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Credit Subsidies and Transactions Costs of Two Government Credit Programs in Ohio Jeffrey H. Kalbus, Warren F. Lee, and Gary D. Schnitkey The authors are former graduate student, professor, and associate professor, respectively, Department of Agricultural Economics and Rural Sociology, The Ohio State University. Helpful comments from Carl Zulauf and two anonymous reviewers are gratefully acknowledged. Abstract <top> This study examines credit subsidies and lenders' transactions costs for Ohio's Linked Deposit (LD) program and Farmers Home Administration's (FmHA) guaranteed loan program. The largest portion of Ohio's LD program credit subsidy originates from its funding costs, while most of FmHA's subsidy results from its default risk costs. Lenders perceive the LD program as one that offers borrowers a reduction in interest rates with relatively little effort on their part. In contrast, the FmHA guaranteed loan program has high transactions costs for lenders; however, they receive up to 90% protection against loan loss. Key words: government credit programs, credit subsidies, transactions costs, lending costs, default risk costs. Article <top> Government credit programs influence alternative methods to distribute and price credit in an attempt to reach policy goals (Hughes and Osborn). Often, credit assistance is intended to improve access to capital or to service highly leveraged agricultural borrowers during periods of financial stress. Federal and state farm credit assistance programs have come under scrutiny. With anticipated federal government spending cuts and possible reductions in federal entitlement programs, some policymakers favor reducing federally funded programs and shifting the responsibilities to the states. Partially as a result, many state credit programs were initially designed to complement the federal credit programs. The majority of the state credit programs were implemented in the mid-1980s in response to farm financial stress, but financial conditions for agricultural producers have improved since that time. Thirty-two states operated 81 agricultural credit programs in the period 1993_94 (Wallace, Erickson, and Mikesell). There were 31,400 loans from state-sponsored agricultural credit programs in 1993_94, with slightly over $1.8 billion in loan volume outstanding. In comparison, there were 42,500 Farmers Home Administration (FmHA) guaranteed loans in the U.S., with $5 billion in loan volume outstanding in 1993, and another 225,000 direct loans, with $13.8 billion in loan volume outstanding. FmHA issued $1.5 billion in loan guarantees in 1993 and made another $612 million in direct farm loans. Although the state programs are smaller, they have been able to target agricultural loans to specific borrowers' needs and provide more efficient use of public funds. This article compares Ohio's Linked Deposit (LD) program and the Farmers Home Administration's (FmHA) guaranteed loan program.1 Currently, 10 states have linked deposit programs (Wallace et al.); Ohio's LD program is one example of a state program.2 Linked deposit programs reduce interest rates on funds provided to lenders, and these savings are passed on to participating borrowers (Froerer, Adams, and Lee). Subsidy costs of the Ohio LD program and the FmHA program are calculated and compared. The results help to quantify subsidy costs that a state is likely to bear. In addition, lender transactions costs for participating in each program are calculated. Results from these comparisons will provide insight into the changing conditions of subsidized agricultural credit. 1The Federal Crop Insurance Reform and Department of Agriculture Reorganization Act of 1994 (PL 103-354) was passed October 13, 1994. Legislation was designed to help streamline and organize the Department of Agriculture to achieve greater efficiency and economies in its organization and management. Part of the organization included combining FmHA with ASCS and SCS to form the Farm Service Agency. We have chosen to use the former name, FmHA, in this study. 2Other types of state credit programs include direct loans (12), guaranteed loans (8), tax-exempt bonds (13), or a combination that offers at least two types within one program (21). The Agricultural Lending Process <top> Lending is a multistage production process. Lenders gather, filter, and analyze information provided by potential borrowers regarding their past performance, financial status, and proposed use of loan funds to determine their creditworthiness. Lending costs are determined not only by the direct costs associated with screening, collecting, and servicing a loan, but also by lenders' exposure to default risk and their costs of funds. The decision to grant a loan is based largely on the probability of success (repayment) or failure (default). Transactions costs are also incurred by lenders throughout the various stages of the