Each depositor insured to at least $250,000 per insured bank

Agricultural and Rural Issues Will Determine Future of Kansas City Region

Rural and agricultural issues continue to drive the Kansas City Region’s economic and banking risk profile. The Kansas City Region is the most rural and agriculturally dependent of the six FDIC Regions, with a share of rural population that is more than twice the national average.¹ These rural areas tend to rely heavily on agriculture. The Region’s FDIC-insured institutions reflect these rural characteristics. Foremost, the Region’s institutions tend to be much smaller than elsewhere in the country.² The Kansas City Region is home to only 4 of the nation’s 122 institutions holding assets greater than $10 billion. Also, more than half the banks in the Region are farm banks, predominately located in rural communities.³

Overall, the agricultural sector is performing well; U.S. farmers started 2006 on the heels of record-high net farm income. Although income levels declined in 2006, they are still expected to reach the 10-year average in 2006.⁴  Despite this favorable performance, rural and agricultural issues—specifically ongoing rural depopulation trends, uncertainty surrounding the next farm bill, and continuing hydrological drought conditions—are expected to influence the regional economy and insured financial institutions in the near and long term.

Depopulation Challenges Banks to Operate with Smaller Customer Bases

Residents have been slowly migrating from the Region’s rural counties for decades, largely because technological advances in agriculture have reduced the need for farm laborers.⁵ In many areas of the Region, the pace of rural depopulation accelerated in the 1990s, raising concerns about the viability of many sparsely populated counties. This trend has continued into the 2000s, as 328 of the Region’s rural counties lost population from 2000 to 2005 at a greater rate than during the 1990s (see Map 1).

To date, FDIC-insured financial institutions in depopulating rural counties have performed well—similar to institutions in rural counties with growing populations. The primary differences in performance between these groups have been in loan and deposit growth, which has been considerably lower for institutions in depopulating counties.⁶  Because depopulation equates to a declining customer base, this situation is slowly threatening the ability of many rural, community banks to obtain adequate funding and generate enough loans to remain in business. Many rural banks have opened branches in more vibrant counties, with varying results depending on the ability of bank management to operate in these new areas. To maximize profits in spite of a waning customer base, others have mastered operating efficiency by keeping costs down. Still other institutions have turned to the Internet as a source of deposits and loans. Although the Internet can be helpful to rural banks, it may also prove to be a “two-way street,” allowing large banks based in urban areas to successfully compete in rural areas.

Rural depopulation is a slow-moving issue, and community banks have been able to adapt to its ­challenges thus far. It is likely that rural banks will continue to expand their reach to attract loans and deposits, which should stem major problems in the near term. Over the long term, however, continued depopulation could result in bank consolidation in rural areas. Also, as current managers retire, the ability to attract and retain qualified bank managers in rural areas is a concern that will likely become more pressing in coming years.

Prosperity of Farmers Depends Heavily on the Future of Federal Farm Policy

The Kansas City Region’s farmers rely heavily on the federal government for financial assistance in the form of price supports and emergency aid. Corn, soybean, and wheat crops are covered by government farm programs and are produced heavily in the Region. Consequently, government assistance to the Region’s farmers has been substantial. Over the past 16 years, the federal government has provided nearly half of the net farm income for the Region’s farmers compared with about a quarter for the rest of the nation (see Map 2).

Because of the Region’s dependence on farm programs, producers and rural constituents are paying close attention to congressional discussions of the 2007 farm bill. Some in Congress want to continue the 2002 bill, which is favorable to farmers; however, the bill has opponents in other countries who claim that price supports distort world agricultural prices. In fact, Brazil has threatened World Trade Organization (WTO) litigation against U.S. corn and soybean programs following successful challenges of the U.S. cotton program and the European Union sugar program. Others in Congress would like to take steps to reduce payments to farmers and replace them with funds for rural development.⁷  Still others would like to expand farm programs to include specialty crops, such as vegetables and fruits, which could cut funds for traditional program crops.

Given farmers’ historic and ongoing dependence on federal farm payments, any changes to current programs could hurt their cash flow positions. Policy changes also may affect the price of farmland, because federal farm supports, which have existed in various forms since the 1930s, have been capitalized into property values.⁸  For example, one U.S. Department of Agriculture study estimates that 69 percent of North Dakota’s farmland value may be attributed to this expected stream of government payments. From a lending standpoint, cuts in programs would affect the value of underlying real estate collateral and the ability of farmers to repay their loans. The Region’s rural economies would also be affected by cuts to traditional programs, although shifts in funding to rural development could offset some of the potentially negative consequences.

Long-Term Drought Conditions Continue to Stress Farmers

The ongoing drought is one more agricultural challenge facing the Kansas City Region. Much of the Region is experiencing drought conditions, and parts of the Region—western Nebraska and Kansas, in particular—are well into their seventh year of drought. Conditions have worsened considerably during the past year, as below-average rainfall has added to long-term water shortages, commonly referred to as “hydrological drought” conditions (see Map 3). Timely precipitation through the growing season helped farmers in most areas produce adequate crop yields. In Kansas, however, wheat yields in 2006 were down 21 percent compared with 2005 levels; during the 2006 growing season, the state received just 14.4 inches of precipitation, compared with 21.5 inches the year before.⁹

Hydrological drought conditions specifically refer to deteriorated levels in streams, reservoirs, and aquifers caused by several years of below-average rainfall and winter snowpack. In many areas of the Region, hydrological drought conditions are significant. For example, the Ogallala aquifer, a massive underground lake that sprawls beneath much of the Great Plains, has declined 30 feet in some areas over the past decade.¹⁰  In addition, Lake McConaghy, the largest reservoir in Nebraska, is filled to only 22 percent of capacity.¹¹  Also, stream flows in Kansas are below the levels posted during the extreme droughts of the 1930s and 1950s.¹² 

