Slide Show 10 Financial Markets and Financial Intermediation

Slide Show #10 Financial Markets and Financial Intermediation 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 ü Assume you have a project that has a strong positive NPV. ü 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. ü 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 § Nonreal Estate Lenders o Farm Credit System o Farm Service Agency o Commercial banks o Individuals and others companies o Individuals and others The two biggest lenders to US agriculture are the Farm Credit System and commercial banks.

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

Farm Credit System

Farm Credit System üMajor long term (mortgage) lender to US farmers. üOriginally a government entity; now a private lender with implied government backing. üObtains capital by issuing consolidated bonds in national bond market as a GSE (government sponsored enterprise).

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

Farm Credit System ü FCS became wholly borrower-owned when the last government loan was repaid in 1968. ü 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

Questions Along the Farm Credit System Supply Chain 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?

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.

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. Capital Farm Credit Assoc.

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

Commercial Banks ü In US today there are 8, 500 independently chartered banks in the US. ü 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. ü Rural commercial banks have a much greater percentage of their loan portfolio devoted to agriculture.

Bank Mergers üThe US banking industry has been consolidating over the last several decades. üUltimately the nation may have less than 2, 000 chartered banks. üStudies 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 ü Life insurance companies – large real estate loans. ü Merchants and dealers – finance purchase or lease of their machinery and equipment. ü 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 System Farm Credit Administration Farm Service Agency USDA and Congress Commercial banks Comptroller of Currency Federal Deposit Insurance Corporation (FDIC) Federal Reserve System State banking agencies Life Insurance Companies None Individuals and others None

Hire ag economists See Handout 7 and 8 for details

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

Commercial Bank Regulation