Strong participation by community banks has helped restore stability to the U.S. Department of Agriculture's lending programs.

In a report released last week, the General Accounting Office said loan delinquencies in the Agriculture Department's direct farm lending portfolio have dropped to 21% of total loans, from 41% in 1995. The accounting office cited several reasons for the improvement, including stricter lending standards and an increase in direct government payments that have helped farmers pay their bills even as commodity prices plummeted. Another key factor: Banks - buoyed by government guarantees for up to 90% of the losses on defaults - originated nearly half of all Agriculture Department loans in fiscal year 2000, compared with less than one-third in 1995.

"The financial condition of the USDA's farm loan programs has continued to improve," the GAO said in its report. "The unpaid principal of USDA's loan portfolio held by delinquent borrowers was reduced by about $2.8 billion between September 1995 and September 2000."

Recognizing this good performance more than 10 years after designating the Agriculture Department a "high-risk" lender, the GAO has withdrawn the label.

Removing the loan programs from high-risk status has no official effect but could free up more federal funds for agricultural lending. Congress has been critical of the agency's lending policies for years, and this, according to an agricultural expert, may have affected how much lawmakers would appropriate for lending by the department.

"USDA's loan program has had few friends on Capitol Hill because of past credit problems," said John M. Blanchfield, director of the American Bankers Association's Center of Agricultural and Rural Banking. "I'm sure that GAO removing this from its watch list is going to have an impact on how Congress looks at this program."

The sharp drop in delinquencies can be attributed, in part, to changes in lending policy resulting from the 1996 Freedom to Farm Act. Provisions of this law prohibited the Agriculture Department from making operating loans to borrowers who fall behind on payments or any type of loan to borrowers who have defaulted in the past. Also, borrowers were limited to one instance of debt forgiveness on direct loans.

The broader role of community banks in agricultural lending has also reduced delinquencies.

In the past five years, the Agriculture Department has switched its focus from direct lending to guaranteeing bank loans. Historically, the programs had made direct loans - primarily to farmers unable to get credit elsewhere - and substantial losses resulted from these loans, according to Charles M. Adams, an assistant director at the accounting office. Guaranteed loans totaled $7.96 billion of the Agriculture Department's portfolio at Sept. 30 and are catching up to direct loans, which totaled $8.66 billion. Mr. Adams said the proportion of guaranteed loans will rise.

Dennis Everson, senior vice president at First Dakota Bank in Yankton, S.D., said guaranteed farm loans are becoming more popular with customers, especially young farmers, because they let lenders be more flexible. For example, he said, a commercial loan that would otherwise have a term of 15 years can be stretched to 30 with a guarantee.

It helps customers "gain rates and terms they need to get the best shot they can to survive," Mr. Everson said, adding that his $347 million-asset bank doubled its volume of guaranteed farm loans in 2000, to $14 million.

Mr. Blanchfield said the guarantees encourage lenders to look for ways to address delinquencies by means other than liquidation. Before banks file for relief from the Agriculture Department, they must consider options such as reamortization and deferments. If default relief is requested, the bank must account for all collateral securing the loan before it gets federal money. This makes bankers more assiduous in servicing the loans, Mr. Blanchfield said.

One other benefit to banks: Farm loans with guarantees are far easier to sell on the secondary market, said Mike Jorgensen, president of $27 million-asset Nebraska State Bank in Oshkosh, Neb.

Ironically, the drop in delinquencies has occurred in the midst of what has been the worst farm crisis since the early 1980s. For nearly three years, farmers have been battling low prices brought on by an oversupply of commodities.

"The amount of delinquency in the guaranteed loan program has not been increasing even though we've had three years of terrible prices in farm country," said Mark K. Scanlan, director of agricultural finance for the Independent Community Bankers of America.

Of course, government bailouts have helped. Last year, direct payments to farmers from the federal government - about $23 billion - accounted for 49% of all farm income. In 1996, government subsidies totaled just $7.3 billion.

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