Despite weakening conditions in the agricultural sector, bank data generally indicate good performance

Poor agricultural conditions in the Ninth District due to low prices and crop disease pose a risk not just to farmers but also to the banks that lend them money. Banks with a concentration of loans to agricultural producers are, of course, particularly vulnerable, and a significant portion of banks in the Ninth District face such exposure. Adding to the current concern is the latest survey of agricultural bankers by the Minneapolis Fed, which reflects a decidedly downbeat tone.

However, the financial data from Ninth District banks to date indicate that agricultural banks are generally still in good condition. There is some variation in the district, with North Dakota agricultural banks reporting a recent drop in profitability and asset quality, while agricultural banks in Minnesota continue to outperform district banks as a whole. These data are certainly not the final word, both because it reports past conditions (as opposed to the survey, which asked about future conditions), and because continued low prices or poor weather could worsen farmers' ability to repay their lenders. As such, regulators are paying particular attention to how banks continue to manage their exposure to agricultural conditions.

Poor agricultural conditions—an overview

Ninth District farmers producing major crops such as corn, wheat and soybeans currently face historically low prices. Additionally, cattle and hog prices have fallen to very low levels. For both crops and livestock, global output is large relative to global demand, which is depressed, in part, by reduced household incomes in Asia.

Scab, a plant disease affecting wheat and other small grains, has made matters worse for many farmers in North Dakota and northwestern Minnesota. This disease has reduced both crop yield and quality repeatedly in the 1990s.

Adverse prices have reduced incomes throughout the Ninth District and across the country. Farm income in North Dakota, for example, is low not only in comparison to record levels achieved in 1996, but to the average for the entire decade.

The reduced income available to farmers poses a threat to banks that finance agricultural production and farm real estate. How exposed are banks in the Ninth District to the fortunes of the agricultural sector?

Exposure of Ninth District banks to agriculture

Perhaps the most direct way to measure the exposure of banks to agricultural production is the percentage of their loan portfolios made to farmers. The table on this page provides such a breakdown. It may be useful to know that regulators, under a commonly used rule of thumb, consider any bank with at least 25 percent of its loans extended to the agricultural sector to be an agriculturally focused lending institution (an "agricultural bank"). By this standard, the table indicates that over half of all banks in the Ninth District are agriculturally focused. Only one other Federal Reserve District, Kansas City, has a similar concentration. Agricultural banks are a particularly large part of the bank population in the Dakotas, where they make up about 80 percent of all banks. A significant number of banks in the district are even more agriculturally dependent than the agricultural bank standard: One-third of all banks in the district have over half of their total loans extended to agricultural producers.

And these banks and others are probably even more dependent on agriculture than these numbers suggest. Banks in rural areas also make loans to small firms—ranging from the town hardware store to the local grain elevator—that depend on the health of the agricultural sectors for their own economic well-being. As a result, agricultural banks are probably even less diversified than their direct agriculture exposure suggests.

While agricultural loans are clearly important to a large number of Ninth District banks, it is important not to overstate their importance to the district banking sector as a whole. Indeed, as of second quarter 1998, agricultural loans made up only about 9 percent of total district loans. How can agricultural loans be so important to so many banks but not to the entire banking sector? Although most of the banks in the Ninth District are small and many of these small banks are agriculturally focused, most of the banking assets of the Ninth District are controlled by very large banks, particularly in Minnesota, that have a relatively small percentage of their portfolios in agricultural lending.

Profitability and asset quality of agricultural banks

Despite their high dependence on the agricultural sector, profitability in the district's agricultural banks as a whole has been consistent with or exceeded profitability of all district banks during the 1990s. And, this same trend has held more recently as well. In the second quarter of 1998, return on average assets (ROAA, the most common measure of bank profitability) in the district's agricultural banks exceeded the district average. The level of loan losses in agricultural banks has been consistent with district averages over this same period.

Not all agricultural banks in the district have performed equally well, with some institutions potentially showing more of an effect from recent poor conditions. For example, in contrast to previous years in the 1990s and perhaps reflecting current, poor agricultural performance, the profitability of agricultural banks in North Dakota has fallen below the district average for all banks, by about 10 percent. This may reflect that North Dakota farmers have been hardest hit by low prices and crop disease.

Why might this data not be as gloomy as the Fed survey of agricultural banks? The financial data analyzed in this article is reported by banks on a quarterly basis. It reflects the bank's most recent past experience, the second quarter of 1998, but does not-necessarily indicate how the bank will perform in the future. Indeed, bank losses and bank failures in particular, tend to increase or decrease in a "lumpy" fashion. That is, rather than increasing or decreasing in a smooth trend, these figures can move up or down by significant amounts.

In contrast, the Fed survey asks bankers for their impressions of the future and is based on a more current period—third quarter 1998. The weakness with a survey, however, is that it does not provide hard data on how the surveyed banks are actually performing, nor does it have the same extensive coverage of banks that the financial reports provide. Thus, both types of reports need to be reviewed by observers of banking conditions.

Looking ahead

A lack of diversification among many banks in the district leaves them vulnerable to a downturn in the agricultural sector. As a result, bank regulators at the Federal Reserve bank and elsewhere pay particularly close attention to agricultural portfolios of these banks when conducting examinations, and to the performance data reviewed in this article as part of regulatory off-site monitoring. Such intensive efforts will certainly increase if poor agricultural conditions continue to worsen.