Statement for the Record
Federal Deposit Insurance Corporation
Current Agricultural Conditions
and the Outlook into 2000
Committee on Agriculture
United States House of Representatives
February 12, 1999
Room 1300 Longworth House Office Building
Mr. Chairman and members of the Committee, I appreciate the opportunity
for the Federal Deposit Insurance Corporation to provide a written statement
for the hearing record on current agricultural conditions and the outlook
for the remainder of 1999 and into 2000. Global market conditions, combined
with agricultural trouble spots in the United States, make this hearing
Let me first summarize our major observations and conclusions. Global
factors surrounding supply and demand conditions and a strong U.S. dollar
kept commodity prices low in 1998. Forecasts suggest that low commodity
prices will continue into 1999. However, farmers generally were in a strong
position entering last year's growing season and many have the financial
resources to withstand a year or two of poor performance. Yet, pockets
of particular vulnerability do exist, particularly in North Dakota and
The nation's 2,371 insured institutions with significant agricultural
loan portfolios remain in generally strong financial condition. These
banks report solid earnings performance, strong capital positions, and
only isolated asset quality problems. However, a number of banks do report
high concentrations in agricultural loans and other elements of higher
risk. The FDIC is closely monitoring these risk indicators for further
signs of deterioration. At the same time we are participating in banker
outreach programs with FDIC-supervised institutions and encouraging bankers
to work constructively with agricultural borrowers who are experiencing
In the longer term, low commodity prices may accelerate the trend toward
fewer, but larger agricultural producers. This long-term trend has broader
economic effects as well, including the ongoing and intensifying depopulation
of rural America. Insured institutions operating in this environment may
be forced to adapt to reduced loan demand and a diminished deposit base.
The remainder of this testimony will discuss these observations and conclusions
in greater detail. First, it will discuss current agricultural conditions
and the outlook for the future. Agricultural credit will be addressed
next. The statement will then outline the supervisory issues raised by
agricultural lending. Finally, it will address some long-term challenges
for smaller agricultural producers and lenders.
CURRENT AGRICULTURAL CONDITIONS AND OUTLOOK
Excessive supplies, weak demand, and a strong U.S. dollar sent commodity
prices to their lowest levels in a decade. The United States Department
of Agriculture (USDA) forecasts that farmers will face continued low prices
in 1999. Corn, soybeans, and wheat prices are expected to decline by as
much as 20 percent. Hog prices are expected to improve slightly but will
remain below the cost of production for most small producers. The value
of agricultural exports is forecast to decline for the second consecutive
year in 1999. The USDA has forecast a decline in net farm income for 1999,
marking the third consecutive year of declining net farm income from the
record set in 1996.
While the USDA forecasts agricultural land prices to gain one and one-half
percent during 1999, the depressed agricultural economy has begun to put
downward pressure on land prices in selected areas. Typically, these areas
have seen recent land price gains and are major production areas for commodities
now under significant price pressure. The first evidence of this trend
appeared in a second quarter 1998 survey of agricultural bankers by Federal
Reserve Banks in Chicago, Minneapolis, and Kansas City. Farmland price
weaknesses were reported in Iowa, Kansas, Nebraska, Montana and northeast
North Dakota. A decline in value of irrigated cropland and ranchland also
was reported in Missouri. This emerging downward trend in land prices
in several states reflects an expectation of lower farm income for the
near future. In addition, a decline in farmland values will weaken farm
Amidst these negative trends, costs of production declined in 1998, the
first year-to-year reduction in costs since 1992. Lower costs of production
are due to low interest rates, low fuel costs, and reduced fertilizer
expenses. In addition, livestock producers are incurring lower feed costs.
However, lower production expenses are only a small relief. There is significant
variation in production expenses across the country and among producers.
For some producers, commodity prices remain below the cost of production.
Further, many regions of the country experienced difficulties in 1998
due to severe weather. Texas and parts of Oklahoma and New Mexico endured
drought conditions that damaged livestock, cotton, corn, and hay crops.
Likewise, little precipitation and abnormally high temperatures affected
cattle, cotton, corn, soybean and other crops in Arkansas, Louisiana,
Mississippi, Alabama and Georgia.
