June 1, 2022

Nontraditional Lenders and their Impact on the Agricultural Credit Markets

In this episode Purdue associate professor and agricultural economist Dr. Brady Brewer along with a panel of experts discuss various aspects of the ag credit market and how nontraditional lenders are impacting the ag credit markets.

The powerpoint slide are available, and the research papers referred to in this episode are linked within the slides.

Audio Transcript

Brady Brewer:  Hi and welcome to the Purdue Commercial AgCast the Purdue University Center for Commercial Agriculture’s podcast, featuring farm management news and information. On today’s episode, I’m your host, Brady Brewer. I’m an associate professor in the Department of Agricultural Economics here at Purdue University. And joining me today is a trio of experts that have studied the ag credit markets. So, our first guest, Jackson Takach, is the chief economist and senior director of strategy research and analytics at Farmer Mac. So, Jackson, welcome.

Jackson Takach: Well, thank you for having me. And then the panel today. Brady, it’s a pleasure to be with you. And for those of you who are unfamiliar out there in the listening public, unfamiliar with Farmer Mac, where the secondary market for agricultural real estate lending in addition to infrastructure lending. So, we’re a secondary market and we see a lot of loans from coast to coast.

Brady Brewer: And also joining us from Farmer Mac is Greg Lyons. So welcome, Greg.

Greg Lyons: Thank you very much, Brady. I really appreciate being here to discuss a very important topic here. Give a quick plug actually for our quarterly publication, The Feed, where we talk a lot about issues like this as well as some fun things like the relationship between the 1980s ostrich boom and farming and hemp production so.

Brady Brewer: I may have to ask you about the 1980s ostrich boom here after we get done recording. So, and then also joining us today on our panel Iuliia Tetteh, and Iuliia is an assistant professor of agribusiness at Illinois State University. So welcome Iuliia.

1:42

Iuliia Tetteh: Thank you. Thank you for the opportunity my pleasure to be here with you today. My research primarily focuses on agricultural credit markets, debt repayment capacity. Some work on succession planning and some work in human capital in agriculture. So, thank you for inviting.

Brady Brewer: Well, thank you for being here to all of our panel today. Before we jump into the research papers that you guys helped coauthor, I do just want to give the audience a quick reminder. So, this is part of a series on nontraditional lending. This podcast, it’ll be linked in the description below. But the other podcasts in the series also cover other papers that were done in this special issue of the Agricultural Finance Review.

I do want to give a quick reminder of what is you know, so I just use the term what is a nontraditional lender? Well, you know, if you think about the traditional lenders, the commercial banks in your small rural community or the farm credit system, those are who we typically label as a traditional lender. Though, as you’ll see today, there are different classes of nontraditional lenders that we need to be cognizant of. But most of the time, we classify a nontraditional lender as someone who isn’t typically set up to loan money or that’s not their primary purpose. A good example of this would be the equipment manufacturers so if you think about going to an equipment manufacturer and getting a loan for the piece of equipment you’re buying.

Yes, I do realize that their credit arm is set up to loan money for that particular piece of equipment or their product that they are selling. They’re not a traditional bank, they don’t have checkable deposits. You can’t open up a savings and checking account. Really, the sole purpose of that business isn’t to loan money. It’s a complement to the piece of equipment that they are selling.

And one of the reasons that we did this research is that nontraditional lenders have gained market share here over the last couple of decades. By some estimates, nontraditional lending is as high as 15 to 25%, depending on where what particular part of the credit market you’re looking at. But that is their market share and that is a pretty high market share. And we don’t know very much about these nontraditional lenders, so we set out to do this research on various aspects of the credit market and how nontraditional lenders are impacting the ag credit markets. So, with that, I want to turn to our first paper that we’re going to discuss, and that is Greg and Jackson’s paper titled A Profile of Nontraditional Agricultural Real Estate Lender Activity in the Secondary Market.

So, Greg or Jackson, does one of you want to give a brief introduction to what your paper was about and why this strain of research was needed?

4:38

Jackson Takach: Yeah. Brady, thank you. I’ll kick us off here and then send it over to Greg for additional thoughts so ultimately what we wanted to do, we wanted to sort of solve two problems. One being that there wasn’t a tremendous amount of data out there in the public’s eye on what real estate lending looks like for nontraditional versus traditional lenders.

And so, we read a lot of papers and, you know, you kind of go back in the history of academic research, pretty far back to find some of these papers that talk about the motivation of nontraditional lenders or why borrowers may choose those nontraditional lenders. And we looked around at data inside of farmer Mac’s portfolio and said, we actually have a lot of insights here.

