Statement Of

Terry Jorde

On Behalf Of The

Independent Bankers Association of America

Before The

Committee on Agriculture, Nutrition and Forestry

United States Senate

September 4, 1997

Thank you. Mr. Chairman, it is a pleasure to be here today to present testimony to you and other members of the Senate Agriculture Committee about rural credit availability -- an issue that is critical to farmers, rural small businessmen and women and other rural borrowers.

I have the honor of serving as Chairman of the Agriculture-Rural America Committee of the Independent Bankers Association of America (IBAA) and also as President and CEO of Towner County State Bank in Cando, North Dakota. Our bank is a $26 million asset bank with 13 employees in a community of 1,600 people that prides itself as being a "growth-oriented" community. But, as members of this committee are aware, growing a small rural community takes a lot of grit and determination, as well as a having a "can-do" attitude. And no matter how successful our economic development activities, the sun still rises and sets on agriculture in rural America.

Mr. Chairman the IBAA, with 75 percent of its member banks located in small communities of under 10,000 population, has a long standing interest in ensuring credit availability to our nation's farmers, small businessmen and women and other credit consumers in our the nation's rural communities. As the only national trade organization that exclusively represents the interests of our nation's community banks, we believe there are some unique and newly emerging challenges ahead for the thousands of small banks in our rural areas and the farmers, small businessmen and other local customers they serve.

IBAA represents some 5,500 independent community banks nationwide with more than 15,000 locations that hold nearly $375 billion in insured deposits, $445 billion in assets, and more than $240 billion in loans for consumers, small businesses and farms in the communities they serve. IBAA members also employ more than 200,000 people in their communities. IBAA maintains its web site at www.ibaa.org.

The Role of Community Banks in Financing Rural America

When we think of community banks, we are basically describing a locally owned, locally operated bank. Its deposits come from the community and stay in that community, rather than being sent to a distant location. Its loans are made in that community as well. The bank may have a single office or may have a small number of offices. But a very important fact to keep in mind is that the policies of the community bank are set locally, they are not dictated from a far-away location by people who know little about the community. So we feel the nation's community banks are ideally situated to meet the local needs of our rural communities.

Community banks are the catalysts for growing their communities. They play an integral role in helping to start or expand small businesses, financing home mortgages, making farm real estate, equipment and production loans, and providing leadership in all areas of community service. The success of our community and its citizens are our very lifeblood. Community banks serve agriculture and Main Street America with a personal touch.

Community banks nationwide have over one trillion in total assets, average about 75 years of existence are in about 6,800 cities and towns across the country. There are about 3,500 so-called "agricultural banks" and about 6,600 non-agricultural banks. The ag banks themselves constitute about 55 percent of the total share of the commercial banking ag lending market. The core business of these institutions is to lend to local small businesses, farmers and consumers. Locally owned and operated banks with less than $100 million in assets (one employee for each $2 million in assets) hold about 10 percent of U.S. deposits, but they lend almost 30 percent (dollar-wise) of the U.S. business bankloans in amounts of less than $100,000. Loans in this size range are the core of small business lending. It is also noteworthy that many banks with less than $300 million in assets are locally owned. Collectively, these banks that hold less than 20 percent of U.S. deposits lend about half of all dollars in bankloans of less than $250,000.

Significant Issues For Rural America

There is growing concern in our agricultural heartland about the problem of ensuring that community banks have adequate funding to meet the loan demand in rural areas. This is an especially important issue from a rural financial perspective since there are approximately 7,500 community banks in the nation and most rural residents have a local bank in their community. In fact, in my small community of 1,600 residents, there are three banks, eight insurance agencies, a large farm supply company and an implement dealership, all of whom offer rural credit financing.

Ironically, in the 18 years that I have been at my bank in Cando, only two financial institutions have left -- a very large Minneapolis-based bank holding company and the Farm Credit System. Both institutions closed their offices in the late 80s during the ag crisis. Fortunately for Cando, the rest of us had no choice but to hunker down, take our losses, and ride it out. Needless to say, we survived the 80s and intense competition still exists today. Its indeed fair to say that the infrastructure exists to meet rural credit needs through commercial lenders if they have the right tools.

We are currently witnessing revolutionary changes in America's financial markets. One trend now underway is a historic merger and acquisition wave occurring among banks and other financial firms in the U.S. Following passage of the Interstate Banking & Branching Act of 1994, merger and acquisition transactions announced in 1995 included nine of the biggest bank mergers in U.S. history.

The 1995 mergers were largely in coastal states, leaving the Heartland relatively untouched. However, in the Midwest, the nation's least concentrated financial market, we have now witnessed NationsBank buying Boatmen's. And although the future is always difficult to predict, the Midwest, with so many strong, mid-sized banks, will undoubtedly become the focus of merger speculation and activity. It may be some years before we know the full extent of the impact on rural credit markets.