Farm equipment manufacturers, including Deere & Co., Case Corp.,
and New Holland, reported weak demand for farm equipment in the fourth
quarter of 1998 and warned that sales will suffer into next year. Manufacturers
have moved quickly to reduce production of large tractors and combines
in response to lower levels of demand. Both Deere & Co. and Case Corp.
have announced the extension of temporary layoffs and additional permanent
layoffs. Case Corp. plans a restructuring that will include the closing
of two plants.
Farmers, in general, were in especially sound financial condition entering
1998 after posting record profits in 1996 and strong results in 1997.
As a result, many have the financial wherewithal to withstand one or two
years of poor performance. Yet, pockets of vulnerability to continuing
low commodity prices exist. For example, farmers in North Dakota, Montana
and northwest Minnesota are particularly susceptible to continuing low
wheat prices that could force many farmers into bankruptcy. Farm banks
in this area are already reporting elevated delinquency levels.
Banks active in agricultural lending typically do not immediately show
the effects of one year, or even two consecutive years, of poor agricultural
conditions. Delinquent or problem loans are generally "carried-over" into
operating loans for the subsequent year. However, continued low commodity
prices may impede farmers' ability to demonstrate adequate cash flow for
operating loans needed to plant crops this spring. Inadequate cash flow
may force banks to base lending decisions on the value of available collateral
rather than cash flow. This may or may not be sufficient to support the
One recent study1 of Iowa farmers
concludes that persistent low commodity prices will lead to significant
deterioration in the financial health of farms. The study simulated the
continuation of 1998 commodity prices through a three-year period from
1998 to 2000. The analysis showed that if the current level of low prices
persists through 2000, more than one-third of Iowa's farms would require
financial restructuring or liquidation. The results of the study may be
applicable to other parts of the Corn Belt where corn, soybeans, and hogs
are primary commodities.
Farm debt was forecast to increase by 3 percent in 1998 to $170 billion
and decline to $169 billion in 1999. Growth in farm debt has been moderate
with farm debt in 1997 remaining below the peak of $193 billion in 1984.
According to the USDA, commercial banks remain the largest creditor to
farmers (see chart on following page). Commercial banks provided 40 percent
of total farm credit in 1997. Forecasts indicate that this percentage
will increase slightly to 41 percent in 1998 and 1999. Despite this dominance
in market share, commercial banks are experiencing strong competition
for agricultural loans. Resurgence in lending activity in the Farm Credit
System since 1994 and loans provided by other nonbank lenders2
have provided stiff competition for commercial banks.
FDIC-insured institutions reported $77.6 billion in direct agricultural
loans outstanding as of September 30, 1998. These loans were spread among
7,586 institutions. Nearly two-thirds of total agricultural loans were
related to production, while the remaining third represented agricultural
real estate loans. From year-end 1988 through the third quarter of 1998,
insured institutions' agricultural loans grew 70 percent compared to overall
loan growth of 31 percent.
The number of farm banks (defined as those insured institutions with
agricultural loans exceeding 25 percent of total loans) totaled 2,371
as of September 30, 1998. These farm banks held agricultural loans totaling
$33.8 billion, or 44 percent of total agricultural loans reported by insured
institutions. Aggregate farm-bank assets totaled $125 billion, equaling
just 2 percent of the nation's banking assets. The average farm bank had
total assets of just $53 million.
Most agricultural financing is held by larger, more diversified, financial
institutions. Insured institutions that make agricultural loans, but do
not meet the threshold definition of a farm bank, held agricultural loans
totaling $43.8 billion, or 56 percent of total agricultural loans. Seventy-eight
of the top 100 insured institutions in terms of dollar volume of agricultural
loans outstanding do not meet the definition of a farm bank. Loan portfolios
at these institutions are more diversified compared to farm banks. California,
in particular, has a number of large
institutions that despite substantial agricultural loan portfolios, are
not particularly susceptible to problems in agriculture because their
agricultural lending is a relatively small part of a more diversified
loan portfolio. Also, the California economy is more diverse and less
reliant on the agricultural sector than other regions.
