficulty in meeting debt service obligations in Farm debt repayment capacity utilization (DRCU actual debt expressed as a percentage of maximum debt that could be repaid from current annual income) measures the extent to which farmers are using their available lines of credit. DRCU is expected to rise from about 60 percent in 2001 to more than 68 percent in 2001, its highest level since 1985 (fig. 9). The rise in DRCU suggests that some farmers will place greater reliance on available credit lines in 2002, and may have Table 3--Farm loan losses (net charge-offs), by lender, Commercial Farm Credit Farm Service Exhibit: Life Year banks 1/ System 2/ Agency 3/ insurance company foreclosures 4/ Million dollars (Percentage of loans outstanding at end of period) 5/ 1980 NA NA -0.8 (-0.0) 6/ 13 (0.1) 18 (0.1) 1981 NA NA 13 (0.0) 6/ 7 (0.0) 6/ 56 (0.4) 1982 NA NA 13 (0.0) 6/ 25 (0.1) 170 (1.3) 1983 NA NA 8 (0.0) 6/ 65 (0.3) 347 (1.9) (2.2) 428 (0.5) 117 (0.5) 289 (2.5) ,366 (3.8) 1,105 (1.6) 234 (0.8) 530 (4.8) ,257 (4.0) 1,321 (2.3) 379 (1.4) 827 (7.9) (1.8) 488 (0.9) 1,119 (4.3) 692 (7.5) (0.5) 413 (0.8) 2,022 (8.1) 364 (4.0) (0.3) -5 (-0.0) 6/ 3,228 (13.9) 204 (2.3) (0.2) 21 (0.0) 6/ 3,142 (16.1) 85 (0.9) (0.4) 47 (0.1) 2,237 (12.8) 95 (1.0) (0.3) 19 (0.0) 6/ 1,824 (11.7) 148 (1.8) (0.2) -2 (-0.0) 6/ 1,702 (12.4) 96 (1.1) (0.2) -26 (-0.1) 1,300 (10.3) 42 (0.5) (0.2) -5 (-0.0) 6/ 1,003 (8.7) 73 (0.8) (0.3) 48 (0.1) 1,298 (12.3) 82 (0.8) (0.2) 27 (0.0) 6/ 756 (7.7) 16 (0.2) (0.2) 68 (0.1) 674 (7.4) 27 (0.2) (0.3) 172 (0.2) 522 (5.8) 9 (0.1) (0.2) 121 (0.2) 478 (5.5) 35 (0.3) / 226 (0.5) 45 (0.1) 333 (3.9) 26 (0.2) NA=Not available. 1/ Calendar year data for nonreal estate loans, computed for those banks that must report this data. Beginning in December 1987, charge-offs do not include losses qualified for the loan deferred loan loss program. 2/ Calendar year data. 3/ Fiscal year data beginning October 1. Include data on the insured (direct) farm loan programs. FSA data are not directly comparable with commercial lenders because of some accounting differences. 4/ Loan charge-off data are not available for life insurance companies. 5/ Loan loss data rounded to nearest million dollars. 6/ Less than 0.05 percent. 7/ Commercial bank data through June 30, 2001, and Farm Credit System and life insurance company data through September 30, Sources: American Council of Life Insurance, Board of Governors of the Federal Reserve System, The Farm Credit Council, and the Farm Service Agency. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

10 a more difficult time meeting interest and principal payments on their outstanding debt. Government payments have provided many farmers with the resources to meet repayment obligations that could have otherwise presented severe cash flow problems during the last few years. If net cash income had been reduced by farm operators share of all government payments, DRCU could have reached about 80 percent in both 1999 and 2000, before declining to 75 percent in 2001 and 73 percent in This suggests that, while government payments have assisted many farmers in meeting principal and interest obligations, improved market returns since 2000 have reduced farmers reliance on payments for debt service. Some additional 2002 funding is likely, given the projected declines in farm income measures in forecasts based on current legislation. An analysis of alternative amounts of government payments was performed in order to gauge the sensitivity of the farmers ability to service debt to the level of government payments. Total direct payments were incrementally increased by $1 billion up to $10 billion more than assumed in the forecast. While each $1- billion addition to government payments improves farmers ability to service debt, with an additional $10 billion in payments, 2002 debt repayment capacity utilization falls from the currently projected 68 percent to 60 percent, a level essentially unchanged from Figure 8 Interest expenses as a share of net cash income, Percent Interest expenses (net cash income + interest expenses) Source: Economic Research Service, USDA. Figure 9 Government payments have helped farm operators meet debt service payments, F Percent DRCU without government payments Debt repayment capacity utilization DRCU with additional $10 billion in government payments Values for 2001 and 2002 are forecasts. Source: Economic Research Service, USDA. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

