Agricultural loans are performing better than other credits, but signs of weakness are all around, and bankers are worried that regulators will overreact.

Already, bankers say their ag loans are coming under greater scrutiny.

"In a few cases we've heard that examiners want to treat ag real estate loans as if they were commercial real estate loans, which raises concerns from bankers because the examiners are being very strict on commercial real estate loans," said Mark Scanlan, the vice president of agricultural and rural policy at the Independent Community Bankers of America.

One Midwestern bank chief executive who asked not to be named, said that during a recent review, the examiner pressed harder into his bank's farm loan portfolio because of the April 10 failure of New Frontier Bank in Greeley, Colo., which was one of the nation's largest lenders to dairy farmers.

Regulators even seem to be bracing for more failures of ag-focused banks. John Blanchfield, senior vice president of the American Bankers Association's Center for Agriculture and Rural Banking, said that the Federal Deposit Insurance Corp. is in talks with the trade group to train examiners on farm loan workouts.

The Department of Agriculture projects that net farm income for 2009 will decline 38% over last year, to $54 billion. Blame falling commodity prices. Dairy farmers are losing money on every gallon of milk they produce. Cattle and hog farmers are breaking even, at best. Meanwhile, exuberance over ethanol has tempered, and export demand is down.

The effect on agricultural banks is that delinquencies and chargeoffs are up, while returns on equity and assets are declining.

At commercial banks, through the first quarter of the year, the share of total delinquent farm real estate loans reached 2.76%, up from 1.66% through the same period a year earlier, according to the Federal Reserve Board.

Seasonally adjusted delinquencies for agricultural production loans rose from 1.06% in the first quarter of 2008 to 1.71% for the same period this year.

Chargeoffs inched up, too, though they are still miniscule. Farm real estate chargeoffs rose to 0.051% in the first quarter, from 0.008% a year earlier. Net chargeoffs for non-real estate farm loans went from 0.02% in the first quarter of 2008 to 0.11% this year.

One concern among farmers and bankers is that, without a broader economic rebound, demand will continue to weaken, prices will continue to fall and delinquencies will spike. Already, there are signs that banks are getting skittish about extending credit. Demand for direct operating loans from the Farm Service Agency, "the lender of last resort," was up 81% through the first eight months of fiscal 2009 over the same period in fiscal 2008, according to the Congressional Oversight Panel, the watchdog for the Troubled Asset Relief Program. Demand for direct ownership loans from the FSA has increased 132% over the same period.

"Every day you tune in to the commodity markets and they're lower," said Keith Carlson, the president of United Farm and Ranch Management, which manages more than 400 farms in Nebraska and is a subsidiary of the $3.3 billion-asset TierOne Bank in Lincoln. "If we have these lower prices for a year, we're going to have farmers who are forced to sell what they produced for less than what it costs to produce. If they don't sell, a banker is going to make them sell it."

Still, bankers said the farm economy is going through a downturn, not a crisis. Income, though down from a year ago, is still higher than the 10-year average, interest rates are near historic lows and farmers' debt-to-income levels are manageable, industry experts said. Most ag banks remain profitable.

Cor Broekhuyse, executive vice president and regional head of Rabobank International-Americas, said volatility is a fact of life in the farm industry.

"That's how every cycle in agriculture is sorted out: Prices go down, people kill off dairy cows, they go into meat, so the production of milk will go down so the demand comes up again," he said. "It's rather deep this time, I must say, but it will come back. …

"People always have to eat," Broekhuyse said. "There is a developing, new middle-class consumer category in countries like China and India, where there is not a strongly developed domestic industry. So they will still rely a lot on imports from the Americas. … So maybe there is a dip now, but that is only temporary."

From a regulatory standpoint, the industry has seemingly dodged one bullet.

In July, the oversight panel held a hearing in Greeley to find out if the failure of New Frontier was an isolated event or if it signaled broader problems in the agricultural economy that might require a Tarp-like rescue of farmers and ranchers.

After hearing rival bankers label many of New Frontier's borrowers as "unbankable," the panel concluded that New Frontier fell victim to its own mismanagement. It decided that forcing a farm loan restructuring mandate for Tarp-recipient banks was not "the right lever" to pull, as Elizabeth Warren, the watchdog's chairwoman, put it.

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