Why falling farm prices put the pressure on Midwestern banks

Across America's farmland the bountiful black fields are broken now and then by small towns and cities. In the towns, often on a street called Main Street, is the bank. It's usually a pillared, solid-brick building, or is at least engineered to look that way. In this ideal picture, the banker makes loans to farmers with a friendly handshake, and the loans finance new tractors, seed, and fertilizers.

The friendly handshake and the anchor in farm country -- these are the main reasons the crisis gripping the nation's farmers today is also gripping their bankers. Some 28 percent of all commercial banks in the United States are agricultural banks, according to the Federal Reserve System. Usually these are in small towns where everyone knows the banker and ``civic duty'' is not just an empty phrase.

Once that relationship meant good business for both farmer and banker. But no longer. Farmers, as anyone reading newspapers or watching the evening news knows, face a credit crisis.

Banks, in turn, face a debt crisis.

Of 889 ``problem banks'' the Federal Deposit Insurance Corporation was watching at this writing, 37 percent held a high degree of farm loans, according to an FDIC spokesman. Most are in the rural Midwest. In the last half of 1984, 22 farm banks failed; in the past year and a half, 11 production credit associations have gone under.

The strong dollar, weak commodity prices, declining real estate values, and high interest rates have hurt the American farmer and hindered his ability to service those loans. As happens every year about this time, many indebted farmers need to borrow more money, and thus go further in debt, to finance spring planting.

For many banks, the farm-debt crisis has been worsened by local conditions that have encouraged risk-taking with agriculture loans. These include longstanding political pressure on local bankers to make local farm loans; state ``unit banking'' laws that hinder risk-diversification of bank loans; the reluctance of banks to write down nonperforming loans; and even what some argue is an overly permissive Federal Deposit Insurance Corporation.

What would help bankers and farmers in the long run? Banking analysts recommend these steps:

Abolition of remaining state laws that prohibit branch banking.

Continued moves toward regional and nationwide interstate banking. This would bring about more competition at the local level and allow a well-hedged big bank to make a somewhat riskier loan than a local bank might.

Reduction of the federal budget deficit. That might bring the dollar into line, take pressure off interest rates, and help strengthen commodity prices, thus easing the debt-servicing burden on farmers.

But those are long-range solutions. In an attempt to win more immediate relief, banks are lobbying Congress to raise federal guarantees of farm loans from the current $650 million level to $3 billion and to make other changes that will help the banks' financial picture. And farmers are asking for an acceleration of commodity price support loans and other forms of financial aid. But in a season of budget cutting, a farm bailout faces high resistance.

Still, federal regulators are not likely to allow confidence in farm banks to erode too greatly. Federal Reserve chairman Paul A. Volcker, the FDIC, and the comptroller of the currency acted together last summer to shore up Chicago's Continental Illinois Bank & Trust Company when depositors began a run on assets. It was an expensive, harrowing episode -- one that regulators do not want to see repeated. Problem banks are one thing; bankruptcies are another, especially in small towns. Mr. Volcker recently told business groups he is not unaware of the farm-loan problem.

If farmers, regulators, and depositors are concerned, so are investors, some of whom fled money-center bank stocks due to the foreign-debt problems and put their investment dollars into regional banks without that overseas exposure. Now many of the regionals are in trouble.

But not all farm-lending banks are in trouble. It varies from region to region, crop to crop, state to state. J. Fredrick Meinke, senior banking analyst of E. F. Hutton in New York, points out that the worst-hit banks are in the Midwest -- Iowa and Nebraska especially. That is the heart of the farm and farm-lending crises.

There are also some problems at banks in the Southeast, where some loans to tobacco growers are performing poorly. In California, agriculture loans are suffering from sluggish cotton and citrus exports. Loans to California vineyards have been affected, too, Mr. Meinke says, due to an influx of French wine brought on by the strong dollar. And a number of regional banks in Texas and Oklahoma have had farm-loan problems added to poor energy and real estate loans.

But the big Florida banks, Mr. Meinke says, had decreased their portfolios of loans to citrus growers before the cold weather and disease visited the orange groves; these banks are not suffering as much as one might think. Although Continental Illinois and First Chicago are located in the farm belt, agricultural loans are not that critical a part of their portfolios, Mr. Meinke says.

Banks are conservative institutions, and attitudes change slowly, he continued. Bankers accustomed to decades of inflation -- in which ``the next oil rig always costs more than the one before it'' -- saw loan-to-value ratios grow constantly. Now, however, values of energy, commodity, and land assets are stagnating.

If a farm loan goes sour, a bank may try to sell the land. But land is of little value if it is not being actively farmed, and in many rural areas there are more sellers than buyers.

``If a farmer [with loan troubles] does what's best for him, he may have to decide to go to auction,'' notes Edward J. Kane, professor of economics and finance at Ohio State University. ``But that is the worst thing for the banks'' because the bank is saddled with useless land. As a result, Dr. Kane says, most banks are trying to keep farmers active, even if it means continually rolling over debt.

Dr. Kane considers government and bank policies are partly to blame.

``Regulations in some states support local bankers and keep out regional and national companies, so you don't have diversification,'' he says. ``And much of the risk is politically protected. Can you imagine what a senator or congressman would say if you didn't make loans in your own state?''

The FDIC, he says, should require banks to employ market-value accounting of loans to reflect their true -- rather than theoretical -- condition. He also thinks the FDIC ``subsidizes risk-taking'' but admits there is no consensus for deposit insurance reform at present.

``If you look at a state like Iowa, it's been sowing the seeds of trouble for years,'' says Samuel Chase of Chase, Brown & Blaxall Inc., a Washington, D.C., economic consulting firm. Those seeds include unit banking, barriers to outside banks, and ``enormous political criticism on banks not in farm lending.''

``Institutions tied to the local economy and the farm borrower base end up with unsound portfolios,'' Mr. Chase says. He sees farm-loan problems as a likely spur to interstate and regional banking.