REQUIRED READING: Rural Residential Lending: Crisis? What Crisis?

Written by Phil Hall
on September 03, 2008 No Comments
Categories : Required Reading

When Scott Thomson encounters news on the crises facing the housing and mortgage markets, it is a subject where he has no firsthand knowledge. As the president of C US Bank in Cresco, Iowa, Thomson, whose bank serves five rural communities, has not been tarred by the residential lending issues that have created tumult in urban and suburban markets.

‘In a nutshell, we have been unfazed by the subprime lending issue," says Thomson. "I think that community banks in towns of under 10,000 people in the heartland have not seen a crisis in the real estate lending field."

Thomson's case in not an aberration within the sphere of rural residential lending. Indeed, lenders who focus primarily on rural homeowners have not seen the commotion that continues to challenge the rest of mortgage banking industry.

"We are thriving," says Beth S. Anderson, vice president and director of correspondent lending at AgFirst Farm Credit Bank in Columbia, S.C. "For the first four months of this year, we were $50 million over budget."

"Our business levels are at near-record levels," says Bill Medley, vice president of marketing for Farm Credit Services of Mid-America, Louisville, Ky. "Last year, our originations were near an all-time high. We expect that to continue to be very high this year. From our singular perception, we're holding up very, very well."

How did rural residential lenders escape the problems that bedeviled their big-city counterparts? It appears that several key issues unique to this sector helped to keep it safe.

Old-fashioned banking
First, rural residential lenders never strayed from the traditional values of mortgage origination. "We've always been conservative," says Anderson. "For most of our loans, the borrowers have very strong credit – usually over 700 FICO and 73-percent loan-to-value."

Needless to say, the so-called "exotic" products didn't take root with the rural lenders. "Adjustable-rate mortgages were not a big product for us," says Medley.

Furthermore, rural residential lenders have primarily been either community banks or, in the case of Medley's organizations, cooperatives owned by farmers and customers. In this smaller and more intimate setting, the originators generally have a strong firsthand notion of what would be best for their borrowers.

"Our clients appreciate that we bring quality and a level of financial stability to the table," says Medley, who notes his organization's residential delinquency rate is a mere 1.2% and the default rate is "very nominal."

If problems arise, it often happens where an originator strays from the community-level operation and seeks out larger markets.

"As a bank that is in five small communities, we know our customers," says Thomson. "However, community banks that have moved into population centers – such as Des Moines, Waterloo, Cedar Rapids -have had to justify and build their market share in those cities, so they have made some real estate loans that they probably shouldn't have."

Ironically, Thomson adds, the borrowers who have experienced loan problems in his marketplace were those who sought out financing from distant lenders with no connection to the community.

"We have seen some foreclosures," he says. "But those people have signed up with Internet banks for their mortgage needs, and in many cases, borrowed up to 100 percent and sometimes more on the value of their homes."

A different GSE world

Rural residential lending also differs from its larger-market counterparts due in large part to its secondary market venues. Ann Grochala, director of lending and accounting policy at the Independent Community Bankers of America, notes that many community banks forego the secondary markets completely when it comes to rural residential loans.

"This has always been a challenge in rural lending," she says. "A lot of community banks keep the loans in their portfolios because so many of the properties are different. In urban areas, there is more uniformity. Rural properties generally have quite a bit of land and the houses are different from their neighbors'."

Grochala doesn't see this strategy as being problematic. "It is good for the customers and the banks. If the customers are in trouble, they know exactly who to go to for working out the situation. The banks are also more likely to know the customers and try to help the customers the best they can. With secondary market loans, it is often difficult to track down who has the loan."

But that is not to say that secondary marketing is alien to rural community banks. "Most small town banks like ours sell their loans to the secondary market and then buy back the servicing rights," says Thomson.

But the destination for the loan sales is often different in this sector. Beyond the traditional outlets of Fannie Mae, Freddie Mac and Ginnie Mae, two other government-sponsored enterprises (GSEs) that operate within this sector are Farmer Mac and the Farm Credit System. Both GSEs focus on offering long-term credit to rural communities, including loans for farmers and ranchers. Homeownership focus, however, is limited for both GSEs.

"Our residential lending is the smallest portion of what we do," explains Tom Stenson, executive vice President and chief operating officer for Farmer Mac. "We don't do a high volume of residential lending."

The Farm Credit System is somewhat more active in residential lending than Farmer Mac (it is the only GSE that doubles as a lender and a secondary marketing source), but its efforts come with a significant caveat: a 1971 Congressional mandate limits its home-mortgage lending activities to towns with populations of 2,500 or less.

However, both GSEs have made efforts to expand their residential activities. In April, Farmer Mac expanded its alliance with the American Bankers Association (ABA) to enable the trade group's members to receive special pricing for Farmer Mac's Part-Time Farm program.

The Part-Time Farm program involves loans secured by first liens on agricultural real estate where a significant portion of the property's value is in a rural residence, with agricultural production under way or planned on the property. Through the expanded alliance, ABA member banks receive special benefits, including pricing discounts for selected Farmer Mac products and AgPower customized loan-packaging services.

Stenson notes that rural residential lending often falls outside of the perimeters set by the leading GSEs. "These properties often fit into jumbo or nonconforming products," he says. "Other agencies also require appraisal with comparable sales about one mile around the property. But rural areas are a different critter – we're talking about 15- to 20-acre parcels with a home."

William Kroll, president of ABA Total Business Solutions, a for-profit subsidiary of the ABA, notes the program offers a secondary market solution that was previously lacking.

"This program will give our members a real advantage because it provides an outlet for the sale of qualified mortgages on properties where the land exceeds the value of the improvements," he says. "Banks normally face a challenge finding secondary market buyers willing to purchase these types of loans."

While Farmer Mac expanded its residential activities, the Farm Credit System took a different approach. Last year, the GSE sought to incorporate HORIZONS, a three-part initiative, into the 2007 Farm Bill.

One of the initiatives raised a hue and cry with many community bankers: allowing the Farm Credit System to make mortgage credit available in communities with populations up to 50,000. Under lobbying pressure from banking trade groups, HORIZONS was deleted from the 2007 Farm Bill while it was still in committee.

"There was some animosity to the Farm Credit System expanding any of that mission," says Medley. "Banks and some other groups feel we have an unfair advantage over them and that any expansion would be inappropriate."

Medley does not expect to see a reprise of the HORIZONS proposal in the near future. "Right now, our focus in on running our business the best way we can," he says.

Looking ahead

The near future of rural residential lending can be determined by the economic viability of the agricultural communities. In many areas, economic vibrancy appears to remain strong.

"Our economies in small-town Iowa, for the most part, are in excellent shape with $5.00 corn and $12.00 beans," says Thomson.

"Agriculture in general is doing very, very well," says Grochala, who adds that some rural resort areas in Montana and New Mexico are also enjoying prosperity. However, she points to the still-uncertain economic effects following the recent flooding in the Midwest, which left damaging effects on many smaller communities.

Yet Medley believes the rest of the country's woes will inevitably permeate rural America. "I believe there will definitely be a slowdown and sluggish growth," he says. "From what some loan officers tell me, there are already some trouble sport in rural areas, just like in urban areas."

But for the moment, it is still sunny in this sector. As AgFirst's Anderson points out: "A lot of investors want to buy our type of loans."

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