loan process (Sealey and Lindley). Servicing loans, including periodically assessing the value of the collateral after the loan proceeds have been disbursed, becomes an opportunity cost for lenders. The opportunity cost of a lender's time allocated for loan servicing could be alternatively spent by initiating new loans or alternative investment opportunities. Lenders must weigh potential default risk costs from inadequate loan servicing against the opportunity costs of time spent assessing the borrowers' collateral and repayment ability. Lenders' transactions costs for servicing problem loans and higher-credit-risk customers include the greater time commitment required to review collateral and monitor the loan. The default risk costs and added transactions costs involved with servicing problem loans interject potential unforeseen costs to the lender, including possible third-party costs (for example, attorney fees) if the repayment pattern becomes interrupted. Ultimately, lenders must determine if the expected returns derived from underwriting the loan outweigh the total costs associated with lending (Baltensperger). Government Credit Programs <top> Government credit programs involving private institutions set rules and policies within the parameters of the legislation that impact the participating financial institution. Hence, they may modify the traditional flow-of-funds process. The type of subsidized credit and the mechanism by which subsidies are transferred to borrowers vary according to the requirements specified by the credit program. Not only are different acceptance criteria established by program guidelines, but application procedures change, the evaluation and approval processes are revised, and distribution of funds may also differ from normal lending procedures. Lenders apply their own perception of costs relative to benefits of a credit program when deciding whether or not to participate. Ohio's Linked Deposit program was created in April 1985, in response to the adverse financial conditions facing the farm sector. Although the "target group" for assistance was never specifically defined by Ohio's General Assembly, the intent of Ohio's program, which reduces interest rates on specified loans, was to assist farmers facing hardship due to circumstances beyond their control, a common goal of most government credit programs. Ohio's LD program has supplied approximately $1.11 billion in reduced-rate loans to agricultural borrowers in its 11 years of operation. To participate in the LD program, the borrower applies for a loan at an approved lending institution. Commercial banks and Farm Credit System (FCS) lenders account for most of the loans, although some farm marketing cooperatives and other state-approved depository institutions are eligible to participate. The lender initially reviews the application to determine if the potential borrower is creditworthy, and then applies for linked deposit funding if reduced-rate funding assists their repayment position. The staff of the State Treasurer's office reviews each application and attaches a ranking. Ranking criteria include: (1) lender mentioning in the application that borrower's acceptance was contingent upon LD approval, (2) lender indicating that LD approval would cash flow the loan or help meet planting deadlines, (3) the debt/equity position and the percentage of interest paid relative to operating expenses, and (4) county location of farm operation. Distribution of the funds (usually in mid-April) is ultimately based on the borrower's need for reduced-rate funds as perceived by the staff of the Treasurer's office. If the borrower's application is approved by program officials, the Treasury purchases a low-yield (below market rate) certificate of deposit from a depository lender or a low yield bond (debenture) from an FCS lender. These low-cost, linked deposit funds are then lent to qualifying farm applicants at rates set at up to four percentage points below the rate that would have been charged based on the prevailing market rate cost of funds. A 4% savings is the maximum rate that can be passed on to accepted borrowers for up to one year. The LD program has provided the full 4% savings to all accepted applicants during each year of the program's existence, except in 1993 when market deposit rates were too low to pass on the full 4% savings. Linked deposit loans are used to pay agricultural production expenses and are limited to $100,000 per borrower. Lenders assume responsibility for the borrower's credit risk. Public funds are not at risk in the event of borrower default. The distribution of loans varies by the general condition of the farm economy and the number and size of the linked deposit applications. The LD program also attempts to distribute funds to all 88 counties and is limited to for-profit Ohio-based farm businesses. The Rural Development Act of 1972 provided FmHA its first authority to guarantee