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Farm Mortgage Lending Faces Leaner Times After Run-Up

MAR 25, 2014 12:40pm ET
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If you listen closely, you may hear the sound of a real estate bubble starting to deflate.

No, it's not the national real estate market. U.S. home values are still 9% lower than the last cyclical peak, according to the Mortgage Bankers Association. (Though that last peak deflated with a bang, so keep an eye out.) I'm talking about a niche market, though it is a sizeable one, with $3 trillion in assets and more than $300 billion in outstanding loans.

The farm mortgage market is a funny animal, dominated by a hybrid residential-commercial mortgage (though much more like commercial) along with a sizeable amount (about 40% now) of non-real estate production loans. Still, according to the U.S. Department of Agriculture, farm debt will reach $316 million this year, with $187 billion of that in real estate loans. And that $187 billion is an amount that has jumped 20% since 2010.

Farmers have been benefiting from steady increases in the prices of commodities in recent years, some of it driven by extreme weather. But the underpinnings of that growth seem to be on the wane now. The USDA is projecting a 22% drop in farm cash income for this year, to $102 billion from $130 billion. And crop receipts are projected to fall by 12%. "The average prices for corn, wheat, soybeans, cotton, vegetables and melons are expected to decline in 2014," says the American Bankers Association.

That's bad news for farm real estate, where the land becomes more valuable the higher the prices it yields on crops, and it bodes poorly for lending against such property. The USDA predicts such debt will grow by 3.2% this year, about a third less than it did last year.

Consultant Bert Ely, who writes about Farm Credit System issues for the ABA, agrees with me that the market is "getting a little frothy. But it's not going to be as bad as it was in the early 1980s," he says, referring to the last big farm disaster. "Whatever dropoff there is isn't going to be as much."

The ABA's performance report on farm banks (it counts 2,152 of them) for 2013 agrees. "One area of concern for farm bankers and their regulators has been the rapid appreciation of farmland values in some areas of the country," it says. "However, the run up in farmland values so far is not a credit driven event. Farm banks are actively managing risk associated with agricultural lending and underwriting standards on farm real estate loans are very conservative."

Farm lenders commenting in a video discussion of ABA’s report see no immediate need to worry. “I’m pretty optimistic [on the outlook for 2014] even though prices are reduced from what they were,” says Kreg Denton, a senior vice president at First Community Bank in Fancy Farm, Ky. “Farmers in our area have gotten themselves in pretty good shape as far as finances are concerned.”

Nate Franzen, the ag division president at First Dakota National Bank in Yankton, S.D., says credit quality is "strong," though he admits "there’s a little more stress than in the past." Still, “It’s not any type of disaster at this point.” Is there potential turbulence ahead? "Ag is cyclical," Franzen says. "We need to plan for tougher times. As long as we do that, everything will be fine."

How big has the run up in prices been? The USDA says farm real estate values hit $2,900 an acre in 2013, up 9% from 2012. Cropland popped 13%, to $4,000 an acre. That seems pretty frothy, indeed.

Some areas of the country are also looking overheated for farm debt. The Northeast region saw farmland loans increase 30% last year, ABA finds. Of course, the Northeast isn't the biggest farming sector in the country. But all other sectors saw healthy jumps, with the South up 5%, the Corn Belt up 8%, the West 9% and the Plains 10%.

Just as farm mortgages are quite a bit different than residential ones, the lenders in the area are a bit of a different cohort as well. The share leader is the Farm Credit System associations, specialized farm lenders funded by an arm of the country's oldest government-sponsored enterprise, the Farm Credit Administration. The Farm Credit System lenders, which lend but do not take deposits, have a little less than half of the farm real estate loans outstanding. Commercial banks have about a third of the market, and are followed by life insurance companies and individuals, which together have more than $25 billion in farm real estate debt.

Commercial banks, however, are smarting over what they see as unfair advantages enjoyed by Farm Credit System lenders, including funding costs. "GSEs borrow very cheaply and at the long end of the yield curve," Ely says, noting that spreads for farm debt recently came to 54 basis points over the 10-year Treasury and 33 basis points for seven years. And, Farm Credit System lenders' profits from real estate lending are exempt from all taxation.

Taking a look at some typical FCS lenders, New Mexico has a total of two that seem to be doing well. Ag New Mexico of Clovis is fairly small, at $185 million in assets. Farm Credit of New Mexico, based in Albuquerque, is much larger, at $1.4 billion in assets. Both are well capitalized, Ag New Mexico at 17% capital-to-assets and Farm Credit at 22% at the end of last year, according to call reports they filed with FCA. Both saw profits increase in the last half of 2013, from $1.4 million at June 30 to $2.9 million at yearend for the smaller institution, and from $14 million to $26 million for the bigger one.

New York's MetLife is an example of a life insurer with a big interest in agricultural mortgages (it says it has been in this field since 1917). It says it originated $3 billion in ag mortgages in 2012. Interestingly, $300 million of that volume went out of country, to Brazilian farmers. Its total ag portfolio was nearly $13 billion at yearend 2012.

As those Brazilian farmers doubtless know, froth is great for specialty coffee. But it's not so good for specialty finance.

Mark Fogarty, Editor at Large at National Mortgage News, is starting a regular blog of analysis and commentary based on his 30 years covering the mortgage industry.

Comments (2)
This article makes things seem like everything is ok. No asset bubbles here, move along.

"Iowa farmland sale hits new record high at $21,900 an acre" headline from Reuters in 2012

"Farmland values dropped, farm credit worsened last last year" More recent headline based on data from the Chicago Fed.

Lenders and borrowers need to watch out. Busts tend to follow booms and credit can not expand forever.
Posted by | Wednesday, March 26 2014 at 12:24PM ET
John, I think I made some of the same points in my blogs. Some people do seem unconcerned though, and maybe they shouldn't be. Sandy, we're always looking for in-depth analysis here!
Posted by markeditor | Friday, March 28 2014 at 11:48AM ET
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