Many farm banks have high agricultural loan concentration levels The
table below depicts agricultural loan concentration as a percent of Tier
1 capital.3 Over 900 banks with total
assets of $48 billion reported over 300 percent of Tier 1 capital invested
in agricultural loans.
Farm Banks Have Significant Concentrations In Agricultural Loans
To Tier 1 Capital
Number of Banks
Total Assets (millions)
Greater Than 300%
200% to 300%
100% to 200%
Less Than 100%
Source: Call Reports, September 30, 1998. Reports of Examination.
Farm banks are spread among 35 states, but the majority of these banks
are concentrated in the central portion of the United States. Ten states4
serve as headquarters to 1,934 farm banks, or 82 percent of the nation's
total number of farm banks. The shaded areas on the following map depict
those counties where exposure to agricultural loans is high.
Bank Exposure to Agricultural Loans is
Concentrated in the Central United States
Source: Bank Call Reports, September 30, 1998.
On the whole, farm banks thus far have maintained profitability despite
competitive pressures and declining crop prices. Farm banks reported return
on assets of 1.3 percent in the third quarter of 1998. The aggregate net
interest margin was 4.3 percent compared to 4.7 percent at other small
nonfarm banks. The narrower margin may reflect the strong competition
farm banks face from other nonbank competitors. However, the trend in
farm bank net interest margin has been steady and does not indicate any
significant margin erosion over the past twelve quarters. Farm banks,
as a group, maintain tight overhead expense controls: noninterest expenses
as a percent of earning assets measured only 3 percent compared to 4.6
percent at other small nonfarm banks. Farm banks generate modest noninterest
or fee income. This suggests that farm banks are very narrowly focused
on traditional lending and have few alternative revenue sources to bolster
earnings performance. This is in contrast to many larger banks and some
smaller nonfarm banks that have expanded revenue sources by delivering
fee generating products and services.
The average Tier 1 capital ratio (Tier 1 capital as a percent of average
total assets) for farm banks of 10.6 percent has been stable over the
past twelve quarters. This ratio is substantially higher than the national
average for all insured institutions of 7.8 percent, but is similar to
other small nonfarm banks. Reported asset quality at farm banks remains
strong. Loan charge-offs and total past due loan levels have been relatively
stable over the past twelve quarters. The current level of charge-offs
to total loans is less than 0.25 percent and is just over one-third of
the national average. Significant growth in agricultural loans may be
straining liquidity among farm banks. In aggregate, farm banks' loan-to-deposit
ratio equaled 72 percent as of September 30, 1998, compared to just 53
percent at year-end 1990. Further, there are a number of farm banks with
significantly higher loan-to-deposit ratios. Over 630 farm banks had loan-to-deposit
ratios greater than 80 percent.
In spite of these overall positive results, some farm banks have characteristics
associated with elements of higher risk. These institutions may be exposed
to greater financial difficulty should stress in the agricultural industry
continue over a sustained period. The table on the following page shows
the current risk areas associated with farm banks.
Farm Banks Exhibiting
Selected Risk Elements
Number of Banks
Unprofitable Farm Banks
Tier 1 Capital Ratio < 6.0%
Past Due Loans/Total Loans Ratio >10%
Loan-to-Deposit Ratio > 80%
Agricultural Loans/Total Loans > 50 %
Loan-to-Deposit Ratio > 90%
Agricultural Loans/Total Loans > 50%
CAMELS Rating 3, 4, or 5
Source: Call Reports, September 30, 1998. Reports of Examination
Through the examination process, collection of financial data, and underwriting
surveys prepared by examiners, we have observed recent increases in agricultural
carryover debt, past due loans, and adverse classifications at some FDIC-supervised
institutions. In light of USDA forecasts that reflect declining prices
for various livestock and grain, we are closely tracking these risk indicators
and other emerging problems in the agricultural sector. Problems, however,
have not yet risen to a level that is cause for critical concern.