11 Government payments and the farm balance sheet The rise in farm business debt during the last few years has been facilitated by substantial government assistance to farmers. Government payments not only contribute to farm income, but also impact both asset and debt components of the farm balance sheet. The value of agricultural land depends largely on its expected future earnings, and a rise in available cash can impact the overall amount and composition of debt. Direct government payments are generally attached to the land, and accrue primarily to landowners, supporting farmland real estate values, which, in turn, support higher mortgage loan levels. Payments also provide funds to facilitate the purchase of machinery, equipment, livestock, and other farm production assets, while also reducing the amount of debt needed to finance the purchase of capital assets. Government payments further impact farm debt, since, depending on the timing of receipt of payments, farmers may require less credit to meet their seasonal production financing needs. More importantly, the generally counter-cyclical nature of government payments tends to stabilize income, minimizing the impact of catastrophic market losses, and reduces the risk faced by both farm operators and the lenders providing them credit. In some instances, the additional funds from government payments can be used to pay down or eliminate existing debt commitments. Debt repayment capacity utilization (DRCU) In applying a debt coverage ratio of, say, 1.25, lenders would effectively require that no more than 80 (1/1.25) percent of a loan applicant's available income be used for repayment of principal and interest. For farm operators, this income available for debt service (measured as net cash income plus interest) determines the maximum loan payment the farmer could make. Given current market interest rates and a predetermined repayment period, the maximum debt that the farmer could carry with this loan payment can be determined. Using current bank interest rates and a 7-year repayment period, maximum feasible debt conceptually measures the line of credit that could be available to farmers. Debt repayment capacity utilization is a measure of actual debt relative to this theoretical maximum feasible debt. For a more complete discussion of DRCU, including the equations used in its calculation, see: sary/def_drcu.htm Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

12 Agricultural Interest Rates Interest Rates on Agricultural Loans Fell Sharply in 2001 The Federal Reserve lowered its target for the federal funds rate 11 times in 2001, resulting in a total decrease of 475 basis points (a basis point is 1/100 percent). A significant decline in the U.S. nonfarm business sector s demand for credit also contributed to the decline in economy-wide interest rates. In response, interest rates on farm loans fell sharply in 2001, especially for shorter term, nonreal estate loans. (Farm interest rates by lender category during the period for (1) short- and intermediate-term and (2) long-term loans are given in appendix tables 4 and 5.) The fourth-quarter to fourth-quarter drop in farm interest rates was the second largest experienced by the farm sector since the decline in rates from 1981 to The large decline in farm rates in the early 1980s was driven by reductions in inflationary expectations. The 2001 decline reflects mostly a fall in the real interest rate, i.e., factors other than inflation. Selected nonreal and real estate interest rates on commercial bank and FCS farm loans for 1981, 1993, and 2001 are shown in fig. 10. Interest rates on new farm nonreal estate loans made by commercial banks from the fourth quarter 2000 to the fourth quarter 2001 fell 380 basis points to 6.2 percent. Large banks experienced the largest one-year decline (440 basis points) to 5.3 percent. The largest fourth-quarter to fourth-quarter change in bank lending rates since 1977 was a 400-basis point decline from 1981 to The average one-year decline in commercial bank nonreal estate rates between fourth quarters from 1977 to 2000 was 145 basis points. Commercial banks accounted for about 52 percent of farm nonreal estate debt in The average rate on nonreal estate loans made by Farm Credit System lenders fell about 250 basis points to about 6 percent. Rates charged by the FSA on direct, regular operating loans fell 160 basis points to 4.92 percent. It now costs an FSA-farmer less to take a new regular, direct operating loan or an FSA-guaranteed operating loan than a limited resource loan. The Farm Credit System accounted for about 20 percent of nonreal estate farm debt in 2001, while FSA accounted for 4 percent of nonreal estate farm debt. The remainder is held by individuals and others. The typical interest rate on new farm real estate loans made by commercial banks fell to 7.5 percent, a 225 basis point drop