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Credit quality concerns crop up in ag lending


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Credit quality concerns crop up in ag lending

President Donald Trump said trade wars are easy to win, but loan losses have already started to spike for some agriculture-focused banks.

Soybean prices have declined by nearly 20% since China announced a 25% tariff on U.S. exports of the crop. That has exacerbated problems for an agricultural industry that was already struggling to pay its debts. The Federal Reserve Bank of Kansas City recently reported that farm loan repayment rates have declined every quarter since the 2013 second quarter. Over that time, farm income has declined by more than 50%.

"It's a one-two punch," said Bert Ely, a banking consultant who focuses on farm credit. "They were going to have problems anyway just because of the decline in commodity prices. You toss the tariffs on top of that, and it just makes it worse."

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Delinquency rates remain relatively modest when looking at the industry in aggregate. Farm loan delinquencies were 2.2% in the second quarter, nearly flat from 2.0% in the year-ago quarter. But some red flags have started to emerge.

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A select number of banks saw delinquencies or charge-offs spike in the second quarter. Of the top 25 banks with highest net charge-off ratios in the second quarter, six were focused on agriculture loans with concentrations greater than 25%. At one such bank, Jackson County Bank in Black River Falls, Wis., the poor loan performance is a brand-new phenomenon. The bank reported a 12.6% net charge-off ratio in the second quarter compared to 1.6% in the first quarter and zero in the year-ago period.

"We've got more than one [borrower] that's struggling some," said President John Drace in an interview. "For us, we've got dairy and we've got crop, and it's affecting both."

There are also signs of stress in the Farm Credit System, a government-sponsored enterprise. The system consists of dozens of banks and associations with aggregate assets of more than $333 billion as of the 2018 second quarter. Ely noted in his Sept. 4 column for the ABA Banking Journal that loans classified as substandard or doubtful increased to 3.3% of total loans outstanding in the first half of the year.

"There clearly has been a deterioration — not a severe one — but a deterioration in loan quality and an increase in nonaccrual loans," Ely said in an interview. "The outlook right now is certainly flashing yellow."

While prices for U.S. crops have declined notably since China announced the tariffs, Jackson County Bank's Drace said he was not sure how much of his bank's credit quality issues were tied to the trade war.

"I couldn't state that that's the reason. I mean, obviously commodity prices are down and they've been down for quite a while and that's what's causing the issue for a lot of farmers," Drace said.

Ely echoed the sentiment, saying that agricultural production has been struggling for some time, highlighting dairy as a particularly soft sector. At the same time, he said there is little doubt that the Chinese tariffs have exacerbated conditions and Trump's stated desire to potentially exit the North American Free Trade Agreement adds further uncertainty.

"We were going through a price cycle and income cycle, and it was forecasted and within the realm of the nature of agriculture. What's really troubling is the tariffs, which are being totally driven by politics and not economics," he said.

Ely said he was also concerned about long-lasting impacts from the trade wars. As U.S. products become less favored abroad due to tariffs, farmers in other countries will increase capacity to meet the demand, creating stronger competitors for U.S. farmers over the long term.

"I don't think we're going to snap out of this very quickly," he said. "We have a huge amount of uncertainty with [tariffs and NAFTA]. Everybody has got to be cautious and focused on assessing these trade risks in addition to the basic price problem."

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