What it means
Banks that lend to farms face a problem. Farm mortgages are long-term, but the banks' funding often comes from shorter-term deposits, and a large pool of farm loans can use up a lot of their capacity.
Farmer Mac was created by Congress in the late 1980s to give them a secondary market, a place to sell loans after they have been made. When a lender sells a pool of loans to Farmer Mac, it receives cash and can use it to make new loans.
Farmer Mac then either holds the loans or packages them into securities (investments backed by a pool of loans) that are sold to investors. In other cases it provides a guarantee, promising to cover losses on the loans for a fee.
The result is more credit for agriculture and rural communities, and often more stable rates. Lenders are willing to offer longer fixed-rate terms because they can pass on the risk.
Farmers benefit because loans are easier to obtain, even in smaller rural banks with limited funds. Farmer Mac also supports loans for rural utilities and certain rural housing and infrastructure.
Its funding comes from issuing debt in the capital markets, and its shares are publicly traded. Like other government-sponsored enterprises, its obligations are not explicitly guaranteed by the federal government.
The business has risks that a finance reader should recognise. Its portfolio depends on the health of agriculture, and a long run of low commodity prices or falling land values can lead to losses.
It manages this through underwriting standards, diversification across regions and crops, and capital requirements set by its regulator. A helpful comparison is with the housing market.
Farmer Mac does for agricultural mortgages what the larger mortgage agencies do for home loans: it creates a link between local lenders and global investors. That link spreads risk and lowers the cost of credit in the long term.
In practice
Real-world examples.
Example
A community bank in the Midwest has reached its limit for farm lending. It sells part of its portfolio to Farmer Mac and uses the proceeds to lend to new customers. The bank's total farm lending increases without raising extra capital.
Example
A young rancher is offered a 25-year fixed-rate loan by her local bank. The bank can offer this because it is able to sell the loan to Farmer Mac and avoid interest rate risk. She gains certainty about her repayments.
Example
An investor buys a bond issued by Farmer Mac. The investor receives interest and understands that repayment depends on the strength of the enterprise and its portfolio. The investor does not assume that the government will step in.
Formula
Calculation
Extra annual income from re-lending = loans sold x margin earned on new loans
Suppose a rural bank sells a $10,000,000 pool of farm mortgages at par (face value) and uses the cash to make new loans earning a net margin of 3% a year. Extra annual income = 10,000,000 x 0.03 = $300,000. This simple example ignores guarantee fees, servicing costs and any gain or loss on the sale. Each of these would reduce the benefit, so the bank must compare the net figure with the cost of keeping the loans.Case study
Seen in the real world.
Heartland Valley Bank is an illustrative, fictional rural lender with $200,000,000 of assets, of which $80,000,000 are farm loans. The board wanted to lend more to local growers but was close to its internal limit on exposure to one sector.
The CFO proposed selling $20,000,000 of fixed-rate farm mortgages to a secondary market buyer of the Farmer Mac type. The sale reduced the share of farm loans from 40% of assets to 30% and released enough room to fund new loans for the planting season.
In this fictional story the bank earned servicing fees on the loans it had sold and kept its customer relationships. The lesson is that a secondary market allows a small lender to keep serving a concentrated sector without carrying all of the risk on its own balance sheet.
Watch out
Common mistakes.
- Assuming Farmer Mac lends directly to every farmer, when its main customers are banks and other lenders.
- Treating its debt as backed by an explicit federal guarantee, when it is a government-sponsored enterprise.
- Ignoring the fees and risk retained when selling loans, and so overstating the benefit.
Questions
People also ask.
What does Farmer Mac do?
It buys and guarantees agricultural and rural loans, giving lenders liquidity and helping credit flow to rural areas.
How is Farmer Mac different from the Farm Credit System?
The Farm Credit System is a network of borrower-owned lenders, while Farmer Mac is a secondary market that buys loans from lenders.
Why does a secondary market lower borrowing costs?
It lets lenders sell loans and manage risk, which increases the supply of credit and encourages competition.
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