Rethinking your business

Northwestern Financial Review, Aug 1, 2001 by Dullum, Justin

Liquidity situation forces bankers to consider new funding avenues, revisit options

Funding is suddenly a conundrum and not a crisis. The Federal Home Loan Bank has taken most of the panic out of the liquidity situation. Yet many experts warn banks against funding too much growth via the FHLB. Bankers should develop a variety of funding sources, the experts say. Discerning between the options, however, can be difficult because not every option is right for every bank.

"When it comes to funding, bankers need to go outside the building, walk around a few times, clear their mind and then come back in and think all new about stuff," said John Blanchfield, who studies agricultural banking for the American Bankers Association. He has at least a couple of suggestions for bankers sorting through their funding options.

"The Farmer Mac program is something more banks should be looking at," Blanchfield said. "It's a pretty good deal and you get pricing that allows you to compete with the Farm Credit System."

Blanchfield said another option is forming an alliance with the Farm Credit System. "Telling a banker they need to sit across the table from the Farm Credit System and talk about a borrowing relationship would probably make people go crazy," Blanchfield admitted. "But it's just a tool and another source of funding."

Citizens Bank of Finley, N.D., is one of a handful of banks that works with the Farm Credit System through its own ag credit company. "A bank cannot access the farm credit's money directly," said Roger Munson, president of Citizens. Munson explained that Citizens owns a separately-capitalized subsidiary that is an ag credit company. The company invests in AgriBank, a St. Paul-based agricultural bank, which entitles it to a predetermined line of ag credit. Citizens originates the loans and the customer never deals with the credit company, AgriBank or the Farm Credit System. Once the loan is made, a paper transaction occurs where Citizens participates some of its loan to the ag credit company. Simultaneously, AgriBank buys up to 90 percent of the ag credit company's balance. "Through this we have access to sources of funding as competitive as those from the Home Loan Bank," said Munson.

Citizens Bank is one of only 25 in the country that work this way. Many more banks utilized ag credit subsidiaries in the early 1980s when funding was also an issue. Munson believes its popularity will rise in light of the current funding challenge. "It's legally complicated to get started," said Munson. "The other factor is that ag banks have credit standards. They reserve the right to come out and see what loans the ag credit company has on their books. They also want to see you make a certain number of loans. But it hasn't been a burden at all. It's simply a very competitive tool."

Farmer Mac offers another funding option for bankers low on cash or high on risk. Farmer Mac full-time farm loans are agricultural first-mortgage loans on commercial farms and ranches. "Once we purchase a loan, all credit risk and interest rate risk is eliminated," said Mary Maloney, director of marketing for Farmer Mac in Washington D.C. "And it still gives banks a source of fee income for the life of that loan." Banks are allowed to set rates up to 100 basis points higher than the rate offered to them by Farmer Mac. Collected for services provided by the bank to the customer for the lifetime of the loan, these fees are income in addition to any loan origination fees.

By selling a loan to Farmer Mac, banks increase liquidity, free up capital, avoid commodity concentration, avoid turning down loan requests on the basis of size, and reduce interest rate and credit risk. "Generally speaking, banks that are ROE-oriented are more interested in our programs because the asset doesn't remain on their books any longer," said Maloney. "But I think we're under-utilized by banks that are fairly liquid. Banks with a low loan-to-deposit ratio can still benefit from the additional loan products they can offer through us as well as risk reduction."

Farmer Mac also has a part-time farmer loan program that allows mainly residential property, such as hobby farms, to fall under the advantageous label of ag property. "There are more and more people who want to buy 20 acres, stable a couple of horses and raise some chickens, but the lion's share of their income will still come from their jobs in the city," said Blanchfield."Many banks could utilize Farmer Mac to clear the blurry line between commercial and residential property such small farms create, since a lot of banks aren't structured to be able to say 'yes' to such loans." Unlike full-time farmer loans, there is no limit as to the amount a bank can increase part-time farmer rates above that set by Farmer Mac.

Core Deposits Strategy

A very alluring prospect is increasing core deposits, perhaps the most sought-after form of inexpensive funding. Retiring baby boomers and senior citizens have a lot to offer banks in terms of core deposits. In order to secure this base, banks are discovering they need to offer something to seniors in return. George Aker, president of Mason City, Iowa-based Heritage Clubs International, said many banks are attracting deposits by offering special benefits to mature customers through a bank club. Membership is generally contingent upon the maintenance of a pre-determined account balance. Heritage Clubs International is a subsidiary of First Citizens Independent Bank in Mason City, which has a very active senior club.