Water shortages have begun taking their toll on farmers who rely on irrigation to grow their crops, largely in Nebraska, Kansas, and South Dakota. For example, irrigation limits in Nebraska have been placed on about one-quarter of the state, and first-time limits will eventually encompass the rest of the state. In addition, more restrictive limits may be imposed in some areas. The reduction in available water for crop producers in the southern portion of Nebraska has already led to declines of 4.2 percent in irrigated land values in 2006, compared with an increase of 9.6 percent in land values statewide.¹³ The statewide average for irrigated cropland was $2,150 in 2006, compared with $1,450 for “dryland” (i.e., nonirrigated land). As irrigation limits become more restrictive, crop yields (and thus farm revenues) will be adversely affected, and irrigated farmland values will decline toward dryland values.

It will take a substantial amount of precipitation to cure problems caused by the Region’s hydrological drought conditions. Unfortunately, the forecast indicates there is an equal chance of drought conditions worsening or improving over the next 12 months.¹⁴ Bankers in the Kansas City Region are taking extra measures to mitigate loan portfolio risk, including conservatively valuing irrigated farmland, stress testing agricultural loans for yield shocks, and reviewing farm operations more frequently.

Looking Ahead: 2007 and Beyond

Of the three rural and agricultural issues facing the Kansas City Region, farm policy could exert the greatest impact in 2007. The 2007 farm bill will be viewed by many as a major test of corn, soybean, and wheat producers’ political strength. Any reductions in federal aid would constrain the debt-repayment ability of farm borrowers and potentially deflate prices for farmland—a major source of collateral coverage. Meanwhile, long-term drought conditions are expected to affect the Region’s farmers well into the future. Rural depopulation has the longest time horizon as the overall effects on the Region worsen each year as this trend accelerates.

Two issues on the national radar screen—slowing housing markets and high energy prices—will not affect the Kansas City Region to the same extent as other parts of the country. The Region’s housing markets have not experienced the double-digit price increases seen in coastal markets, and, therefore, a slowdown in residential building and home sales is not expected to lead to outright declines in home prices. Rather, a deceleration in the already moderate rate of appreciation is more likely. In addition, higher energy costs have stressed the Region’s paycheck-to-paycheck consumers but have not substantially constrained most consumer spending. However, energy costs have affected farm operations as the cost of energy for agricultural use is forecasted to increase almost 10 percent in 2006 on the heels of a 22 percent increase in 2005.¹⁵

John M. Anderlik, Regional Manager
janderlik@fdic.gov

¹ Almost 35 percent (34.7 percent) of the Region’s population lived in rural areas in 2005, compared with less than 16 percent elsewhere in the country. U.S. Census, “2005 Estimates of County Population,” http://www.census.gov/popest/counties/.
² More than 86 percent of the Region’s institutions hold less than $250 million in assets, while outside the Region two-thirds of banks and thrifts are this small.
³ Farm banks are defined by the FDIC as insured financial institutions with at least 25 percent of loan portfolios invested in loans to agri­cultural operations or secured by agricultural real estate.
⁴ U.S. Department of Agriculture, Economic Research Service, “2006 Forecast,” http://www.ers.usda.gov/Briefing/FarmIncome/nationalestimates.htm.
⁵ For a detailed analysis of the causes and implications of rural depopulation in the Great Plains, see Jeffrey Walser and John Anderlik, “Rural Depopulation: What Does It Mean for the Future Economic Health of Rural Areas and Community Banks That Support Them?” FDIC Banking Review 16, no. 3 (2004): pages 57-95.
⁶ Ibid. An FDIC analysis showed that commercial banks headquartered in metropolitan statistical areas had ten-year annualized asset, loan, and deposit growth rates of 8.9 percent, 11.2 percent, and 8.6 percent, respectively, between 1993 and 2003. In comparison, commercial banks headquartered in nonmetropolitan statistical areas had growth rates of just 4.4 percent, 6.8 percent, and 3.8 percent, respectively.
⁷ The WTO had been negotiating worldwide limits on agricultural support programs, which could have altered U.S. policy considerably. These negotiations, which had been ongoing since 2001, were suspended in July 2006 and are not expected to place mandates on the next farm bill. However, some members of Congress believe the next farm bill should take steps in the direction of the WTO discussions.
⁸ Bruce Gardner, “U.S. Commodity Policies and Land Values,” in Government Policy and Farmland Markets, ed. Charles Moss and Andrew Schmitz (Ames, IA: Iowa State University Press, 2003).
⁹ National Oceanic and Atmospheric Administration, “Climate at a Glance,” September 2006, http://lwf.ncdc.noaa.gov/oa/climate/research/cag3/ks.html.
¹⁰ Editorial, “Irrigation Is Mining a Finite Resource,” McCook Daily Gazette, October 3, 2006.
¹¹ Central Nebraska Public Power and Irrigation District, Reservoir Elevation and Platte River Flow Data, September 2006.
¹² U.S. Geological Survey, “2000–2006 Flows at Some USGS Streamgauges Lower than 1930’s or 1950’s Droughts,” August 10, 2006.
¹³ Cornhusker Economics, University of Nebraska, Lincoln, “Nebraska’s Agricultural Land Markets: Dynamic and Diverse,” March 22, 2006.
¹⁴ National Weather Service, Climate Prediction Center, September 2006.
¹⁵ Economic Research Service, 2006 Forecast.