Certainly the number of banks have been declining, although not nearly with the dramatic rapidity percentage-wise that the number of Farm Credit System (FCS) associations have declined in recent years. We expect the future profile of the banking industry to be barbell-shaped. Meaning there will be a small number of very large national banks at one end of the barbell and thousands of smaller community banks at the other end, with few regional banks in between. Many of the regional banks existing today as well as some community banks, will likely be merger and acquisition targets.

Several concerns arise from concentrated markets including that at times credit for smaller borrowers becomes less accessible, interest rates tend to be higher and there is often a loss of local decision making as decisions for credits over a certain size threshold are moved to a distant headquarter office and made by bank employees unfamiliar with the farming or small business operation and its history.

An Emerging Liquidity Problem

The key role community banks play in providing credit to the rural communities they serve will become increasingly important as the financial services industry consolidates. However, a second major concern for community bankers and their farmer and small business customers is an emerging liquidity problem caused by a declining deposit base in rural America. Community banks are facing a serious challenge in fulfilling this role of providing the necessary lending to farmers and small businesses due to their heavy reliance on deposits as their primary source of funds available for loan making.

There are many reasons for this loss of deposits from rural areas. Some of these include the flight of traditional deposits to mutual funds, which do not provide liquidity for lending purposes, even if the bank is the one selling the mutual funds since the invested dollars leave both the bank and the community. The dollars are basically funneled to Wall Street firms. Many rural communities are also faced with an ageing population, and as individuals pass away, their estates are often divided up between their children living in distant cities. And we would suggest that with financial consolidation, rural communities often face a loss of deposits since the out-of-state bank often removes deposits from local communities to use them for other economic opportunities, often non-rural in nature.

For example, from 1990 to 1994 the assets of the mutual fund industry doubled and the number of product offerings and shareholder accounts nearly doubled. In fact, assets invested in funds rose from a total of $295 billion in 1982 to over $3 trillion at the end of June, 1997. Similarly, the sheer number of funds offered increased dramatically, from 857 in 1982 to 5,375 at the end of 1994. The primary source of mutual fund cash flow in the last two decades has been the disintermediation of bank and thrift deposits. Deposits now comprise only 28% of household discretionary assets compared to 49% a decade ago.

I mentioned the point of our elderly depositors passing away and their deposits leaving community banks. I know of at least two instances in my bank this year where the death of an elderly depositor resulted in a loss of over $250,000 each in deposits. That's a significant amount for a small community bank like mine that now won't be available for making loans to farmers and other citizens in Cando. Unfortunately, its extremely difficult to create new wealth in our rural communities fast enough to make up for these losses. However, we try to retain deposits whenever we can. One program which has helped is called our "Match-A-Rate-CD" where we promise to match any Certificate of Deposit (CD) rate of any bank within a 60 mile radius of Cando in order to keep our customers investing in our bank's CDs. In my rural area of north central North Dakota, we have 16 banks within that 60 mile radius. That does not include credit unions, thrifts and brokerage firms.

We also have a Northern Neighbors Club for our senior citizens in order to retain deposits. We provide them with free checking accounts, a free Christmas dinner, free movies, and so forth just to hang onto their deposits. Our 196 Northern Neighbors, all over age 55, hold $5.7 million in deposits with our bank -- more than 25% of our total deposits. Many of them are dying off. We even send flowers to their funerals in hopes that their heirs will keep the deposits with our bank! Since our club is fairly new we have many more elderly customers that have not joined Northern Neighbors yet and I would estimate that they hold another 30% of our deposits. We are facing a funding crisis of significant proportions in the next five years.

Before flying to Washington, I looked up the statistics for all of the state chartered banking institutions in North Dakota. From March of last year through March of this year there was more than a seven percent decrease in total deposits! In just one year.

Competition for deposits has always been intense in rural areas, but the declining deposit base is a relatively recent phenomenon spurred to a large extent, as noted, by the shift of deposits to mutual funds. So the problem of ensuring that community banks have access to adequate funds has been compounding in recent years and community banks don't have access to the nation's capital markets. I am convinced that relying on deposits alone will not be sufficient to fund my customer's credit needs in the future. Unfortunately, commercial banks have been extremely limited in their access to FCS funds through the OFI ("Other Financial Institutions") window even though there has been a strong congressional mandate for this program and even though Congress envisioned the OFI program would be a very active and user friendly program when the Farm Credit Act amendments were passed in 1981. This was the commitment and agreement made by the FCA\FCS the last time commercial banks compromised on legislation with the FCS. However, the OFI program has not evolved as Congress anticipated. And today, there are only about 20 OFIs and the FCA is trying to revive the program through new regulations. But as long as Farm Credit funding banks dictate all the terms and community banks are viewed as second-class citizens, it is extremely doubtful the program can be resuscitated.

