Agriculture Banks Are Outperforming Their Peers, But How Long Will It Last?

Gary S. Corner

The domestic agriculture industry has been thriving over the last decade. According to the U.S. Department of Agriculture (USDA), six of the past eight years rank among the top 10 income-producing years for the industry (adjusted for inflation) since 1980. As commodity prices and farm incomes soared, farmland prices also surged. Ancillary agricultural businesses, such as farm equipment manufacturers and dealers, have also benefited from recent farm prosperity.

As a result of strong industry conditions in recent years, agriculture banks have generally outperformed community banks without an agricultural focus. The level of problem assets at agriculture banks has, by and large, remained manageable, resulting in lower loan losses. Moreover, given their business model, agriculture banks have generally had lower exposures to the weak commercial real estate sector compared with other community banks. As illustrated in the table below, agriculture banks exhibit stronger asset quality, capital protection and earnings levels than their nonagricultural counterparts.

Agriculture Bank Performance Assessment

 District Ag Banks 
District Non-Ag Banks
U.S. Ag Banks 
U.S. Non-Ag Banks 
ROA 1.05% 0.73% 0.80% 0.77% 1.06% 0.96% 0.49% 0.29%
Nonperforming Loans + OREO / Total Loans + OREO2 2.39 2.37 4.27 3.71 2.51 2.56 5.66 5.38
Tier 1 Capital Ratio 10.31 10.41 9.70 9.44 9.91 9.93 9.69 9.44
Net Interest Margin 3.97 4.00 3.88 3.80 3.91 3.99 3.84 3.79
Average CAMELS Rating3 1.89 1.84 2.18 2.16 1.89 1.86 2.44 2.39
Provision Expense / Average Assets 0.36 0.64 0.39 0.45 0.24 0.41 0.54 0.77
Loan Loss Reserve / Nonperforming Loans 95.21 86.74 68.29 70.38 93.12 79.87 54.71 50.27
Ag Production Loans / Total Loans 11.60 12.09 1.94 2.04 20.96 21.75 1.40 1.42
Farmland Loans / Total Loans 25.17 25.46 5.21 5.21 21.26 20.33 3.00 2.88
Total Ag Loans / Total Loans 36.77 37.55 7.15 7.26 42.22 42.08 4.40 4.30

SOURCE: Reports of Condition and Income for Insured Commercial Banks. This assessment covers only banks with less than $1 billion in assets.
1 The Federal Reserve's Eighth District has 137 agriculture banks, with most having less than $1 billion in assets. The average asset size of an agriculture bank nationwide is $128 million. A bank is defined as an agriculture bank if the combined agricultural production and farmland loans account for 25 percent or more of its total loans.
2 The nonperforming loans + OREO (other real estate owned) ratio measures the percentage of problem loans and real estate property held by banks after foreclosure. High percentages of these types of assets undermine a bank's health and severely impair earnings.
3 CAMELS stands for the composite supervisory rating for Capital, Asset Quality, Management, Earnings, Liquidity and Market Sensitivity.

Despite strong conditions in the agricultural sector, farm debt has remained moderate. In 2010, combined farm debt held by all U.S. banks and the Farm Credit System (FCS) increased 2.01 percent from the prior year, down from a 3.51-percent increase in 2009. According to the USDA, banks and the FCS supply 80 percent of farm credit outstanding. As such, it appears the surge in land values and capital expenditures are primarily funded by cash derived from farm profits.

Data also suggest that debt repayment ability of farmers continues to improve. According to Federal Reserve agricultural credit surveys, agriculture banks reported higher loan customer repayment rates and fewer loan extensions in 2010.

Risk Factors for Agriculture Banks

The soaring commodity prices and farm incomes that have strengthened the sector are not without risk. Escalating farm incomes and low interest rates have led to a recent surge in farmland values. The sustainability of higher farmland values depends on this trend continuing.

The table above also highlights another risk facing agriculture banks: the potential for over-relying on collateral values when making credit decisions. Since loans secured by farmland constitute more than twice the amount of credit extended for agricultural production, the majority of agricultural loans on an agriculture bank’s book are secured by farm real estate. In an environment of surging farmland values, lenders must therefore exert additional caution when underwriting these loans.

To Summarize

Overall, industry factors remain favorable for agriculture banks. However, because a concentration in any economic sector can result in volatility, bankers should ensure that strong risk management practices are in place.

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The author thanks Daigo Gubo, senior research associate in the Supervisory Policy and Risk Analysis unit, for contributing to this article.

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