from the fourth quarter 2000 to the fourth quarter Rates on real estate loans made by Farm Credit lenders fell 230 points over the same period to 5.99 percent. Average rates on life insurance real estate loans to farmers fell 230 basis points to 6.14 percent. Rates on FSA direct, regular Farm Ownership loans fell about 40 basis points to 6.08 percent. Commercial banks and the Farm Credit System each hold one-third of farm real estate debt. Life insurance companies hold 12 percent of farm real estate debt while the FSA holds 3 percent. Individuals and others hold about 19 percent of farm real estate debt. Comparing farm interest rates to the Treasury rates for similar maturities can give insight into how lenders Figure 10 Selected interest rates, selected years Percent 25 Prime rate Commercial bank nonreal estate Commercial bank real estate 20 FCS nonreal estate FCS real estate Source: Board of Governors of the Federal Reserve System and various Farm Credit District Banks. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

13 perceive the cost of farm lending. The farm-loan premium can be calculated as the farm rate less the relevant Treasury rate. The greater the farm-loan premium, the greater the degree of farm default risk (assuming other cost factors remain constant). The farm-loan premium incorporated on nonreal estate commercial bank loans ranged from 240 to 500 basis points from 1980 to 2000, averaging 370 basis points. The annual farm-loan premium in 2001 was 430 basis points, the highest since This suggests that lenders may see farm lending as a greater risk and are charging higher spreads. It also indicates that rates for farmers do not go lock-step with Federal Reserve Board policy changes and that farm loan interest rates may adjust slower than Treasuries. The higher farmloan premium means that the cost of new debt is higher for farmers than it would have been if banks priced farm loans directly off comparable Treasury rates. The fixed-rate premium (the fixed rate minus the variable rate for the same loan) for the Upper Midwestern United States increased on agricultural loans during The premium increased from zero to about 22 basis points for nonreal estate farm loans and from zero to about 40 basis points on real estate farm loans from the fourth quarter 2000 to the fourth quarter These premiums are higher than their fourth-quarter averages for the period. This suggests lenders anticipated rising interest rates on farm loans in Greater uncertainty regarding the reliability of financial statements in the nonfarm business sector is likely helping drive up the cost of credit in the nonfarm business sector and leading to a flight to safety (i.e., Treasuries). Banks are increasing their loan loss reserves as a result. Under the current circumstances the Fed is not likely to increase interest rates in the near term. Lending to government entities and farmers may be seen by lenders in 2002 to be relatively less risky vis-à-vis lending to the corporate sector, especially after passage of new farm legislation. The farm sector may benefit from this relative risk reassessment as lenders reallocate their credit to those borrowers whose financial status is more reliable and predictable. Interest rates on new farm loans are expected to decline in the first half of 2002, then remain relatively stable throughout the remainder of the year. Nominal and real farm sector interest expenses for are given in fig. 11. It is important to consider how the ongoing interest rate changes will translate into changes in total farm sector interest expenses in Recent interest rate reductions by the Federal Reserve Bank suggest that a more favorable interest rate environment for farm borrowers developed in 2001 and will continue in But interest rates are declining at the same time total farm debt is increasing. Farm debt is estimated to have grown $8.8 billion in 2001 and is forecast to expand another $4 billion in Interest paid on outstanding debt and rates on existing loans will not be immediately reduced to reflect the changes in current market interest rates because a sizable portion are longer term loans. While about three-fourths of bank nonreal estate loans made in 2001 were variable rate loans, these loans adjust at regularly scheduled dates and lag Federal Reserve rate changes. Thus, total farm sector interest expenses (excluding households) increased 3.3 percent in 2001 to $14.2 billion. In 2002, total sector interest expenses are forecast to decrease about 3.7 percent to $13.6 billion. Figure 11 Farm sector interest expenses (excluding households), $ billion Real farm sector interest expenses, 1996 dollars 10 Farm sector interest expenses Source: Economic Research Service, USDA. Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,