More Tools Mean More Options For More Rural Borrowers

We must clearly become problem solvers if we are to address the new challenges of a declining deposit base for small banks in rural areas and the need to finance many of the small businesses and farmers as the number of lenders declines. The banking industry has offered a workable solution to ensuring an adequate funding source and Senator Bennet has also proposed what could be a complementary idea, expanded secondary market authorities for small business loans, an idea that merits further review.

I would like to address both proposals. In the previous Congress, the IBAA and ABA proposed utilizing the Farm Credit System's (FCS) funding mechanism as a Government Sponsored Enterprise (GSE) as a funding source, which we believed offered an alternative source of funds for banks while increasing the volume and diversity of financing the System was involved with, but in a way of cooperating with, not co-opting, the role of private sector, tax-paying commercial banks.

Although several meetings have taken place between commercial lenders and System representatives, the System has in the past declined our offers to negotiate. The System's only response so far has been to oppose ideas presented by bankers and to claim bankers are against greater competition when bankers in turn oppose FCS ideas to expand into traditional markets already well served by commercial banks.

However, we believe the banking industry's proposal could be a "win-win" situation for both sides in the age-old debate of who should serve rural customers. This approach would utilize some of the strengths of both community banks and the FCS, namely the delivery system of community banks and the GSE access window of the FCS, to ensure rural credit markets have the necessary tools and the delivery system to best serve rural consumers. Offering rural banks access to the capital markets will grow the economic pie in rural America.

Although the USDA report mentioned several positive aspects of the proposal made by commercial bankers, it seemed to gloss over a few key aspects. One aspect being the expanded opportunities available to rural borrowers from having additional types of financing available from community banks, such as long-term, fixed-rated financing. The ability to access long term financing at fixed rates has played an important role in an expanding urban housing market. Borrowers obviously benefit when they can finance a home for 30 years at an interest rate guaranteed not to rise. Managing interest rate risk is as important to the borrower as it is to the bank. If community banks could borrow funds on a long-term, fixed rate basis, they could provide a long-term, fixed rate loan product to their rural borrowers. Today, community banks can't get funds to loan on a long-term basis because our traditional funding sources, bank deposits, are not available on a long-term basis. Bank depositors are simply unwilling to take on interest rate risk. The elderly depositor doesn't think that they'll live long enough, and the rest of us are sure that rates will go up. This philosophy even held true back in the early 1980s when we were paying 18%. Fortunately, very few people locked in rates longer than five years. The terms of most CDs today run from six months to two years.

This means that community banks must rely on short-term deposits, which hampers their ability to meet the long term credit needs because of the mismatch between the characteristics of their short-term deposit base and the types of long-term credit that can be required for meaningful rural economic development. Access to the nation's capital markets would allow community banks to more efficiently provide rural borrowers with access to long-term capital.

Yes, the community bank would benefit as well by being able to better manage their interest rate risks. We should keep in mind that certainly the farmer and small business borrower need to be kept foremost in mind, but we also need to ensure we have an environment and lending tools that are favorable to the continued ability of community financial institutions to serve local customers in their local markets. If community banks are forced to focus primarily on less credit worthy and risky borrowers while a mix of other players in the market have unlimited access to the capital markets, lighter or no tax burdens, or minimal if any regulatory supervision, it is hardly a level playing field and its questionable whether such competitive disadvantages between the various mix of lenders provides the most favorable environment for community banks and the borrowers that depend on them.

The FHLB As A Funding Source?

Some commercial banks can now utilize the Federal Home Loan Bank as a funding source, but this option is limited for rural community banks. Unfortunately, many community banks can't qualify for membership due to their relatively low level of residential mortgage assets. Others can join but their low levels of qualifying collateral limits their ability to pledge collateral, and therefore limits the amount of funds they can borrow from FHLB to finance their customers. For example, rural banks cannot pledge their farm real estate loans as collateral for advances.

There is a provision in the House Banking bill that modifies the FHLB System to address some of these concerns. However, we have found it necessary to strongly oppose the House banking restructuring legislation (HR 10) because we believe it is bad overall policy for America and especially rural America. It takes one step forward and 10 steps back. We are especially concerned about the bill's provisions to allow the common ownership of banking and non-financial commercial firms, which will jeopardize the impartial allocation of credit and lead to credit being provided or not provided based on a customer's business and banking relationships rather than the customer's creditworthiness. This is especially troublesome for rural citizens such as farmers and small businesses. The mixing of banking with non-financial commercial firms would be in addition to also allowing the common ownership of the largest commercial banks, securities firms, and insurance underwriters.