loans made by other lenders. However, it was not until the Food Security Act of 1985 that FmHA was instructed to gradually move away from direct lending to loan guarantees. The loan guarantee program was perceived as a way to lower interest rate subsidies, reduce loan losses, and decrease the operating costs [U.S. General Accounting Office (USGAO) 1989]. There has also been an attempt to use FmHA's guaranteed loans as an intermediate step for their direct loan customers to graduate to commercial credit sources. FmHA's guaranteed loans are designed to serve family-sized farm operators. To qualify for a guarantee, borrowers must be U.S. citizens or permanent residents and must demonstrate that they are unable to obtain credit from commercial lenders at reasonable rates and terms. A borrower must demonstrate repayment ability to be eligible. Guaranteed lending limits are $400,000 for operating loans (OL) and $300,000 for farm ownership (FO) loans (Koenig and Sullivan). FmHA's guaranteed loan applications are filled out by lenders and submitted to the local FmHA county office for approval. FmHA provides a checklist of 19 items that are to be verified to complete the lender's portion of the application form and another 20 items for the FmHA loan officer's checklist. If the loan is approved, FmHA assesses the lender a nonrefundable fee of 1% of the value of the guarantee, which is usually passed on to the borrower. Loan terms are negotiated between the lender and borrower, but the interest rate cannot exceed the average rate charged on the lender's agricultural loan portfolio. Participating lenders are responsible for collecting principal and interest, and they are responsible for servicing loans with sound administrative procedures. Lenders are required to report on an annual basis to FmHA on the status of multiperiod loans, and FmHA's supervisors are responsible for monitoring lenders to ensure the required servicing takes place. FmHA will repay up to 90% of the realized losses (principal, interest, and liquidation costs) in the event of default. Loan funds are provided by lenders, not by the government. Federal government accounting attempts to estimate the future costs of default risk when issuing a loan guarantee, but actual costs are known only when borrowers default and lenders are compensated for up to 90% of their losses. FmHA's guaranteed loan payments to lenders are obtained after a claim has been filed through the Federal Financing Bank, which is the mechanism the government uses to finance its credit programs. Fee deposits help to replenish a U.S. Treasury revolving fund account. Shortages are made up by Congress, which also authorizes the agency's annual budget. Estimation Procedures <top> The "cost approach" was used to estimate subsidy costs for the credit programs (Hughes and Osborn; Herr; Price Waterhouse; USGAO 1992). Lending costs were separated into three components for measurement: funding cost, operating cost, and default risk cost. A contingency liability technique and a "benefit approach" were also considered. The contingency claims model, formulated from a Black-Scholes option pricing formula, has been used to measure the value in wealth transfers imbedded in loan guarantees (Sherrick). Because the linked deposit program does not include a default risk component or any contingent liability claims, the cost approach was a more flexible and consistent method to calculate credit program subsidies. Although the benefit approach has also been used to measure credit subsidy benefits to participating borrowers, the cost approach is preferred because it can be used regardless of the internal pricing policies of the program or default risk characteristics for each borrower (Hughes and Osborn). Credit subsidies of government credit programs may or may not include all three cost components. The following sections specifically address how the cost components for the Ohio LD program and FmHA's guaranteed loan program were estimated in this study. A nine-year period, 1985 through 1993, was investigated to compute the subsidy costs of the two credit programs. Ohio Linked Deposit Program <top> The LD program subsidy includes a cost of funds (F) and an operating expense (O) portion, but it does not include the default risk (K) component. Commercial lenders, not the LD program or the State Treasurer's office, are responsible for the credit risk exposure. Therefore, subsidy costs for the LD program are: SLD = F + O. (1) The incremental difference between the prevailing market rate of interest and the rate charged to the borrower, multiplied by the loan volume (Vi), determines the maximum funding subsidy segment for a particular time period. Annual funding costs are determined by the following equation: F = [Vi(Rm Rs)t], (2) where Vi is volume of loans, Rm is the market rate of interest, Rs is the subsidized rate of interest, and t denotes the time/duration of the loan. In each year studied, $100 million was placed in the program.3 Hence, funding costs equal $100 million ´ 4%, or $4 million, and the deposits were held for 12 months. 