CYCLICAL BUSINESS: "We're heading into a time when [farm] cash flows will be more difficult to manage," said Matt Williams, chairman of Gothenburg State Bank. "Regulators and bankers are looking to make sure cash flows work and that farmers and ranchers monitor their expenses."
CYCLICAL BUSINESS: "We're heading into a time when [farm] cash flows will be more difficult to manage," said Matt Williams, chairman of Gothenburg State Bank. "Regulators and bankers are looking to make sure cash flows work and that farmers and ranchers monitor their expenses."

Agricultural lending, which had been a bright spot for many banks in recent years, is facing a number of significant challenges.

For several years, strong borrower demand and low delinquency rates have delivered welcome profits to banks that target the farming industry. But commodity prices are falling in many areas, depressing farmers' incomes and forcing a number of banks to increase their monitoring of credit trends.

"We're looking at a rapid readjustment of the farm income statement," said John Blanchfield, a principal at Agricultural Banking Advisory Services. "Income pays loans."

A correction could be particularly painful given the significant increase in ag lending in recent years. Total farm loans rose by almost 14% in 2014 from a year earlier, to nearly $95 billion, according to a recent report from the American Bankers Association. Roughly one out of every $3 lent by a farm bank is an agricultural loan, the report found.

Farmers had enjoyed a solid run, which should help many borrowers weather a storm. During a 10-year span through 2013, farmers experienced six of their most profitable years ever, said James Schipper, superintendent of the Iowa Division of Banking.

"There was a lot of wealth created," Schipper said. "Farmers and banks are coming into this downturn with strong positions."

The run of luck may be ending. The Department of Agriculture is forecasting that net farm income will drop nearly 32% this year compared with the agency's 2014 estimate, to $73.6 billion. This would be its lowest level since 2009 and the second straight year with a significant decline.

Strong harvests have caused the price for crops such as corn and soybean to decline, industry observers said. For example, the price of corn has fallen by 43% in the last two years, Schipper said.

Meanwhile, countries such as Brazil, Argentina and China have become more competitive, and a stronger U.S. dollar has affected demand for exports, Blanchfield said. At the same time, expenses for farmers have not dropped meaningfully.

Bankers are concerned that low prices will eventually hurt farmers' ability to repay loans or qualify for new credit, said Mark Scanlan, senior vice president of agriculture and rural policy at the Independent Community Bankers of America. Some farmers facing severe and prolonged stress may have to sell assets to stay afloat. Others may have to shutter operations because of a declining customer base.

"It hasn't affected a significant number of customers at this point since they had several robust years," Scanlan said. "If prices continue to fall even lower, and that lasts for several years, then this will cause significant stress in the farm community."

Farmers are likely looking at ways to cut costs in areas like capital purchases and materials such as fertilizer, said Gary Schnitkey, a professor in agriculture and consumer economics at the University of Illinois.

Farmers who rent their land may aim to renegotiate multiyear contracts to get a better deal, he said. Others could look at "borrowing more and hoping the situation becomes better in future years," he added.

"The need for more credit … will improve opportunities to make loans in some cases," Schipper said. "There has been some fairly soft loan demand in local situations."

Gothenburg State Bank in Nebraska has started to see more requests from farmers to raise borrowing limits as profits decline, said Matt Williams, the $157 million-asset bank's chairman.

"We recognize in the agriculture-lending business that it is somewhat cyclical," Williams said. "We're heading into a time when cash flows will be more difficult to manage than they were. ... Regulators and bankers are looking to make sure cash flows work and that farmers and ranchers monitor their expenses."

More banks are likely to turn to programs through the Farm Service Agency, which is part of the Department of Agriculture, or the Federal Agricultural Mortgage Corp., which is also known as Farmer Mac, to help control for risk, experts said. FSA-backed loans provide lenders with a guarantee of up to 95% of the loss on the principle and interest on a loan. Farmer Mac buys loans secured by mortgages on agricultural real estate to allow banks to make longer-term loans that they may not want to keep on their balance sheets.

"I often tell investors a little bit of stress will probably help our business," said Timothy Buzby, Farmer Mac's president and chief executive.

Banks may also want to work with some borrowers to restructure debt, industry experts said. For instance, a bank may request that a farmer borrow against his land to repay an operating loan, Buzby said.

Still, some factors may temper the effects of the farm downturn on banks, experts said, noting that fuel prices, a large expense for farmers, have declined and interest rates are likely to remain level.

There are some agricultural areas that are doing well because of declining prices for crops. For example, a drop in price of corn helps cattle ranchers lower their feed costs.

Banks with diverse loan books should have an advantage, though it can be difficult for lenders in rural farm communities to widen their mix. Farmer Mac expects to weather a drop in prices because it works with lenders throughout the country, giving it geographic and product diversity, Buzby said.

Additionally, farm banks have strong capital levels and low delinquencies. The median noncurrent loan ratio at farm banks fell to 0.5% last year, compared with 1.96% for the industry, the ABA reported. The median Tier 1 leverage ratio for farm banks was 10.17% last year, the group's report said.

"The majority of our farm banks have reasonable ratios of farmland lending to Tier 1 capital," said Brittany Dengler, a senior manager in economic and policy research at the ABA. "These banks are adequately capitalized. They are aware of concerns and are making sure everyone is prepared for the future."

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