Let’s try to talk about some of those and put some of those out there into the research. So, part of it was hey, let’s just take the data that we have and can expose and answer some initial questions on. And I say the other one is to sort of raise additional awareness of different types of lenders and motivations. So, you know, we go to some lengths to describe some of those economic motivators inside of those nontraditional lenders. So, it’s not just one group. There are several different subtypes inside of this whole real estate lending population that’s driving activity. So, it’s not just the vendor credit. There’s also portfolio lenders in that mix. There’s also people who kind of look for pairing their products with other products so there’s a lot of different motivations inside that group.

We wanted to sort of extend those definitions specific to really say that’s really where Farmer Mac’s portfolio lives is in real estate. So, we thought we had a unique perspective and wanted to share it through this paper and the research. I’d say maybe the last thing we want to do is raise additional questions. So, we can point out maybe the capability to provide future research and help other people maybe ask more questions about nontraditional AG real estate as a specific asset class, maybe different from other credit providers.

6:39

Brady Brewer: So, Jackson, I want to follow up real quick before Greg jumps in and you talk about the real estate market. And, you know, my understanding is that nontraditional or at least the nontraditionals I’m aware of in my introduction, I use the dealer credit as an example. I don’t really think of nontraditional serving the real estate market. So, can you give us a little bit of a sense of who these entities are that are loaning money for real estate who we would classify as a nontraditional lender?

Jackson Takach: Yeah, sure. I mean, there are some vendor providers out there who are pairing up. Maybe they do one type of a financing against equipment, but they want to also be able to bundle a real estate product. So, they offer maybe the real estate product that they sell to the secondary markets. As a way to have multiple offerings, right? So, to increase their value to the customer, we definitely see participants in that line of business, but also mortgage brokers who build portfolios of loans in the same sense you might see in a residential lending marketplace. There are brokers and mortgage bankers who will sell, they originate and sell into the secondary market as a source of a revenue.

Maybe, if they don’t have any other products, maybe it’s just their business is to go out, meet with farmers, hit their needs and make sure they’re getting the cheapest access to a long term ag real estate credit that they can get, and they find a marketplace out there just for those services. And then I’d say maybe a third one is that portfolio lender, they actually like to build a portfolio of assets and then they sell off ones that fit into the secondary market standards. And they use that as a way to funnel additional revenues and to do more transactions through us. So, I think there’s, you know, three big buckets. But inside of each you get a little nuance of people who are participating in the market.

8:30

Brady Brewer: So, Greg, I want to turn to you now would you mind going over what you guys did to study this issue and then maybe thinking about some of the findings related to the borrowers of who use these nontraditional lenders?

Greg Lyons: Yeah. And so, the way that we really looked at this was just to go through the entire life cycle of a loan, because you can go back and see questions all along the chain that are very important. I think right at the start you’re talking about, you know, does a traditional borrower have an advantage because are they able to through, you know, things like mortgages or other products can they see unobservable characteristics that will allow them to better risk borrowers or to better assess the borrower’s credit worthiness?

And all along the chain that comes up, the question of whether or not there are differences in cost, differences in performance. And so, it’s really important for us to understand the entire lifecycle of the loan from the day it comes in the door from somebody who submit the loan to us to well after we purchased it to see loan performance.

And so, the very first question, as you point out, was whether or not these borrowers look any different or do we see any evidence that the people who use loans from nontraditional entities, do they differ? And there are some differences that we observed I think the most noticeable one that we saw is that loans from nontraditional entities were significantly larger than loans from traditional entities, almost two times as large on average, over the period that we observed here.

But there were some other differences as well. One that will sound fairly obvious, is that people borrowing from nontraditional entities are typically much further away from the actual loan officer than people who are right next door. And that sort of lends into that idea of are there these sorts of “unobservables”. And so, we think that we didn’t necessarily see was large differences in the overall the credit characteristics of the borrowers.

There was some difference in LTV, but a lot of the other characteristics we looked at the term debt coverage or other financial ratios were largely similar. Now, a couple of variations we did notice was that we did see a lot more prevalence of nontraditional lender activity in permanent plantings, for example, highly specialized, highly capital intensive commodities, which makes sense given some of the larger loan size see there, and we saw less activity in row crops.

And one thing that we did see that in areas of the country, like Iowa, for example, and Iowa is as a really robust commercial banking sector, they have this incredibly efficient farm credit system, and we see very little nontraditional lender activity. Compare that to areas in, say, the southeast and the West Coast. We see some evidence that things like the Agricultural Resource Management Survey, where they’re paying a little bit more for their loans, they have higher note rates. We see some evidence there that there’s more activity for nontraditional in those parts of the country. And so, I think those are some of the primary differences that we noticed.