3The state legislature authorized an additional $10 million in 1989. This increase was justified by the financial problems caused by the 1988 drought. Variable operating costs were calculated by multiplying the number of applications received (a), by the time needed to process the application (t), by a per input unit (w) cost factor (labor, capital, and other miscellaneous inputs): O = (a) ´ (t) ´ (w) + b. (3) Other LD program costs (b) included promotion and communication expenses, printing expenses for application forms and promotional flyers, postage, and general overhead expenses.4 4The State Treasurer and staff traveled to four to eight county meetings throughout the state each year to promote the program. Annual subsidy costs for the LD program were calculated by following equation: SLD = [Vi(Rm Rs)t] + [(a)(t)(w) + (b)]. (4) Although some variance may exist in computing the operating cost estimates, these costs were minor compared to the funding costs. Data for the LD program were collected from the program's annual summary reports and other information supplied by the program's coordinator. FmHA Guaranteed Loan Program <top> Cost estimates of FmHA's guaranteed loan program for most borrowers include an operating cost (O) subsidy plus a default risk (K) cost. The cost of funds (F) was included in the subsidy estimates only if the borrower also received interest rate assistance. Operating expenses for the guaranteed loan program are partially offset by an administrative fee (A) charged to the lenders (1% of the amount of the loan guarantee). Fees assessed by FmHA for guaranteeing loans are up-front, and the charge is normally passed on to the borrower. For most FmHA guaranteed loans, the subsidy costs were computed by equation (5): SFmHA = O + K (A). (5) For those guaranteed loans also receiving interest assistance (F), the subsidy included all three components, as shown in equation (6): S*FmHA = F + O + K. (6) Provisions for the interest rate assistance allowed qualified borrowers to receive rate reductions of up to four percentage points Prior to 1991, FmHA and lenders shared equally in the cost of interest rate reduction. Since then, FmHA has absorbed the full cost of the interest rate reduction, in addition to waiving the administration fees (A) for those FmHA borrowers who qualified for interest rate assistance (Koenig and Sullivan). Data availability problems were encountered with FmHA sources. Some data were unavailable or incompatible with LD program data. For example, data for the amount of interest assistance funds were available from 1990 through 1993, but the specific interest rate reductions were not. Funding estimates were calculated by multiplying the volume of interest-assisted loans by 2%. Interest rate savings ranged from 0.5 to 4.0% for borrowers receiving interest rate assistance according to state FmHA officials. The accuracy of the funding costs from 1990 through 1993 is suspect, but it represents only a minor portion of the total subsidy costs. A 1% change in the average interest rate saving would change the total subsidy cost by only 0.05%. For the years 1986 through 1989, a single cost was available for interest rate reductions. The funding cost estimates were equally divided for the four-year period. In addition, interest-assisted guaranteed farm ownership loans were discounted over a longer period than operating loan guarantees. Interest assistance and the associated costs were adjusted accordingly.5 5The length of interest rate assistance for farm ownership loans was not available. Farm ownership guaranteed loans receiving interest rate assistance are examined each year to reassess the need for interest rate relief. Operating cost estimates for the guarantee program were also handled in a slightly different fashion from the LD program estimates [see equation (3)]. Ideally, the total number of guaranteed loan applications processed, the number of loans monitored, and the number of labor hours needed for servicing requirements would have provided a similar variable cost estimate. Unfortunately, consistent data were not available on a per case basis. Operating cost estimates were calculated by a fixed rate of loan volume, similar to the procedure used in the Herr study. Annual loan volume data and the number of loans were obtained from FmHA Reports 4067 to compute operating cost estimates for the guaranteed loan program. Default risk and the associated default costs are not realized until delinquent loans are charged off and lenders collect on their loan guarantees. Guaranteed loan charge-offs were compiled from FmHA Report 4131. Per-unit estimates were computed on an annual basis by loan volume from 1985 through 1993.6 Lags in FmHA reports of loan charge-offs cause overstatement of default risk costs for participating borrowers during periods when financial conditions improve, and vice versa. Other sources were used to complement FmHA's reports (Herr; Price Waterhouse). 