Mixing banking and commerce would also allow for massive conglomeration of the ownership of America's assets, with one result being to hasten economic concentration within agricultural markets. We have been joined in our opposition to HR 10 by numerous organizations representing small business, agriculture, consumer groups, labor and the elderly. Obviously, reasonably expanding community bank access to a GSE's funding window as a source of funding for rural banks to provide lending in rural communities to farmers, small businesses and other rural customers would be a major step towards reaching the goal of greater credit availability for rural America. The Kansas City Fed's proceedings on their "Financing Rural America" conference does a good job in discussing many of these issues.

If the banking industry and the Farm Credit System cannot get together to open the FCS's funding arm to community banks, then perhaps the advance window of the Federal Home Loan Bank System should be the increasingly important alternative.

We need to keep in mind that Congress created the Government Sponsored Enterprises to help meet perceived credit needs and this should continue to be their function. If the financial landscape of rural credit markets is changing, then the GSEs need to accommodate change by working with private sector lenders and not trying to venture into new markets seeking to target the best credits and capture market share from commercial lenders who lack the tax and funding advantages that GSEs have. Otherwise, the GSE that competes directly with the private sector creates an organization whose strategies center around getting a bigger piece of the pie rather than making the pie bigger. The banking industry and GSEs that desire to serve or continue serving rural markets should seek to creatively address future liquidity issues with a "win-win" approach.

Using Farmer Mac As A Secondary Market For Small Business Loans

Senator Bennet has proposed a second idea -- using Farmer Mac as a secondary market for small business loans -- which as I noted could be complimentary in nature to the proposal for direct access to a GSE funding window and which deserves further review. The reason these proposals could be complimentary, not competing ideas, is that most community banks, just like the Farm Credit System, are portfolio lenders. They hold loans in their portfolio and earn income based on the difference between their costs of funds and the interest rates charged on loans, adjusted for fixed expenses, operating costs and other factors. By and large, a community bank's loans represent its only profitable earning assets. Obviously community banks will want to keep most of these loans on their own books. The banking industry's proposal would help ensure that banks have access to a reliable and long-term funding source to make more long-term loans to borrowers and help banks better manage their interest rate risks.

However, some community banks may at times desire to sell a few loans into a well functioning secondary market. By originating and selling loans to a secondary market, banks can receive fee income, freeing them to make new loans. The secondary market for housing has been successful, although a secondary market for small business loans is still in its infancy. But some banks feel it could be another tool to better aid the small business customer.

IBAA policy committees will be taking a closer look at this issue in the near future and we have done a brief initial survey to a couple of our policy committees, including IBAA's Agriculture-Rural America committee. We would offer the following observations regarding the design of such a program.

Such a program should be designed to ensure wide spread use by community banks and to ensure that usage of the program does not gravitate to a few large lenders who may have the staffing and resources to gear up to do a large volume of business loans.

The program should have streamlined paperwork and application requirements, otherwise it may have little direct use by community banks. Community banks actively use the SBA guaranteed loan programs, for example, where the average loan size is approximately $250,000. However, the average loan size of the B&I program appears to be approximately $1 million. Community banks may be using the SBA loan program because it is streamlined and adaptable for small rural businesses. An example of a guaranteed loan program that has been very successful and widely used by community banks is the SBA "Low-Doc" loan program for loans under $100,000.

The program should not detract from existing programs in use by community banks. There are currently new regulations coming out to allow commercial lenders the same authority to sell both the guaranteed and non-guaranteed portions of small business loans into the SBA secondary market that non-bank lenders now utilize, instead of just the guaranteed portion.

There would have to be a willingness by Farmer Mac to take the small individualized loans of community banks rather than focusing on larger, higher dollar loans packages. Further, community banks that would only be able to sell a few loans per year due to their limited geographic constraints or limited needs, should be assured the same rates as larger volume lenders.

Questions regarding who has the obligation to collect on loans that may go into default would need to be addressed.

Some rural banks have indicated their view that securitizing small rural business loans could be quite complex because of the nature of the local businesses, their need for continued servicing and their desire to periodically adjust the terms and conditions of the loan. Some community banks believe that larger money center banks and branches would eventually benefit most under this program because they have loan specialists and staff that could be devoted full time to making secondary market loans, versus a community bank's staff which has a variety of responsibilities.

But it may also be true that under a properly designed pilot program, establishing a limited secondary market could help small lenders better compete in the marketplace. We would expect that such a secondary market would target the stronger small business credits for securitization since there would need to be a relatively high degree of standardization for the market to be efficient. Small business borrowers could also benefit since they would have the availability of loan funds for longer terms.

Conclusion

In conclusion, we believe that to better finance rural America we need to expand small bank access to the broader capital markets, ensuring Government Sponsored Enterprises work in partnership with community banks -- not against them. We look forward to working with committee members to achieve this aim and advance the committee's broad policy goals on behalf of rural financial markets and rural consumers.