KC Federal Reserve: Operating Loans on the Rise

October 20, 2017 11:32 AM

The downturn in the farm economy is forcing more farmers to turn to banks for operating loans. The Kansas City Federal Reserve’s Ag Finance Databook is released each quarter. The latest report shows lending at agricultural banks stabilized in the third quarter of 2017, but the authors noted risks in the ag sector remain due to a persistently weak agricultural economy. Nathan Kauffman, Assistant Vice President and Omaha Branch Executive, says when gauging the health of the farm economy, it’s not accurate to just focus on prices.

“A lot of a lot of farmers will need to be thinking about their profit margins and $3.50 corn doesn't sound so great if your yields are 150 bushels per acre, but if you're yielding 250 (bushels per acre), that's a different picture,” said Kauffman. “For a lot of farmers I think it's adjusting maybe a bit more to be thinking more holistically about revenue and cash flow and profit margins.”

Operating Loans:

As farmers make adjustments, the KC Fed says farm lending at commercial banks in the third quarter was steady with 2016 levels. However, the amount of non-real estate farm loans increased 2 percent from last year. That increase mirrors what the Fed saw in the second quarter of 2017. That trend is opposite of what economists saw the previous two quarters, where ag lenders reported a sharp decline in lending activity.


“Operating loans have continued to account for a rising share of commercial banks’ farm loan portfolio in recent years,” Kauffman noted in the report. “In fact, operating loans have accounted for nearly 60 percent of the total volume of non-real estate farm loans over the past four quarters, the highest in the 40-year survey history. Conversely, the share of other loans has fallen to levels last seen in the early 1990s.”


Economists say the volume of loans used to pay for current operator expenses increased 15 percent from the previous year, whereas the volume of loans used to finance livestock and equipment purchases slid.

Another sector of non-real estate farm loans that economists are watching is what’s classified as “special mention.” Those loans increased 4 percent from 2016, while the share of loan classified as minimal risk declined 2 percent.

“Although the share of loans classified as special mention continued to increase, nearly 90 percent of farm loans still were assigned a rating of “acceptable” or better in the third quarter, suggesting that financial conditions have only deteriorated modestly,” said Kauffman.


Delinquency Rates


Delinquency rates within the ag lending sector were up from 2016, but lower than the first quarter of the year. The KC Fed says despite the slight uptick in delinquency rates on farm loans from a year ago, less than 3 percent of agricultural banks had a portfolio with more than 5 percent of loans considered nonperforming, loans where the debtor hasn’t made a schedule payment for at least 90 days.


Economists at the KC Fed say there are some concerns about liquidity at agricultural banks, specifically looking at how farm loans are performing, but a key area to note is profitability at agricultural banks has remained steady.


“The rate of return on assets was unchanged from the previous quarter and slightly above the average of the past five years,” said Kauffman in the report. “Agricultural banks also continued to outperform small nonagricultural banks.”


Interest rates:


As the banking sector waits for guidance from the Federal Reserve on interest rates, the KC Fed says bankers have continued to gradually raise interest rates, with rates on loans used to finance operating expenses, farm machinery and livestock increasing 50 to 75 basis points from the previous year.

“Although current rates remain historically low, interest rates on operating loans have increased about a full percentage point since the lows observed in 2015.”


This fall, the Federal Reserve alluded to another interest rate hike, but as the calendar draws closer to the end of the year, economists have one more opportunity to make that happen in 2017 when the Fed meets in December. Kauffman says the Fed looks at the health of the overall economy, as well as the rate of inflation, when making a decision on possible rate hikes.


“From the Federal Reserve’s perspective - and this goes back to the 100 plus years the Fed has been in existence - the Fed will track macroeconomic indicators to get a sense of what might be the right time to either slow an economy that that appears to be overheating or to stimulate an economy that seems to be struggling,” said Kauffman.

He says the Fed has a dual mandate: to balance economic growth while ensuring price stability.

“We have started to see economic growth pick up and there appears to be some momentum, and I think that's part of the reason why we have seen several increases in interest rates over the last couple of years,” said Kauffman. “On the other hand though, on the price stability side, inflationary pressures have remained relatively low. So the Fed has a goal for inflation of 2 percent and inflation has been running a bit below that, in terms of the Fed's metric that we look at so it's balancing those two sides of things. “

Overall Health of Farm Economy:

When looking at the overall ag picture, Kauffman knows there’s stress in farm country – something that’s been gradually building over the past three to four years.


“It's a very case by case scenario,” he said. “I think for some producers carry over debt has become a problem and they're having to interact with lenders and be very direct about what some options might look like - it really might be needing to sell some assets to be able to make things work for the next year. Then, for other producers that maybe made some very good adjustments going from one year to the next, they recognize the pressures that they were facing and were very careful about monitoring their own debt.”


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