6Charge-off data used to calculate the default risk subsidy estimates do not include an opportunity cost of the additional "in-house" FmHA loan officer time to resolve defaulted loans. Although commercial lenders are primarily responsible for guaranteed loan monitoring, a borrower's progress is still subject to review by FmHA loan officers on an annual basis for multiperiod loans. Different circumstances are warranted for each case, and detailed information is available only at FmHA's local offices. Lender Transactions Costs <top> An inventory assessment model was used to examine transactions costs. The inventory assessment model provides an indicator of the number of hours required for different loans and for a lender's involvement in credit programs. One common feature among the lenders participating in the survey was that they all made non-real estate agricultural loans. The "average" amounts of a lender's time required to produce and service a "typical" non-real estate loan were established as input and output benchmarks. Once the performance standards were established, deviations from the norm were monitored (Garrison). The model was used to monitor incremental changes in the input-output relationship. Variations from these initial criteria reflected added lender requirements to service problem loans and the requirements to participate in government credit programs. The amount of lender time allocated for a loan, multiplied by a per unit cost factor, translated into an input cost—the lender's cost to make and service a loan. Converting a lender's opportunity cost (lender time allocated) to a transaction cost was accomplished by multiplying the number of lender hours required to produce and service a loan by an hourly wage rate of $27.50 (Agri Finance Staff).7 7The average salary of an agricultural lender in 1992 was $42,100 per year, which is equivalent to an hourly rate of $21.05. The wage rate used in the calculations was $27.50 per hour, including employee benefits at 30% of the hourly rate. A sample of loan officers, consisting of 60 Farm Credit System (FCS) and 139 commercial bank personnel throughout Ohio, was surveyed in April 1992. The commercial banks included 75 "agricultural" banks selected for an earlier study of credit scoring (see LaDue, Lee, Hanson, Hanson, and Kohl). These banks either had at least $5 million of agricultural loans or had 50% of their portfolios in agricultural loans. Another 64 banks or branches were selected from a mailing list from the State Treasurer's office. The FCS list included virtually all Ohio offices of Farm Credit Services of Mid-America (ACA) which serves most of Ohio, and Ag Credit ACA, which serves an 18-county area in northern Ohio. Bank and FCS loan officers received essentially the same surveys. Responses were tested for statistical significance between lending groups. Subsidy Costs of Government Credit Programs <top> Table 1 summarizes the average total costs per year and the per unit costs for the two government credit programs. The LD program has offered an interest rate reduction of up to four percentage points for operating farm loans up to $100,000 per borrower. The LD program supplied $910 million in reduced-rate funds from 1985 through 1993 for 13,300 loans, an average of 1,480 loans per year. Subsidy cost estimates for the LD program were estimated at $3.967 million per year, or 3.92% of total volume of linked deposit loans. The largest contributor to costs originated from the funding component (98% of the total costs). Operating costs comprised the program's remaining costs, about $84,000 per year (0.08% of the dollars deposited). The primary benefit of the LD program is the reduction in the price of loanable funds to borrowers via reduced-rate funds from the State Treasurer's investment portfolio. Lenders also receive indirect benefits from the LD program: (1) a lower cost of funds with an equal interest rate spread, (2) improved short-term cash flow for higher-risk borrowers, and (3) an alternative source of funds. Most borrowers (92%) accepted into the program were considered to be acceptable credit risks by lenders with or without LD program approval. In our judgment, the LD program has had a negligible impact on default risk. Approximately 196 FmHA guaranteed loans were made annually in Ohio from 1985 through 1993. The volume of guaranteed operating and farm ownership loans made averaged $21.1 million per year. Total subsidy costs for FmHA's guaranteed OL were $454,000 per year, or 2.88% of the guaranteed OL volume from 1985 through 1993. FmHA's guaranteed FO loan subsidies averaged $286,000 per year, or 5.35% of the guaranteed FO loan volume. Default risk costs for guaranteed loans were ultimately determined by the success or failure of