Financial Markets in Agriculture Paul Ellinger and Bruce Sherrick October 15, 2008 IFEU 08-02 Overview The unprecedented events of the past two billion of illiquid assets from ailing months have severely shaken global financial institutions. financial markets. Spillover effects from declining housing prices and increased On October 13, the government subprime delinquencies eventually led to announced the availability of $250 billion a freezing of global credit markets. for direct equity investments through Impacts on many large financial preferred stock purchases in financial institutions included substantial liquidity institutions. One half will go to large and capital problems which in turn led to international banks while the other half is large-scale reorganizations among major targeted to regional and community banks and others in the financial services banks. The move is intended to restore sector. Moreover, major stock indices confidence and stability of the financial have year-to-date declines exceeding markets by providing direct capital relief. 35%, the worst annual decline on record Treasury Secretary Henry Paulson since the great depression. 1 A resulting summarized the severity of the problem concern relates to the impacts of these and the rationale for such a significant events on the firms serving the financing move with his comments that: needs of the agricultural sector. This article provides an overview of major “ Government owning a stake in any events affecting the health of the finance private U.S. company is sector and identifies issues of importance objectionable to most Americans – to the related financial markets in me included. Yet the alternative of agriculture. leaving businesses and consumers without access to financing is totally Government Intervention unacceptable. When financing isn't available, consumers and Congress recently passed the troubled businesses shrink their spending, asset relief program (TARP) designed to which leads to businesses cutting shore up the financial system by jobs and even closing up shop.” authorizing the purchase of up to $700 Two other components of the current plan include temporary guarantees of senior debt and large non-interest bearing 1 Dow industrial average YTD decline was 36% deposits at commercial banks. while the S&P 500 YTD is decline 35% as of Beginning October 27, the government October 10, 2008.
will fund purchases of commercial paper Agricultural Financial Markets from high quality issuers. Commercial paper is a primary funding mechanism for Agricultural lenders are generally in corporations to finance their short term strong financial health. Most of the working capital needs. agricultural-related institutions did not participate in the higher-risk housing These actions are in addition to previous lending procedures of larger urban banks announcements that the FDIC will extend nor were they substantially invested in the their deposit insurance on deposits to structured securities that have lost $250,000. Additionally, the minimum substantial market value. Hence, most capital regulatory framework was relaxed agricultural lenders have not incurred the in certain cases for firms whose huge losses of the Wall Street banks. requirements to “mark-to-market” resulted in capital shortages due to unrealized In comparison with other sectors of the losses on investments with downgraded economy, agriculture is generally ratings. characterized as using a low amount of debt relative to assets. The U.S. The interconnectedness among major Department of Agriculture estimates total financial institutions and with the global farm debt of approximately $211 billion at financial markets has accentuated the the end of 2007. Total assets in the farm crisis worldwide. Central banks from other sector exceeded $2.2 trillion resulting in a countries have also assisted financial farm aggregate debt-to-asset ratio of only institutions through infusions of capital 9.6%. and liquidity in addition to guarantees. The primary lenders in agriculture are The market reactions to these commercial banks, the Farm Credit announcements have been mixed, but System, insurance companies, Farm generally positive. The U.S. stock market Service Agencies and captive finance experienced a 1 day increase of 11% in companies. the Dow on October 13. Commercial paper and interbank lending spreads have The Farm Credit System holds declined; an indication that large banks approximately 42% of the real estate debt are more willing to lend to each other. and 31% of the nonreal estate farm debt. Commercial banks have the highest A key question currently facing farmers is market share of nonreal estate farm debt how the economic disruptions and turmoil (53%) while lending 38% of the farm real will impact the availability and cost of estate loans. (Figures 1 and 2). credit through their traditional lending channels. Another issue is how the recent government actions will impact lenders serving agriculture. To address these issues, we provide a brief overview of the two major lender types in agriculture and discuss potential impacts of the market distortions on their delivery of credit to farmers. 2
as their primary source of funds. As a Figure 1. Real Estate Farm Debt, 2007. group, they have fared relatively well. Storage Real Estate Farm Debt, 2007 facility loans Only 5% of “agricultural banks” had 0% 107.8 $Billion negative income during the first half of Individuals 2008 – a far smaller fraction than of all and others Life 8% commercial banks. Moreover, over 50% insurance companies of agricultural banks reported net income 10% 2 higher than the previous 6 month period. Farm Credit System 42% Table 1 provides summary information about commercial banks lending to Commercial agriculture. Over 78% of the volume and banks 38% over 93% of the banks are from those less than $10 billion in asset size. Farm Service Approximately, 18% of the banks lending Agency 2% money to agriculture are publicly traded or owned by a publicly traded bank holding company. While these summaries indicate that Figure 2 Nonreal Estate Farm Debt , community banks are a significant lender 2007. to agriculture, there remains some Nonreal Estate Farm Debt, 2007 exposure to the issues facing larger 103.7 $Billion banks through the remaining market share. The largest 15 banks lending to Individuals and others agriculture are reported in Table 2. These 13% large banks hold approximately 20% of Farm Credit System the total farm debt. These banks have 31% been more exposed to the financial stresses occurring in the credit markets, hence their agricultural activities are not likely insulated from the effects of the Farm Service Commercial Agency banks current financial market disruptions either. 3% 53% Source:US DA, Economic Research Service Table 1. Commercial Banks Lending to Agriculture by Asset Size. Asset Size ($ Million) Percent of Ag Loans The following sections summarize at Commercial Banks Number of Banks characteristics of the two major lenders, Less than $100 16.09% 2,507 and identify the primary areas of concern 100-500 33.96% 2,677 regarding the availability of credit and potential risks faced by these institutions 500-1,000 10.44% 474 in the current environment. 1,000-10,000 17.85% 347 Greater than 10,0000 21.66% 66 Commercial Banks Source: Call and Income Reports, 6/30/2008 Commercial banks lending to agriculture 2 Agricultural banks are defined by FDIC as are generally dominated by small, banks that have 25% of their loan portfolio in community banks that use local deposits agriculture. 3
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