Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Ag Lending Rises, While Farmland Values Give Regulators Pause

By Andrew Wolcott, SNL Financial

(click to enlarge)Click to enlarge

Agricultural production and farmland loan balances at U.S. commercial banks have increased above and beyond pre-financial crisis levels. According to an analysis conducted by SNL, loans secured by farmland rose to roughly $72 billion at the end of 2012, up from over $52 billion at the end of 2006, representing a 38% increase. Over the same time period, loans made for the purpose of financing agricultural production rose just over 19%, a rate less than that of farmland loans, but still above the 17.7% increase registered by banks' total loan and lease portfolios.

(click to enlarge)Click to enlarge

It is interesting to note the seasonality in agricultural production lending. Loan balances tend to rise over the course of a year peaking in the third or fourth quarter, only to retreat in the first quarter of the following year. This phenomenon is reflective of the U.S. planting and harvesting cycles. As an example, Illinois corn farmers' planting and harvesting seasons fall during or between the second and fourth calendar quarters of each year. According to an analysis conducted by the U.S. Department of Agriculture, the most active "usual planting dates" fall between April 21 and May 23, while the most active "usual harvesting dates" lie between Sept. 23 and Nov. 5.

Agricultural production and farmland lending has risen drastically over the past six years, recently registering year-over-year growth rates of 5.73% and 6.28%, respectively, for the period ended Dec. 31, 2012. While these growth rates are impressive, both types of lending represent relatively small portions of total loan and lease portfolios. Together, agricultural production and farmland lending represented 1.94% of total U.S. commercial bank loan portfolios at the end of 2012, up from 1.78% at the end of 2006.

(click to enlarge)Click to enlarge

Banks have witnessed sharp divergences in the quality of their loan portfolios over the past six years. At the end of 2006, past due and nonaccrual rates stood between 1% and 2% for bank's agricultural production, farmland and total loan and lease portfolios. However, over the course of six years, loan quality for these types of loans has taken very different paths. The percentage of agricultural production loans that were either past due or nonaccrual stood at 1.28% at the end of 2012, only 19 basis points higher than the 1.09% logged in the fourth quarter of 2006 and down from recent highs of 3.48% in the first quarter of 2010.

(click to enlarge)Click to enlarge

While agricultural production loan quality stands close to pre-financial crisis levels, the portion of farmland loans that are either past due or nonaccrual remains elevated. Farmland loans registered a past due or nonaccrual rate of 2.59% at the end of 2012, a full 128 basis points above the 1.31% recorded at the end of 2006. Within the context of the total loan portfolio, both loan types still compare favorably. Starting at the end of 2006, the portion of total loans and leases that were either past due or nonaccrual stood at 1.78%; over the course of the next six years the rate rose to 7.55% in the first quarter of 2010 only to fall back down to 4.77% at the end of 2012.

Farmland loan balances have increased right along with farmland values. So much so that many fear a farmland bubble could be forming. Esther George, president and CEO of the Federal Reserve Bank of Kansas City, stated in a speech Jan. 10 that farmland prices were of particular concern. "We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances. Prices of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels. A sharp correction in asset prices could be destabilizing." Despite George's cautions, farmland values continued to rise through the end of 2012.

For the fourth quarter of 2012, regional Federal Reserve banks in the Midwest reported significant year-over-year increases in farmland values. The Federal Reserve Bank of Kansas City reported that "both irrigated and non-irrigated cropland values posted year-over-year gains of more than 20 percent for the seventh consecutive quarter … [while] ranchland values surged nearly 20 percent." In addition, the Federal Reserve Bank of Chicago stated that "after adjusting for inflation, the district's 2012 annual increase in agricultural land values (14 percent) was the third largest in 35 years. … [F]armland values experienced a cumulative rise of 52 percent over the period 2010-12, matching the fastest gain of the 1970s boom (over the period 1974-76) in real terms." Because farmland values represent the value of the collateral underlying farmland loans, the loan-to-value ratios for these loans could be in jeopardy if farmland values were to retrace.

(click to enlarge)Click to enlarge

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.