One thing I do want to note here, though, is that the loans that we see are only the loans that people submit to us, and because we have our own underwriting standards, that’s not necessarily going to be representative of what these lenders are doing entirely. It’s just what we see that they sent to us.

11:34

Brady Brewer: Yeah, so we are seeing a snapshot, but I would assume a fairly decently sized sample of the snapshot of the ag credit market. And you guys both just hit on a lot of stuff that I know when we get to Iuliia’s paper, which is on the strategy of these nontraditional lenders will come into play, especially when you think about the convenience and the interest rate and why some of these people or the customers of these nontraditional lenders choose to do business with them.

So, Jackson, I want to turn now back to you. So, Greg went over the findings for, you know, who borrows from these nontraditional lenders. What about the performance of these nontraditional lenders? Do we see any implications in the credit markets from the performance of these nontraditional lenders?

Jackson Takach: Yeah, once you’ve controlled for all the things you could control for, right? So, we’re looking at lots of different variables and fixed effects. There really is no difference in the performance of loans. So, once they’ve closed, they’ve met all the criteria that’s kind of cleared the hurdle of the underwriting standards in the secondary markets. They tend to be, a loan is a loa, is a loan at that point.

So, we don’t see a tremendous amount of difference in those two populations of loans. Based off of just who submitted that or who the loan came from. That was not a driver of future defaults. So again, it makes sense if you think about all those different financial metrics were largely the same. You know, and you control for the things that you wanted to control for, that there is no difference in delinquencies, I think makes a lot of sense. Right? So that’s what the data show. We looked at short term, medium term and longer term, cumulative default rates and didn’t find any evidence of that separation between the non-traditionals and traditionals. Which I think again really ties back to the type and quality of loans that are kind of coming through these pipelines.

13:32

Brady Brewer: Yeah, and that’s probably good news for the ag credit markets. I will say from my experience, I have heard a lot of issues surrounding nontraditional lenders. You know, I mentioned the beginning 15 to 25% of the market share and we don’t know a whole lot about some of these loans due to the regulatory environment surrounding some of these nontraditional lenders. So, there’s a lot of speculation that they could be increasing the risk of the ag credit markets because maybe farmers that have less liquidity, less equity may be driven to them, and they’re willing to loan.

I want to, you know, thinking broadly and I’ll open this to both Greg and Jackson, if you think about some of the implications for the research that you guys did, what should we be thinking about for? What are the implications that this research tells us?

Greg Lyons: Well, I’ll just kick this off Brady. Actually, I think you raised a great point there is that when there’s an unknown here, there’s a lot of uncertainty. And the question I think that’s on everybody’s mind here is, are we seeing differences in risk coming from these borrowers? And one thing we did actually look at in the paper was, for example, the use of more variable rate products, where we did see that non nontraditional entities were much more likely to submit loans with variable rate products, where traditional entities were more likely to use fixed rate loans with a little more controlling of interest rate risk.

Again, so different types of borrowers here. But just a lot of these questions that we just sort of want to explore, explore how they differ and whether or not there’s any risks that are being passed along. We didn’t see a lot of evidence of that. But I think as this is a growing market share, it’s very important for us to understand the dimensions

5:13

Jackson Takach: Yeah, and I’ll add in there just that the market developments are where our nontraditional is active and where are they not. It’s really a good exercising competition across the ag lending landscape. And so that’s something I think we’re going to continue to study and there probably additional research opportunities here as to where these nontraditional are popping up and are they lowering the cost of credit for farmers and ranchers across. Our evidence today points to yes, but again, further research is probably warranted in that space.

Brady Brewer: So, I want to turn now to the second paper that we’re going to discuss on today’s episode, and that is titled Strategic Behavior of Nontraditional Lenders in the Agricultural Credit Markets. And this paper was authored by Iuliia Tetteh at Illinois State University and Michael Boehlje, Anil Giri, and Sankalp Sharma. So first off, welcome back Iuliia. Do you want to give the audience a brief overview of what your paper was about and then maybe what motivates you to do this research?

16:25

Iuliia Tetteh: Sure. So, kind of following up on what Jackson and Greg were talking about, that nontraditional lending is not really a new phenomenon. It’s been around and it became a buzzword in the last ten years probably. But we’ve seen quite a bit of research on the demand side, not on the supply side. And so, what really motivated us to dig a little bit deeper is to really gain some insights into who those nontraditional lenders are, what kind of credit programs they offer, what business models they use, what operational activities they’re engaged in, right?

