The Capital Structure of Commercial Banks and its Impact on Participation in the Farm Service Agency's Guaranteed Loan Program

This work presents a statistical analysis of the importance of the “Capitalization Effect” among smaller rural banks which may have more restricted access to capital for lending than agricultural banks with greater total assets. This Effect occurs when banks seek ways to leverage scarce surplus capital to increase their lending capacity. Because the terms of Farm Service Agency agricultural loan guarantees provide more unencumbered capital to banks than a conventional loan, as only 10 percent of a guaranteed loan’s value is counted toward its regulatory capital, these guarantees are expected to benefit banks with more restrictive capital limitations. A Binomial Logit Regression analysis was performed using the quarterly data of U.S. Commercial Banks and Thrifts offering agricultural loans. The dependent variable was the choice to participate (yes/no) in the FSA Guaranteed Loan Program in the quarter. The analysis found the Capitalization Effect to be statistically significant at the 90-percent confidence level for all agricultural banks. Although the magnitude of the estimated 0.021 increase in participation per 1-percent increase in the ratio of surplus capital was relatively low. This result, together with the finding the Effect was statistically significant in the opposite direction for mid-sized banks with assets between $500 million and $1 billion, suggests the Effect is strongest at small and medium community banks with up to $500 million in assets and possibly at regional banks with $1 billion to $10 billion in assets. Supplementary analyses, not included here, indicated there was not a significant Capitalization Effect at large money center banks with assets greater than $10 billion. Further testing is required to fully support these conclusions as the analysis was applied to only one quarter of data, although the sample size was large with n=5,640 institutions. Other preliminary findings include strong positive relationships between GLP participation and lower loan-making costs, portfolios heavily weighted toward real estate, both of which suggest the ability to securitize a guaranteed loan is considered valuable. In addition, there were strong relationships between the log of agricultural loan share in a portfolio, the log of total assets, and the banks’ interest margins and GLP participation.