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Tuesday, October 21, 2008

Farm credit still flows, but standards tighten

Strong commodity prices, high land values and a low rate of farm loan delinquencies should insulate the farm credit market from the Wall Street woes that have tightened the nation's credit market. Lenders say California farmers and ranchers should have little problem obtaining loans, but will face more scrutiny and higher interest rates.

"The positive thing is we are doing business today. I would not term it as business as usual, though," said Ron Carli, chief executive officer of Santa Rosa-based American AgCredit, one of eight Farm Credit Services associations in California that specialize in agricultural loans.

Unlike financial institutions that have been devastated by subprime mortgages, the agricultural lending sector has remained on solid financial footing because of its strict lending practices. Not only are farmers required to answer questions about their assets, production costs and crop plans, but they must also substantiate the financial details of their operations and show proof that they can pay off their debts.

"Farm Credit didn't lower its underwriting standards like the mortgage brokers did on housing," said Ken Graff, chief executive officer of Farm Credit West in Roseville. "And because the ag sector of the economy has had good commodity prices, our credit quality remains solid and sound at this time."

Carli said while the government-sponsored, farmer-owned cooperative has not suffered mortgage-related losses like other investment and commercial banks have and will have funds available to lend to qualified farmers and ranchers, those funds will come at a cost.

"The interest rate on the variable side is going to go up because the cost for us to get our monies is going up," he said.

Interest rates could soar dramatically for farmers who are considered a high credit risk, either because they're farming a crop that has not been profitable or they're farming in an area where water availability could curtail their production, said Cornelius Gallagher, senior vice president and agribusiness executive for Bank of America in Roseville.

Farmers can also expect tighter lending standards from banks on some loan products. In many cases, long-term loans with fixed interest rates are simply not available at this time, Graff said.

Roger Sturdevant, executive vice president and head of the agribusiness banking division for Bank of the West in Fresno, said lending institutions are looking for the greatest return for the least amount of risk and increasing scrutiny of borrowers' credit worthiness. Customers who want just a loan and are unwilling to bring over their entire banking relationship or use other financial services will be less attractive to banks during this lending crunch, he added.

"A lot of institutions are being very selective and planning on managing their growth more closely than what they have been doing in the last year or two," Sturdevant said.

Carli said American AgCredit plans to stick to its core business and core customers but will likely tighten its underwriting standards and make fewer exceptions to loan qualifications than it may have allowed in the past.

"There would be certain risks that we may not be willing to take today that we were willing to take a year ago when the economy was still doing pretty well," he said.

Today's tighter lending standards have their roots in the agricultural recession of the 1980s, said Steven Blank, University of California Cooperative Extension agricultural economist in Davis. Inflation in the previous decade had pushed farmland values so high that many producers, feeling wealthy, borrowed against their equity to buy more acreage to expand their operations, he said.

When farmland values dropped as much as 60 percent in a couple of years, many growers had gone so far into debt that their farm incomes were no longer sufficient to meet their loan payments.

"It was just like the foreclosure problems we have now, except it was in farms," Blank said.

The farm and bank failures of the 1980s led to major regulatory changes in the banking industry. One significant change that affected agriculture was the shift from lending based on a farmer's equity to his farm income, Blank said.

"Those are traditional underwriting requirements that have been in place since the '80s and haven't changed materially," said Gallagher of Bank of America.

And while the farm lending business today has generally been somewhat insulated from the dire conditions of the housing market, agricultural sectors such as nurseries, which rely on that market for much of their sales, could be feeling ripple effects that will ultimately hurt their businesses.

"There are going to be spot sectors that have different markets, and those sectors could be indirectly impacted by the housing issues," said Gallagher. "The mortgage crisis has significantly reduced housing starts and housing sales, and that in turn causes people to buy less nursery plants and products."

San Bernardino County nursery producer Jim Rietkerk said because his business is more closely tied to the retail level than some other farm sectors, he has already felt the effects of the slowing economy and was forced to cut back some of his employees' hours.

"If credit lines are not extended or lowered, that makes it difficult for some people to build inventory and meet payroll obligations," Rietkerk said.

Joe Zanger, a diversified farmer in San Benito County, said many farmers are making production plans for next year and depend on a line of credit to plant crops, buy or lease land and replace equipment. Without a line of credit, there's not much they can do, he said.

Faced with rising fuel, fertilizer, feed and other production costs, they are also borrowing more money than ever before to cover their operating expenses. That has increased the demand for credit and loan products, as well as put a strain on the amount of capital available in the system to support the growth in agricultural lending, Sturdevant said.

While high commodity prices mean more income and credit advantages for some farm segments, they can spell trouble for livestock and dairy producers who depend on commodities such as corn for feed. Those higher prices cut into their already-narrow profit margins, potentially putting a strain on their ability to borrow.

Mary Cameron, a dairy farmer in Kings County, said she purchased 170 acres of land this year to expand her operation and is concerned about how her outstanding debt will affect her ability to secure additional loans to run her dairy in the future. While fuel and feed prices have leveled off recently, milk prices have also softened. If milk prices come down faster than her input costs, that could put her in a financial bind.

"The way it is now, we cannot even pay our monthly bills because our income is less than our feed costs and payroll," Cameron said. "If you've borrowed enough money from the bank that you're close to your 75 percent LTV (loan-to-value ratio), the bank is not going to loan you any more money. That's why we have so many dairies selling out because the banks are calling in the loans."

The credit crunch will also cause indirect impacts even for farmers with strong balance sheets, as agricultural businesses such as fertilizer dealers cope with costlier credit, according to an economic analysis by the American Farm Bureau Federation.

With fertilizer prices doubling in the past two years and continuing to rise, farmers are now being asked to make commitments for their 2009 fertilizer needs and to pay a substantial amount, sometimes 100 percent, up front, said Terry Francl, AFBF senior economist.

"What is happening is that the credit function of these transactions is being shifted from the fertilizer producers and retail dealers to the farmers," he said. "The net result is that it increases the farmers' cost."

Blank said not only will fertilizer dealers likely pass along some of their higher credit costs to their farm customers, but in extreme cases, they may refuse to sell fertilizer to customers who have to pay on credit. To the extent possible, some of these costs will likely be rolled into prices that consumers will pay for processed goods.

Despite the gloomy economic forecast, Blank said he remains optimistic that, in a couple of years, "we'll be right back to normal."

"Being in agriculture is a great place to be in down times because people are going to eat," he said. "Even if the economy is a little soft, we're all going to keep getting hungry. I think agriculture in many ways is a bit more of a safe harbor than other parts of the economy in that regard."