One area of agriculture has consistently been outperforming its peers for years, despite the challenges faced by the industry. That area: agricultural banks.
As farmers across the country continue to look for ways to cut costs and “trim the fat,” agricultural banks are regularly surpassing commercial banks and the industry benchmark known as “all insured institutions,” which covers the nearly 6,000 federally insured lenders in the U.S.
As their designation implies, agricultural banks have greater focus and loan exposure to agriculture. The last time agricultural banks ended the year with a return-on-asset ratio that was lower than their peers was 2006. Except for a few brief anomalies, agricultural banks have routinely demonstrated a better net-interest margin, fewer charge-offs and a much smaller percentage of unprofitable institutions. These banks are typically better capitalized than their peers and have set aside significant cash in case loans start to go bad. Several years ago, we saw a number of commercial banks make aggressive moves to increase their exposure to agriculture in order to participate in this success. These times are likely to change but not quite yet.
Agricultural banks are well prepared for the challenges that lie ahead. As of September 2017, agricultural banks have a provision-to-charge-off percentage of 200.5% versus 125.98% for all insured institutions. They have set aside a lot of money to guard against loan losses, despite having significantly fewer charge-offs than their peers.
So far, there hasn’t been much change in loan repayment to agricultural banks. In fact, year-over-year, the number of loans 30 to 89 days past due has declined slightly. Loans more than 90 days past due and total charge-offs rose marginally. For the moment, loan repayment is strong.
We won’t know the impact of low commodity prices on banks for several years. The equity strength of agriculture will give banks and borrowers options before charge-offs become a real issue. This delay means bank financial statements are likely to look strong a while longer. It’s likely to take two to three years of continued, industrywide challenges before we see problems on bank financial statements.
According to several studies, in the 1980s, a bank’s loan-to-asset ratio was the largest single determining factor on whether it failed. The loan-to-asset ratio indicates how much a bank’s balance sheet is leveraged. Similar to a farm, too much leverage on a bank’s balance sheet eliminates options if financial performance falls. We need to watch this lesser-known ratio.
In addition to repayment rates, monitoring loan growth and land values remains critical. Loan growth can indicate borrowers are struggling with carryover debt and/or losses. For an extended period of time, these drivers of loan growth will choke a business to death. When you combine this with a decline in land values, we can quickly reach dangerous levels of debt not witnessed since the 1980s.
The bottom line is while agricultural banks are strong, it’s likely they’ll face some challenges within the next three years. It’s worth checking up on your bank’s financial performance from time to time. You can assess your lender’s financial safety through the FDIC’s website or the “Safe and Sound Ratings” section at www.bankrate.com.