Agriculture credit standards are tightening according to the Main Street Economist Report from the Federal Reserve Bank of Kansas City. The report highlighted that ag banks are experiencing falling return on assets (ROA) and return on equities (ROE), although still outperforming commercial and small banks in these tough times.

Ag banks, defined as having loan portfolios of at least 14% ag loans, have experienced falling ROAs and ROEs lately. Compared to commercial and small banks, ag banks are still performing better.

Some factors that are contributing to the decline of ag bank’s profits are:

1.     Interest rates on ag loans are decreasing, thus lowering ag bank revenues

2.     A rise in the cost of capital for banks

Banks are paying higher fees to other banks in order to borrow from them. The London Inter-Bank Offered Rate (LIBOR) is a rate that banks charge each other for lending. LIBOR had risen previously creating expensive lending, but recently it has fallen which is a sign of better banking conditions.

3.     Loan delinquencies are rising

Banks are experiencing higher loan delinquency rates. From the first to third quarters of 2008, ag loan delinquency rates had risen from 1.08% to 1.23%, while all other types of loans had risen to 3.65%. Ag loans are still significantly lower, showing their relative strength.

Ag banks must tighten credit in order to stay stronger than other banks. They are primarily doing this by raising the amount of collateral needed on loans, and shortening loan maturities.

The outlook

Ag banks will require more collateral because asset values are decreasing in this recession. Secondly, loan maturities will be shortened to pass the risk onto the borrowers. Finally, it will becoming harder for ag banks to provide lending if their bank deposits decrease, which lowers the amount of money available for lending. The volume of deposits would decrease if interest rates stay low on CD’s and other savings vehicles.

Even though ag bank credit is tight, it could get even tighter before it loosens. One thing is for certain though, ag banks are still outperforming commercial and small banks. The data proves it.

- Colvin