borrowers. Default risk costs comprised the largest cost component for guaranteed loans (66% for OL and 65% for FO loans). Total per unit costs for the OL (2.88%) fell within the ranges of the Price Waterhouse (1.0%) and Herr (10.1%) estimates. Farm ownership loan costs were 5.35% and also within the Price Waterhouse (3.6%) and Herr (7.6%) estimates. Administrative fees collected from issuing loan guarantees only partially offset the program's operating costs. Our results coincide with other studies which found that the fees collected on OL loans and FO guaranteed loans do not cover the program's costs. The fees collected are slightly less than 1% because the administrative fee was waived for those borrowers receiving interest rate assistance. Funding costs added to the program's costs for borrowers who also qualified for interest rate assistance. An average of only 22 OL borrowers per year qualified from 1991 through 1993. Funding costs, $66,000 per year, for FmHA's guaranteed programs were 0.17% of OL and 0.74% of FO loans guaranteed—small compared to the LD program's funding costs of 3.84%.
Sources: FmHA Reports 4067 and 4131 (various issues); Herr. Notes: OL = operating loan; FO = farm ownership loan. aAdministrative costs were computed by multiplying the annual OL loan volume by 1.125% and the FO loan volume by 1.5% (Herr). bDefault risk costs were computed from FmHA Reports 4067 and 4131 on loan charge-offs. The accounting period when a loan was charged off does not always match the period the loan became delinquent. Average cost may be overstated because some of the loans issued before 1985 were charged off during the period examined. cThe administrative fees collected are computed at 1% of the annual guaranteed loan volume issued. Guaranteed loan borrowers receiving interest rate assistance are not required to pay administrative fees.
Sources: Lender survey; Agri Finance Staff. Note: Survey respondents were comprised of 43 FCS and 61 commercial bank loan officers. aColumn figures may not total because of rounding. bLending group response was found to be statistically significant at the 5% confidence level. cTotals for all lenders submitting response, excluding the Special Accounts section for FCS. Special Accounts offices handle these types of loans for the FCS lenders in Ohio. Lenders' Transactions Costs <top> A total of 43 FCS and 61 commercial bank loan officers responded to our survey, for an overall response rate of 52%. Lenders reported spending an average of 6.9 hours per year with the "typical" non-real estate agricultural customer (Table 2). Results between lending groups were nearly identical and were very similar to the findings of bank credit delivery costs by Ellinger and Barry (7.1 hours per customer per year). Loan monitoring and collateral inspection accounted for 29% of a lender's time spent on a non-real estate loan. Ellinger and Barry found lenders spending 34% of their time analyzing, verifying, and approving a loan; 25% for loan preparation; 24% for monitoring the borrower's progress; and 18% for farm visits. The additional lender time to service a delinquent loan was 6.7 hours ($184 per loan), or about twice that for the average non-real estate loan (Table 2). FCS lenders reported spending an added 19.5 hours ($536) to restructure a loan, compared to 7.5 hours ($206) for bank lenders. This difference between lender groups was significant at the 5% level. One explanation for the disparity between FCS and banks may be the procedures outlined in the Agricultural Credit Act of 1987 for FCS lenders to follow when restructuring or foreclosing loans. Borrowers were permitted to appeal at various stages of the process, lengthening the period required to resolve a problem loan.8 FCS lenders required an added 27.5 hours ($756) to foreclose a loan compared to 22 hours ($605) for bank lenders. 8FCS's Special Accounts offices are used to resolve most problem loans (loans delinquent for more than 60 days). Delinquent loan files remain in the Special Accounts loan officer's file until payments become current, or the file is sent to FCS's litigation personnel. Lenders' Time Requirements with Government Credit Programs <top> Lenders responding to the survey represented considerable experience with the LD program and the FmHA guaranteed loan programs. All of the FCS loan officers and 95% of the commercial bank respondents had participated in the LD program. About two-thirds of the lenders reported some experience with FmHA's guaranteed loan program. Agricultural lenders reported spending an average of 1.9 hours to comply with the requirements of the LD program (Table 3). Total lender costs to participate in the program averaged $52 per linked deposit loan. Completing the application required about 40 minutes. Other program requirements took between 20 to 30 minutes for each function. The average amount of time spent by lenders for a FmHA guaranteed loan was 15.2 hours ($418) for FCS respondents and 10.4 hours ($286) for bankers. Most of the lender's time was spent on processing the application; responses were statistically different between lending groups (9.2 hours for FCS lenders and 5.5 hours for bankers) at the 5% level of significance. About 50% more time was spent by FCS lenders than by bankers to comply with FmHA's guaranteed loan requirements, primarily due to their lack of experience with the program. These results may explain why fewer FCS lenders participate and account for only 29% of the guaranteed loans made in Ohio.