14 Agricultural Banks Agricultural Banks Hold a Slim Majority of Farm Loans Made by Commercial Banks Agricultural banks reported a $1-billion increase to $42.7 billion in the total value of their farm lending portfolios during June 2000-June 2001, compared with a $1.5-billion increase the previous year (table 4). A $2.3-billion gain for nonagricultural banks left them with 49 percent of commercial bank farm loans, up slightly from the previous year. The increase in farm loans outstanding at agricultural banks is consistent with prior reports of increased carryover debt due to low farm prices. But it may also reflect new loans by bankers who believe that continued Federal support payments in times of low prices will enable most farmers to remain current on their loans. While large firms dominate most aggregate statistics in the commercial banking industry, the farm sector is somewhat different. Nonagricultural banks with assets over $500 million do have a 73-percent share of commercial bank farm debt held by all nonfarm banks (table 4). But few farm banks reach this size, and as a group those with assets below $500 million hold more farm loans in their portfolios than the large nonagricultural banks. Agricultural Banks Remain Highly Profitable Problems in the farm sector are not reflected in aggregate data for agricultural banks, as this group of lenders remained very profitable through the middle of Low loan loss provisions and large interest rate spreads supported healthy profits for agricultural lenders. An annualized mid-2001 rate of return on assets (ROA) of 1.2 percent is the same as it has been since 1992 (table 5). At 11.3 percent, return on equity was the lowest since But this value is still high, and other information suggests that the decline was due to building up capital levels rather than a reflection of weak profits. Continued strength in ROA reflects substantial quality in farm bank loan portfolios. Loans in nonperforming status at midyear were 1.1 percent of total loans, above the average of 0.9 percent for small nonagricultural banks but about the same as agricultural bank values of recent years (table 6). As measured by ROA, return on equity (ROE), and loan quality, agricultural bank performance was similar to that of small What is an Agricultural Bank? The Board of Governors of the Federal Reserve System (FRB) classifies a bank as agricultural if its ratio of farm loans to total loans exceeds the unweighted average of the ratio at all banks on a given date percent on June 30, 2001, (table 7). The Federal Deposit Insurance Corporation (FDIC) criterion is a constant 25-percent ratio of agricultural loans to total loans. Unless otherwise indicated, the FRB definition is used throughout this report. Most farm banks retain much larger agricultural shares in their loan portfolios, and therefore remain sensitive to conditions in the agricultural sector of the economy. Farm loans averaged about 33 percent of total loans at all farm banks in 2001 and are near 46 percent for farm banks with below $25 million in assets (table 4). The dollar amount of farm loans outstanding typically peaks in the summer and declines the rest of the year as production loans are paid down. Thus, the use of June data rather than end-of-year data in the last column of table 7 distorts recent trends in the number of agricultural banks. For the 6 months ending June 30, 2001, farm banks declined by only 29 to 2,744 using the FRB definition and decreased by 10 to 1,969 using the FDIC definition. Both definitions show much larger declines when comparing June 2001 to June 2000 (not shown in the table) with 98 fewer FRB farm banks and a drop of 120 in FDIC s count of agricultural banks. The trend toward fewer agricultural banks reflects an industry-wide drop in the number of commercial banks over the last decade due mostly to mergers, but also some bank failures. nonagricultural banks (tables 5 and 6). Agricultural banks maintained high average capital-to-asset ratios during Large banks lend a greater percentage of their deposit base (table 8), but they used to earn lower rates of return on those assets than did smaller banks (table 9). However, in the first part of 2001, the smallest banks registered the lowest ROA and the highest came from banks with over $500 million in assets. Large banks improved their profitability in part by continuing to keep real estate loan problems under control. As of June 30, 2001, under 1 percent of big bank real estate Economic Research Service, USDA Agricultural Income & Finance Outlook/AIS-78/February 26,