Though farm lending is a profitable niche, many of the banks engaged in it underperform because they lack the ability to diversify their loan portfolios, according to a recent study.
"That's sort of a long-term dilemma for them," said Glenn Pederson, a professor of applied economics at the University of Minnesota, who co- authored the study of Minnesota banks' performance. "It's not an easy situation for them because their market has been limited."
In the study, Mr. Pederson and Jeffrey Stensland studied bank management strategies' impact on their performance between 1988 and 1994.
They used call-report data on the state's banks, as well as survey data from 112 Minnesota banks, with average assets of $46.7 million.
The study categorized banks as high-, middle- or low-performing according to return on assets and equity.
The 53 high-performing banks had 17.8% of their loans in agriculture and 19.9% in commercial credits, the study found. The 39 low-performing banks had 42.6% of their loan portfolio in agriculture and 16.3% in commercial loans.
Of the smallest banks studied - with under $25 million in assets - the low-performing banks had 46.6% of loans in agriculture. The high-performing banks in that category had more diversified portfolios, with farm loans comprising 31% of total loans.
Commercial lending in that size group followed a somewhat similar track: High-performing banks had 19.9% in commercial loans and low performers had 15.2%
"Agricultural lending has been relatively profitable in recent years, but agricultural banks have performed poorly due to a lack of other lending opportunities in rural areas," the study said.
"While small rural banks are justified in their continued lending to agriculture, the rural banker's dilemma is quite often that there is lack of opportunities to make additional residential real estate and consumer loans," the study said.
In addition, many agricultural banks lack economies of scale, it said.
Still, the authors determined "that agricultural loans are still significantly more profitable than holding securities."
The study also examined how fee-generating services affected performance.
For instance, it found that 60% of the high-performing farm banks under $50 million in assets had automated teller machines, compared with just 32% for low-performing banks.
