Financial Markets and Financial Intermediation Slide Show #10 AGEC 489/690 Spring 2009

Both Sides of the Desk The borrower: Enterprise analysis Cash management Line of credit needs Operating loan application Investment planning Term loan application Planning for long run

Both Sides of the Desk The borrower: Enterprise analysis Cash management Line of credit needs Operating loan application Investment planning Term loan application Planning for long run The lender: Loan application analysis Credit scoring Loan pricing for risk Loan approval process Loan portfolio analysis Loan loss reserves Regulatory oversight Lending institutions serving commercial agriculture and rural businesses.

Financing Investment Projects Assume you have a project that has a strong positive NPV. What is the next step – financing with loan or obtaining a financial lease?  Financing with loan requires completing a loan application with a financial institution.  Applying for a financial lease to finance purchase equipment often obtained through manufacturer. Be prepared to present financial statements and income tax reports in either case.

Lenders Serving US Agriculture  Real Estate Lenders o Farm Credit System o Farm Service Agency o Commercial banks o Life insurance companies o Individuals and others  Nonreal Estate Lenders o Farm Credit System o Farm Service Agency o Commercial banks o Individuals and others The two biggest lenders to US agriculture are the Farm Credit System and commercial banks. The two biggest lenders to US agriculture are the Farm Credit System and commercial banks.

Financial Intermediation Investors in bond market Investors in bond market Government bond market Government bond market Farm Credit System entities Farm Credit System entities Farm borrowers Farm borrowers Farm Credit System Commercial Banks Individual depositors Individual depositors Commercial banks Commercial banks Farm borrowers Farm borrowers In both instances, financial intermediation transfers savings and investment of others into loan funds borrowed by farmers.

Farm Credit System

Major long term (mortgage) lender to US farmers. Originally a government entity; now a private lender with implied government backing. Obtains capital by issuing consolidated bonds in national bond market as a GSE (government sponsored enterprise).

Farm Credit System Also makes short and intermediate term loans for the production of farm products, aquatic products, and purchase or repair of rural homes. The FCS today accounts for 20% of non-real estate farm debt outstanding. The FCS today also accounts for over 40% of the real estate farm debt outstanding ( debt secured by real estate mortgage).

Farm Credit System FCS became wholly borrower-owned when the last government loan was repaid in FCS is regulated by the Farm Credit Administration, which is an agency of the Federal government’s Executive Branch. The FCA regularly examines loan portfolios to ensure compliance with sound lending practices set forth in examination manuals.

The original 12 district banks have consolidated into 6 districts today.

Characteristics of Farm Credit System Loans

Financial Intermediation Process in the Farm Credit System

Building debt repayment capacity stress? Adequate loan application assessment and risk pricing? Portfolio stress testing? Adequacy of loan loss reserves? Potential for higher cost of funds over the longer run? Global loss of wealth and perceived risk in US securities affect demand? Questions Along the Farm Credit System Supply Chain

Let’s Look at a Farm Credit Association

Website for the Farm Credit Bank of Texas – a district bank that serves credit associations within this district like Capital Farm Credit.

Capital Farm Credit Assoc. The Capital Farm Credit Association is headquartered in Bryan Texas. It has 35 offices throughout the state of Texas and one office in the state of Tennessee.

You can apply electronically for various types of loans from the Capital Farm Credit Association.

Loan applications differ by the size of the loan requested

Less information required on smaller loan requests – greater reliance placed on scorecard lending practices.

Annual LOC Electronic access to cash

Commercial Banks

In US today there are 8,500 independently chartered banks in the US. small portion Large commercial banks like Bank of America have a significant amount of farm loans, but this represents a small portion of their total loan portfolio. Rural commercial banks have a much greater percentage of their loan portfolio devoted to agriculture.

Bank Mergers The US banking industry has been consolidating over the last several decades. Ultimately the nation may have less than 2,000 chartered banks. net outflow Studies have shown that mergers have generally resulted in a net outflow of loan funds from rural to urban areas.

US Bank Consolidation

Characteristics of rural commercial banks

Other Ag Lenders

Niche Lenders Life insurance companies Life insurance companies – large real estate loans. Merchants and dealers Merchants and dealers – finance purchase or lease of their machinery and equipment. Farm Service Agency Farm Service Agency – government lender making subsidized loans to small and beginning farmers, direct lender of last resort, source of emergency loans, and source of guarantees on loans made by others.

Regulators of Lenders

Regulator of Lenders Farm Credit SystemFarm Credit Administration Farm Service AgencyUSDA and Congress Commercial banksComptroller of Currency Federal Deposit Insurance Corporation (FDIC) Federal Reserve System State banking agencies Life Insurance CompaniesNone Individuals and othersNone

See Handout 7 and 8 for details Hire ag economists

Commercial Bank Regulation The Comptroller of the Currency is an agency within the U.S. Treasury.

Commercial Bank Regulation