The FDIC recognizes that the effects of such external factors on agricultural
borrowers are often transitory. The FDIC Manual of Examination Policies
provide standing instructions for FDIC examiners to show flexibility when
reviewing agricultural loans temporarily affected by economic or weather-related
events. Examiners are instructed to recognize that prudent efforts by
financial institutions to work with these borrowers are consistent with
safe and sound financial institution practices and are in the public interest.
The FDIC also issues periodic Financial Institution Letters ("FIL"s) to
address specific problems. For example, in August 1998, the FDIC issued
a FIL to all FDIC-supervised institutions in Texas and Oklahoma to encourage
those institutions to work constructively with agricultural borrowers
hurt by the drought that affected much of their states. In addition, emerging
problems in the agricultural sector are tracked closely and noted in quarterly
publications provided to our examiners. Much of the information is also
available on the FDIC's Internet web site.
Lower commodity prices will intensify the long-range trend in agribusiness
toward fewer, but larger producers. The hog market in 1998 provides a
telling example of the impact of low prices on the long-term structure
of agriculture. Modern large-scale producers have achieved lower costs
of production through technological and managerial innovation. These operators,
who continue to produce at high volumes to realize economies of scale,
are better able to weather periods of low prices. Smaller producers typically
lack the resources to achieve the lower costs necessary to survive in
an extended down market. Although the pork industry as a whole will continue
to expand production, increasing numbers of smaller hog producers could
continue to be forced out of the industry. While these economies of scale
may not be replicated to the same extent among other commodities like
crops, the general trend is toward consolidation among producers.
Long-term trends in agriculture have broader economic effects as well.
An ongoing and intensifying trend affecting rural America -- primarily
the Great Plains region -- has been rural depopulation. This demographic
trend is a result of consolidation and technological advancement in agriculture.
A great majority of geographically isolated, farm-dependent counties have
lost population and remain susceptible to further population erosion.
The immediate consequences of rural depopulation include skewed age profiles,
real or perceived negative attitudes toward local investment, and weakening
links between agriculture and the local economy.
These long-term trends in agribusiness and rural communities affect local
commercial banks as well. Larger farms rely less on the local economy
for all inputs, including financing. Smaller community banks may face
a decline in loan demand and greater competition from nonlocal banks and
nontraditional lenders. Big agribusiness operations will require larger
loans and banks will need to acquire more specialized expertise to market
and manage agricultural loan portfolios. Banks in counties with declining
populations may have difficulty maintaining an adequate deposit base.
Reductions in deposits, especially those from local farmers and business
owners, resulting from households leaving the area or selling the family
business may present challenges to local banks seeking viable lower-cost
local funding sources.
Several successive years of low prices and poor production in parts of
Minnesota, Montana and North Dakota have caused a decline in asset quality
for farm banks located in those states. Continued low wheat prices that
are forecasted for 1999 would further distress farm borrowers and lead
to increased asset quality problems for farm banks in those states.
Most farm banks elsewhere are entering 1999 in good financial condition.
However, a continuation of low commodity prices in 1999 and 2000 would
stress farm borrowers and may lead to more asset quality problems in farm
banks throughout the country. The FDIC will continue to encourage financial
institutions to work constructively with agricultural borrowers in financial
distress and has issued standing instructions to examiners to recognize
that prudent efforts by financial institutions to work with borrowers
experiencing temporary setbacks are consistent with safe and sound financial
R.W. and A. Vontalge. "How Many Iowa Commercial Farm Businesses Will Survive
Until 2000?" Iowa State University. September 20, 1998.
2 Other nonbank lenders include
input suppliers like feed, seed, and chemical suppliers and farm implement
3 Tier 1 (core) capital includes:
common equity plus noncumulative perpetual preferred stock plus minority
interests in consolidated subsidiaries less goodwill and other ineligible
intangible assets. The amount of eligible intangibles (including mortgage
servicing rights) included in core capital is limited in accordance with
supervisory capital regulations.
4 The ten states with the largest
number of farm banks are Iowa (340), Nebraska (266), Minnesota (250),
Illinois (245), Kansas (242), Texas (180), Missouri (119), Oklahoma (113),
North Dakota (102) and South Dakota (77).