So really trying to understand who they are but the issue, like they said, is that not all, but some of them don’t. Most and most of them don’t have financial reporting requirements and so that’s why where the data vacuum comes in. So, the only option we had, my collaborators and I had, was to do a study, just have an executive interview with five companies.

So, we’ve interviewed five interviewed five nontraditional lenders. One of them represented a vendor financing kind of segment, and the other four represented collateral based nontraditional lenders. And so, we asked them just a set of questions on who do they serve, who their customers are, what products they offer, what credit evaluation process they follow, what about their collateral requirements, loan volumes, interest rates, funding sources, where they got their funding, etc.

17:53

So that’s what the study was all about. Why was it important? It’s because as I said, because of growing market share. Market share of nontraditional lenders is going up and then farmers are becoming more reliant, reliant on them particularly in the times of economic downturn and so and limited data, so those were kind of the motivators.

Brady Brewer: Yeah. And there’s a lot to go on here when you think about some of the strategy implications of these nontraditional lenders. As Greg and Jackson just laid out, I think Greg said that they’re typically farther away some of the loans, at least on the real estate side, tend to be larger. So, there’s obviously some pretty important things that they’re doing to attract customers away from the more traditional lenders that we think of that play in the credit markets.

So Iuliia, so you did these five executive interviews. What were some of the key findings that you found through this research process?

18:52

Iuliia Tetteh: And just a quick note, so just to remind our listeners that this was a case study type of work, right? So, we’ve interviewed only five companies, and we cannot generalize across all, we cannot say that we know all of these nontraditional lenders, but we just know a little bit of them. So just could have been a warning. So, what did we find?

First of all, kind of following back on what Jackson and Greg talked about, we found that nontraditional lenders actually work primarily with financially stable or strong customers, which is kind of opposite to what the stereotype was before we dig into these papers. We thought that they were the kind of the last resort lender, right? What we found is, yes, some of them do have an alternative financing product. So, they do work with financially fragile or maybe firms in transition. But a lot of them do prefer to start working with customers who really are in at least financially neutral with the goal or stable position. The other interesting thing that we find is within that is that the nontraditional lenders market is very segmented. So, these companies seem to be doing a really good job of identifying the gaps in the agricultural credit markets the traditional lenders for one or the other, reason cannot fill in. So, and then they do a really good job of trying to figure out a strategy to best fill in those gaps. And a couple of other interesting things that we kind of have to remember is that some of them really work as pass through entities. So technically, what they do, they channel the funds from the credit from credit providers to the borrowers.

20:30

An example, I’ll give you on one of the vendor financings companies that we’ve interviewed in the provider. Technically, their purpose is to grow their sales, right? And so, what they do, they work with the traditional lender, and they channel funds to their customers by giving credit, right? And so that way that’s how we see them as a pass-through entity. And when they do that, they accept their credit application process, etc. So technically they follow their guidelines of the traditional lender. That’s something to keep in mind.

And another big takeaway is that when we looked at four companies that we interviewed where it belonged to the Collateral Secured Nontraditional Lenders segment, and so we’ve seen a lot of differences within that segment. We’ve kind of segregated them into two, which was production secured nontraditional lenders. So those that use crop insurance as a as a collateral and then they give loans to farmers, primarily operating loans. And then the other one was real estate secured nontraditional lenders. So that’s what Greg and Jackson were talking about. And those are who use real estate as collateral.

And so, we found a lot of differences within that segment because they use different loan approval guidelines. They have different geographic footprint because they cover crops production, for example, production secured NTLs, they cover only insured crops, they work only with customers who can have their crops insured. Whereas the real estate secured NTLs, they have a wider scope and then sourcing of funds we see that production secured NTLs, they use multiple sources of funds, but primarily they rely heavily on private equity markets, and they work with some securitization partners. But when it comes to real estate secured, nontraditional lenders, their funding sources are more diverse. It can be traditional lender, it can be other nontraditional lender. Like we’ve seen a unique dynamic when one real estate secured nontraditional lender would work with another NTL and channeling money through that way as well, and then they use public and private equity markets as well.

22:46

Brady Brewer: So, these nontraditional lenders are providing, you know, they’re closing gaps right in in the traditional market. Is there a reason that these gaps exist earlier? Did you did you get into in your interviews with these nontraditional lenders? Why do you think traditional lenders are not lending to these gaps in the credit markets? Because obviously, there’s a need here for these farmers to have credit for, you know, these inputs or certain circumstances. Why are they their needs are not already being served?

