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
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
The two biggest lenders to US agriculture are the Farm Credit System and commercial banks.
Nonreal Estate Lenders
o Farm Credit System o Farm Service Agency o Commercial banks o Individuals and others
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
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 1968. 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
In US today there are 8,500 independently
chartered banks in the US. 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. 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 – large real estate
loans. Merchants and dealers – finance purchase or lease of their machinery and equipment. 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 Service Agency
Commercial banks
Farm Credit Administration USDA and Congress
Comptroller of Currency Federal Deposit Insurance Corporation (FDIC) Federal Reserve System State banking agencies None
Life Insurance Companies 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