Sources: Lender survey; Agri Finance Staff. aColumn figures may not total due to rounding. bDifferences between lenders' responses were found to be statistically significant at the 5% confidence level. cCosts were computed by multiplying the number of hours times the lenders' wage rate ($27.50/per hour). Lenders' opinions of FmHA's guaranteed loan program from our survey showed the application approval process was too long, the application procedure was perceived as too complicated, and servicing requirements were too cumbersome.9 Another problem reported by FCS lenders was the inflexibility of FmHA in adjusting their average interest rate pricing policy. FCS lenders and officials felt that since more of a lender's time is required to comply with the FmHA program, interest rates on these loans should be higher. 9The Agricultural Credit Act of 1992 directed FmHA to streamline its guaranteed lending programs. Regulations on new procedures did not come into effect until fiscal year 1993_94. Interviews with three FmHA loan officers revealed that they spent 8 to 16 hours per loan to package a loan guarantee, almost double the time allocated by a lender for the typical non-real estate loan. Most of their time was allocated up-front in the application process and verifying FmHA's lengthy checklist. The majority of the FmHA loan officers' time is still involved with monitoring their direct loan portfolios. A commercial lender's lack of experience with the guarantee program also tended to lengthen the required time for the application process. A new lender unfamiliar with the program increased the FmHA loan officers' time to 24 hours per application. In contrast, the staff of the Ohio State Treasurer's office spends between 45 minutes and one hour to process and review each application and distribute the linked deposit funds. Policy Implications <top> The two government credit programs examined in this study are not identical, but they have some common features. Both require commercial lender participation, and both try to target borrowers in weak financial positions. FmHA's guaranteed loan program has 30 to 35 offices in Ohio that provide fewer than 200 guaranteed farm loans per year. FmHA's guaranteed loans have enabled high-credit-risk borrowers to continue to receive financing. The LD program has one centralized office that oversees the approval of approximately 1,480 reduced-rate loans out of about 2,550 applications per year. Ninety-two percent of Ohio's Linked Deposit program borrowers are considered acceptable credit risks with or without program approval. Most linked deposit participants are considered to be lower credit risks than those borrowers receiving guaranteed loans. In fact, a borrower must be considered an unacceptable credit risk to be eligible to receive a guaranteed loan. Borrower benefits from the LD program are obvious: a 4% reduction in interest rates on operating loans up to $100,000 per borrower, or $4,000 more pre-tax income per year. Lenders' benefits include an identical interest rate spread on linked deposit loans and on loans to borrowers not participating in the program. Although lenders' goodwill toward their linked deposit customers has been an accommodating issue, the program's success has also been driven by a true business objective—a higher return on investment. Access to credit and avoidance of failure are obvious and real benefits to the high-risk borrower, although they are not as easily quantified as the interest rate subsidy. With acceptance into FmHA's guaranteed loan program, the borrower receives credit at the average rate charged for the lender's portfolio, which is usually lower than rates charged its highest risk customers. Lenders are the real beneficiaries of the guaranteed loan program. FmHA's guaranteed loans were not intended to be a bailout for lenders with poor quality loans, although some argue that this practice has been occurring. FmHA's guaranteed loan program has developed into a "double-edged sword". Lenders are released from their responsibility to assume the majority of the default risk because they are compensated for up to 90% of loan losses. The largest portion of FmHA's guaranteed loan costs originate from their default risk costs. The exact price tag of FmHA's guaranteed loan program cannot be determined until all defaulted loan obligations have been met. To maintain