Iuliia Tetteh: Yes, it’s a good question. So, part of it, I believe it may be coming from the regulatory environment, right. Traditional lenders are more regulated than nontraditional lenders. And so that’s what limits some of the things that they can do with certain borrowers. But another is what they offer. Right? So, if you look at why farmers use would use a nontraditional lender, they would use sometimes because of convenience and speed or time to close on the loan like an input provider, as I said, issuing credit to a producer, sometimes they would you know, they would have a credit program that they offer to a producer.And at times they can subsidize those interest rates to grow their sales, right? So that would be one of the reasons why a farmer would want to go with them. Another reason if a producer, for example, is a heavy renter, right? If a large or too large operation grows at the expense of renting, not buying land.

In that case, that producer would be would have limited equity. And as they have limited equity, traditional lender because of the way they structure risk and their regulatory framework, they would not be they will be limited in what they can do with that producer. So that’s when the production secured a nontraditional lender would come in because they use crop insurance as their collateral. That’s another example.

24:46

Brady Brewer: So obviously, there’s some pretty strategic implications here for the credit markets. So, I want to turn next to kind of the implications of, you know, what are these nontraditional lenders playing in the ag credit markets from the research that you did, what should be the large takeaways from your research.

Iuliia Tetteh: So, I think the large takeaways from the research is that we I guess as we continue to seeing this trend more toward heavy reliance on the rented acres and the producer side, I think we got to look more closely on these nontraditional lenders and the strategies they use because that that that’s probably where they are going to fill in the gap the most, right? Because of the kind of collateral they use, so I think that’s one implication. Another implication, I think would be interesting to look at. As you know, in five to ten years as the producer population becomes younger, is the next generation of producers going to be more loyal to traditional lenders or will they be more likely to shop around and to really look at conditions?

We see some evidence actually out of Purdue, right? You guys did some research on input providers that farmers really go for the best deal. And so, at this point, it would be very interesting, I think, to look at the perception of farmers a traditional versus nontraditional. And I think finally, what one of the most exciting things about this research was that how dynamic the market is.

I came in the research thinking that, well, it’s pretty competitive, we know that. But I think that I didn’t realize how much opportunity of collaboration there exists for traditional nontraditional lenders actually on participating loans and servicing loans, et cetera. And so, I think as it would be interesting to see how as the regulatory environment changes and financial condition in agriculture changes, how the dynamics between traditional nontraditional lenders would change, I believe that there will be definitely areas of competition, but I think maybe more opportunities for collaboration as well.

Brady Brewer: Thank you Iuliia. So, I want to give Greg and Jackson a time to respond to Iuliia’s research project. Are there any cross implications you know that she talked about that you guys also found in your paper?

27:24

Jackson Takach: Yeah. I think there is a ton of really great supporting evidence across both pieces of research. So, I mean, it was a fascinating read, a great piece of research, and you talk about the strategies of why lenders get into the space and maybe why borrowers choose those lenders. We see those same types of strategies being deployed in the secondary market as well.

So, there was a lot of supporting evidence, I think in our research to what Iuliia and her coauthors laid out in this piece. So, it’s really a great read, I think a good piece of cross in supporting research.

Greg Lyons: Yeah, I just want to say that I think you can look at our research and her research and I think the discussion of gaps is incredibly important and the question of why those gaps exist and should any and, and what’s being done to address those gaps is critically important as we think to how we’re going to finance the farm sector over the course of the next few decades.

Brady Brewer: Yeah, no, I completely agree. And I do just want to point out, as I said at the beginning, this is part of a series, the findings that these two papers found. There are other similar findings from some of the other papers in this special issue of the Agricultural Finance Review that find that these nontraditional lenders aren’t necessarily increasing the risk of the market and that they are filling gaps in whether it be niche markets or certain demographics of farmers that may be being underserved there.

They’re stepping in and getting money to people that may otherwise have a tough time getting money to finance their operation, which as someone who studies the ag finance market, as an economist, I view that as a really good thing for the ag, not just ag credit markets, but ag markets in general. Selfishly, since I as I said, I study ag finance, I tend to view that the production process starts at the bank, right?

Without money to put the crop in the ground, you’re not going to get that crop going in the first place. So, a crucial first step in ag.

29:19

I just want to remind our viewers that if you’re looking for any other economic information to please visit us at the Purdue Center for Commercial Agriculture’s website or follow us on Twitter.

The Twitter handle is at @PCommercialAg. The PowerPoint for this podcast, along with the transcription of the podcast, can be found in the description below. The research papers that we discussed here today are also linked in that PowerPoint and will also be linked in the description on behalf of the entire Purdue Center for Commercial Agriculture team, I thank you for listening to today’s episode.

 

 

 

 

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