The Federal Deposit Insurance Corporation smells smoke again. In warnings over the past several months, the agency has said there may be significant risk in having high concentrations of agricultural loans-a claim that ag bankers strongly dispute.
Unfortunately for the bankers, there is the pesky fact that the last time the FDIC sounded a fire alarm-over commercial real estate concentrations-an inferno erupted, wiping out scores of banks. But those in the ag sector insist it cannot be compared with the commercial real estate market in the years before the financial crisis.
"Agriculture is very different from a lot of other industries," says Cori Price, vice president and senior commercial loan officer at South Valley Bank & Trust in Klamath Falls, Ore. "Lenders have long-term relationships with borrowers. We know our customers. People who are in agriculture don't jump in and out of it, the way some commercial real estate lenders did, looking for a quick profit. They are in it for a lifetime."
Still, the FDIC sees a complex combination of factors that, supervisors believe, could engender overconfidence in lenders. To counter that, it recommends that banks limit concentrations, both directly and through third parties.
Bankers are concerned that after such recommendations come, supervisory pressure often follows. "As a practical matter, following this advice to the letter, you would see small banks quickly become paralyzed in their agricultural lending," says John Blanchfield, the senior vice president of agricultural and rural banking at the American Bankers Association. "It is very frustrating because you can't pull the ag bank out of the ag economy."
However, given the FDIC's recent track record for spotting potential problems, bankers might ignore its advice at their peril. In a December 15 Financial Institutions Letter, the agency noted the ag sector's strong performance in recent years, but called for caution. "Despite this generally positive outlook, the agricultural sector remains susceptible to shocks from a number of sources, including volatile commodity prices. Financial institutions engaged in agricultural lending must remain diligent in enforcing sound underwriting principles and establishing effective risk management procedures to help mitigate these risks."
The FDIC's concerns range from the speculative to the concrete. The possibility of a massive drought or an unexpected spike in fertilizer prices-either of which could send many farmers into default-are among the troubling prospects listed by Richard D. Cofer Jr., a regional manager of the Division of Insurance and Research, and Allen E. McGregor, a supervisory examiner in the Division of Supervision and Consumer Protection, in an analysis published late last year. They also cite the possibility of interest rates rising or federal subsidies for farmers being withdrawn.
But the most pressing worry-and the one most grounded in hard data-is that ag banks might be facing similar market dynamics as their commercial real estate counterparts in the recent past: lending against greatly inflated real estate values.
Cofer and McGregor pointed out the swelling prices of farmland. "Land values currently are experiencing a boom of historic proportions based in part on strong agricultural conditions," they wrote. "Similar episodes in the past ended with a sharp contraction of agricultural land values."
For its part, the banking industry views the FDIC's warnings as unnecessarily alarmist. "It almost seems as though the FDIC can't accept the fact that the ag sector has performed very well," Blanchfield says. "Yes, it could always crash and burn, but you can't run a business based on that."
Blanchfield describes the underwriting standards of ag banks as "incredibly sound and extremely conservative" and says regulators are creating uncertainty among bankers. "The practical impact is push-me-pull-you regulatory guidance," he says. "Policymakers want banks to make loans, but there is this semi-veiled threat that they will slap you down if you don't make loans that are perfect."
Rick Adkins, president of the $145 million-asset Security National Bank in Laurel, Neb., says ag banks are already being careful about inflated land values and have multiple lending safeguards in place. "Most are not loaning more than 50 percent of that value and are requiring a positive cash flow as well," he says.
Stress-testing also helps banks like his anticipate trouble. "We have the ability and tools in place to shock our ag portfolio as if, say, there were to be a 40 percent drop in land values," Adkins says. "We use it as an early warning system."
Some bankers are concerned that regulators-smarting from all the criticism they received for not being more proactive before the financial crisis-will overcompensate this time. The big fear is a one-size-fits-all regulatory mandate to limit concentration of agricultural loans, possibly to a certain percentage of capital.
"Bankers are seeing this as an overreaction and are worried about regulators coming in and applying a bright line 300-percent-of-capital rule," says Mark Scanlan, the vice president of agricultural and rural policy at the Independent Community Bankers of America.
While he conceded that the FDIC had been prescient in its warnings about commercial real estate, he says there are few parallels between ag lending and commercial real estate lending. "You can't just say it is the same kind of lending," he says. "Most ag bankers have been doing it a long time and they have implemented a lot of risk-mitigation strategies. They have the farm safety net, crop insurance, regular stress-testing of portfolios. Some bankers have said that they are already adhering to the underwriting guidance by not following the land value up. Some are going back to where land values were five years ago."
Price, who focuses on the ag lending portfolio at the $850 million-asset South Valley, also says in the agricultural industry, unlike in commercial real estate, people are simply not inclined toward taking excessive risk. "In the ag sector, the bankers and our borrowers are more conservative to begin with," she says.
Of course, those who remember recent history can hear the echoes of 2007, when banks loading up on commercial real estate loans touted their skillful risk management and dedication to sound underwriting. But even regulators could be thankful if this time their warnings turned out to be a false alarm.
