Several times per week federal banking officials close a bank at the end of the day and it reopens as a new branch of a larger bank the next morning. Deposits are still there, so are the employees, but the change indicates the banking industry remains fragile for some banks. Fortunately, banks with largely agricultural clientele remain in good shape, but for how long is uncertain. What the Federal Reserve does report is that agricultural banks are taking measures to strengthen their own financial foundation, and that has an impact on farmers.

The latest issue of The Main Street Economist which is published by the Federal Reserve Bank at Kansas City, reports that agricultural credit standards are tightening, and agricultural borrowers are becoming concerned about their access to credit at the same time agricultural bankers are becoming concerned about the creditworthiness of their borrowers. The reason is the weakening agricultural economy.

In the wake of the global economic meltdown, US agricultural banks remained generally strong, but their profitability has been trimmed while still outperforming banks in the general commercial sector. Comparatively, returns on equity at agricultural banks had declined to 7.6% by September of 2008 while returns for all commercial banks were down to 2.86%. The decline in ag bank returns was due to lower interest rates, since the average rate on operating loans was 9% in 2006 and it was down to 7% in the last quarter of 2008. Correspondingly, the cost of capital for banks to borrow from other banks increased. At the same time, loan delinquencies have increased from 1.08% in the first quarter of 2008 to 1.23% in the third quarter, with delinquencies and write-offs rising faster than at small commercial banks.

In this lending environment, agricultural banks have tightened their lending standards to preserve their capital and manage their risk. However, 84% of the banks in the Kansas City Fed District report having the same amount or more money to lend in the first quarter of 2009 as they did in 2008. But while funds were available to lend, the bankers reported raising collateral requirements on operating loans by as much as 20%. However the change did not restrict loan activity, since farm debt levels rose at the same time, meaning that farmers were able to meet the increased collateral requirements and obtain borrowed capital. But while issuing loans, the average risk rating on farming lending increased and loan quality, particularly those associated with livestock operations, deteriorated. There have been more loan renewals and extensions, indicating that farming operations were unable to completely repay the loan in the prescribed time. One reason may have been the shorter time period banks allowed for loans to be repaid.

The Federal Reserve says banks are at risk themselves by having insufficient funds to loan from their own operations. Specifically, bank deposits are growing slowly because of low interest rates being offered and that reduces the amount of money that can be loaned for farm operating and land loans. With more job losses, many savings accounts are being depleted and that also limits funds. Banks also have the option to issue commercial paper, but with lower equity values at banks, there is a declining interest in loaning money to banks.

During 2009 the creditworthiness of agricultural borrowers is expected to decline with narrower profit margins for crop operations and elusive profit margins for livestock operations. The Kansas City Fed says loan defaults are low at this time, but delinquency rates, loan write-offs, and risk ratings are rising. At the same time, land values are softening because of lower income and that means collateral values will shrink when the lending season begins anew.

Summary:
At the outset of global economic crisis, agriculture seemed to be insulated following two strong years of commodity prices and rising land values. With declining prices, rising costs, and softer land values, the financial stability of the farm economy is weaker, and banks serving agricultural clientele are responding by tightening the availability of credit. Borrowers have to post more collateral, and loans are being written for shorter periods of time. Meanwhile, banks are having more trouble obtaining money to loan.