control over the costs, each aspect of the lending process must be properly monitored and controlled. Loan loss for guaranteed loans is ultimately determined by loan acceptance standards, the delinquency rate, loan monitoring provisions, collateral, and the general economic climate of the farm economy. Ohio taxpayers bear up to $4 million per year in foregone interest earnings on the state's deposits, plus modest operating costs in the State Treasurer's office. Contributing factors having the greatest impact on the program's funding costs were: the interest rate reduction (up to 4%), the length deposits were outstanding (up to 12 months), and amount of funds available ($100 million per year). Program officials reported that the LD program was not intended to be a "cure-all" solution. The program's intent was to provide temporary relief to farm borrowers as they recovered from adverse economic conditions during the 1980s. However, the program has continued into the 1990s even though the general economic climate of the farm sector has improved and interest rates have declined. In fact, legislation passed in 1987 made the program permanent. Potential legislative changes could reduce the subsidy during periods of economic prosperity or limit the number of times borrowers are accepted into the program. Linked deposit funding was provided to lenders at 0.5% in 1993 and 0.75% in 1994. As a cost-saving measure, distribution of linked deposit funds could be discontinued during periods when interest rates fall below certain preestablished levels or when the interest rate exceeds a predetermined level, such as 40% of the total funding costs for participating borrowers. In recent years, about three-quarters of approved borrowers have previously received one or more LD loan. Any cost-saving initiatives considered for the LD program, however, directly impact the benefits received by borrowers. For example, the interest subsidy was reduced by 100 basis points in 1993 due to low market rates of interest. Thus, the subsidy cost (borrower benefit) was reduced from 4 to 3%. Decreasing the interval that the linked deposits remain outstanding would also have a similar impact on lowering the funding costs. Excessive paperwork and complicated procedures discourage lender involvement with FmHA (Klinefelter). Programs will be used less if the opportunity costs required to participate become prohibitive (Lins, Drabenstott, and Brake). Heavy administrative requirements to apply for FmHA's guaranteed loans and added loan servicing requirements have created artificial barriers which discourage lender involvement. If the guaranteed loan program is to be a successful federal credit assistance program, the process needs to be more "user friendly" to induce lenders to participate. Federal policymakers could learn from the operating efficiency of state programs. Because lender involvement is required throughout the FmHA lending process, FmHA clearly needs to address the problems of complicated application procedures, slow turnaround, and cumbersome loan servicing requirements. Too much time is spent on the application process. FmHA also should develop a consistent procedure among local offices to accept and review applications. The use of a credit scoring model and lenders' financial records would improve procedures and improve lenders' attitudes toward the program. FmHA's "certified lender" program attempts to reduce the turnaround time and improve the acceptance procedure. However, only a few lenders (nine in Ohio) qualified for these privileges. FmHA's "operations assist" has helped to reduce lender time spent in the application process. Assistance provided varies among field offices. One FmHA office in Ohio accounts for about 17% of the state's guaranteed loan volume. It is unlikely that consistency among offices will improve during the transition to the Farm Service Agency. Transactions costs for lenders to participate in the LD program were minimal—less than two hours ($52 per loan). In some cases, borrowers complete the application forms. Total subsidy costs of the LD program (3.92%) were only slightly larger than the benefits in interest savings received by borrowers (3.84%). The trade-offs between the program's costs and the borrowers' benefits were practically identical because of the low operating costs. Program officials have carried out the intent of the LD program in an efficient manner. Both credit programs provide guidelines in identifying what type of borrowers can participate. Policymakers should be concerned with program motives, the type of benefits received, who receives benefits, and the cost to taxpayers. Both require a better understanding of borrowers served and the amount and type of cost involved before policy for federal farm credit programs can become more effective or lending authority can be shifted to state levels. References <top>
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