Farmer Mac's troubled start - Federal Agricultural Mortgage Corporation; weak loan demand; market looks small; most farm operators do not qualify; includes related article about language of secondary markets - U.S. Dept. of Agriculture, Economic Research Service report

Agricultural Outlook, Dec, 1991 by Steve Koenig, Jim Ryan

The Federal Agricultural Mortgage Corporation, known as Farmer Mac, was chartered by Congress in 1987 with the dual mission of expanding the availability of long-term, fixed-rate real estate credit to farmers, and easing financial stress among farmers and lenders. Farmer Mac has the authority to operate a secondary loan market to package agricultural real estate loans for sale to investors.

In a secondary mortgage market, lenders sell existing loans to investors. These loans were created in a primary market, by lenders making new loans to borrowers. Loans sold through the Farmer Mac market would be bundled together (pooled) by a financial intermediary (pooler), and securities backed by the pool would be sold to investors based on the type of loans in the pool. Investors would be guaranteed repayment on these securities by Farmer Mac, which is backed by the U.S. Treasury.

But nearly 4 years after its authorization, expectations for the secondary loan market are withering, as a Farmer Mac has yet to guarantee a loan pool.

Weak Loan Demand

A Problem

Farmer Mac's troubled start is the result of a complex mix of economic and structural factors. One cause is a weak demand for farm real estate financing in recent years, but another involves the fixed-rate financing provided by Farmer Mac.

Farmers' demand for land was strong during the 1970's and early 1980's. Rapidly appreciating farmland values coupled with low real interest rates encouraged farmers to take on debt to expand their farms. Then, during the farm financial crisis of the 1980's, declining land values and mounting debt combined to dull farmers' appetite for farmland credit as well as lenders' willingness to provide it.

Farmers are now more cautions about assuming new debt to purchase land, and continue to shed debt accumulated in past years. With improved farm incomes, less credit is needed to finance purchases. When farmers have made recent purchases, they have generally done so with cash. In the last 3 years, debt was incurred on only two-thirds of farmland transfer, down from 90 percent 10 years ago.

These developments suggest that the need for a secondary market has receded. With reduced credit demand, lenders have ample funds for extending credit to farmers, lowering their incentive to participate in the Farmer Mac secondary market.

Not only has demand for new credit been weak, but so has demand for the fixed-rate financing that Farmer Mac offers. Lately, variable-rate loans are preferred because they offer lower cost financing. And unlike a decade ago, most farm borrowers are now accustomed to variable-rate loans.

When loans are made with fixed rates, lenders run the risk of interest rates using above rates at which outstanding loans are being repaid. A secondary market allows lenders to pass on such interest-rate risk to investors while offering fixed-rate loans to farm borrowers. But when interest rates are falling and fixed rates are high relative to short-term variable rates, farmers often prefer variable-rate loans, despite the risk to the borrower.

Surveys of agricultural banks indicate that roughly two-thirds of farm real estate lending in recent years has been at variable rates. To offer lower rates and at the same time to minimize their interest-rate risk, lenders have recently been offering fixed rate-rate, lower interest loans with short maturities - typically 5 years - that require the borrower to refinance at a new rate.

Potential Market

Looks Small

ERS estimates, based on the latest (1988) data available, suggest that commercial banks, life insurance companies, and the Farm Credit System (FCS) originated around $7 billion that year in farm and farm-related mortgages. This is less than half the annual volume in the early 1980's when credit demand was greater. Volume from these lenders is critical to Farmer Mac's development since these are the principal farm lenders and own the majority of Farmer Mac stock required for participation.

But the actual origination value from which Farmer Mac pooler can draw will be much less. Data for life insurance companies suggest that as much as 25 percent of their $1.4-billion volume is for agribusiness and timber operations, which may not qualify for pooling. Only a handful of life insurance companies are still active in farm lending, so life insurance company participation will depend heavily on the decision of just a few companies.

If life insurance companies and the FCS hold back, then poolers must rely on commercial banks for most of their origination volume. But much of current farm lending by banks will not qualify for pooling since only 15 percent of banks bought Farmer Mac stock. And those banks account for only 30 percent of outstanding farmland secured debt owed to all banks.

Success of the Farmer Mac market would encourage more banks to buy participation stock. But whether or not the market is successful, much of the $7 billion annual volume would not meet Farmer Mac's loan documentation requirements. Neither financially strong borrowers nor their lenders will comply with documentation requirements unless they gain substantial benefits.