REQUIRED READING: Citizens First Bank operates in five small communities in southwestern Wisconsin. The largest of the five is Sparta, with a population of 8,600, and the smallest is Viola, which counts 667 citizens.
Eric Nottestad, vice president of Citizens First Bank, works out of Viola and mainly focuses on agricultural and commercial loans. It's been a busy year for him, and that bounty has benefited a growing focus of his bank: residential lending.
‘We are starting to see more loan applications come in,’ he says. ‘We are also seeing a lot more activity with home builders.’
When asked how his borrowers did during the recession, Nottestad says, ‘I don't think we had any foreclosures.’
Rural America, particularly in the Midwest, did not experience the housing bubble and, as a result, avoided the subsequent bust. Home prices have been stable, and if there was any real weakness in the rural housing market, at least incomes were enhanced by successful agricultural-production years. These markets missed the recession pain experienced elsewhere in the country because the local economies were more solid and because most of these small markets did not see a lot of population expansion.
‘The Corn Belt did better economically than the rest of the nation during the Great Recession because of agriculture, natural resources and commodities, but it is not like that translated into great growth in housing: It just shielded it from the fall,’ notes Jim Diffley, regional housing economist for IHS Global Insight in Philadelphia.
‘Since you didn't have a lot of overbuilding, the markets didn't tank the way they did elsewhere,’ Diffley explains. ‘On the other hand, demographics are slow. What generates demand for new housing is population growth, and you don't have a lot of that in these markets.’
Individually, the markets may be small, but there are thousands of these towns spread across most of the center of the country. Not unlike their big city cousins, the population needs financing to buy homes. Yet the attractiveness of these markets was a long time coming.
‘Back in 1988, when I first started my career, it was very difficult for rural home properties to get sold into the secondary market because Fannie Mae did not want properties that were on gravel roads, had septic tanks or were far away from fire protection,’ recalls John Blanchfield, senior vice president for agricultural and rural lending at the American Bankers Association. ‘That has changed, although there still is the perception that the secondary markets do not look favorably upon rural housing.’
But times have changed, and major banks have taken a big slice of the rural lending market. Jonathan Dienhart, director of published research for Hanley Wood Market Intelligence in Costa Mesa, Calif., took a look at the rural housing markets across the center of the country – from North Dakota south to northern Texas – and discovered Wells Fargo Home Mortgage, U.S. Bank and Bank of America were very active in these areas.
Visitors from Washington
In addition, a number of federal entities also operate in this sector. One of the most successful federal participants is the U.S. Department of Agriculture's (USDA) Rural Housing Service.
‘The USDA Rural Development guaranteed loan program continues to grow in both loan volume and dollars obligated each fiscal year and is a strong performer,’ says Tammye Trevino, administrator of the Rural Housing Service. ‘The guaranteed loan program has an outstanding portfolio of nearly 607,000 guarantees totaling over $67 billion. Private-sector lenders continue to originate guaranteed loans.’
Also in the market is the Farm Credit System. Founded in 1916, it operates both as a government-sponsored enterprise and – through its network of cooperatives and related service organizations – as a mortgage originator.
‘Unlike Fannie, Freddie and the Federal Home Loan Bank, the Farm Credit System makes loans directly to borrowers,’ says Blanchfield. ‘In some parts of the country, the Farm Credit System is a very significant home mortgage lender.’
‘We are a lender to farmers, part-time farmers and rural residents,’ says David Lynn, senior vice president of financial services for Tennessee and Kentucky at Farm Credit Services of Mid-America, a Louisville, Ky.-based cooperative. ‘Our presence in the market helps keep rates more competitive for farmers and agri-consumers. This type of lending is more of a niche market, and we understand it.
‘We are an $18 billion organization with loans to 95,000 customers,’ Lynn adds. ‘Of that $18 billion, about $6.5 billion are loans to residential and small, agri-consumer customers.’
The recession hit Lynn's clientele fairly hard, and his institution saw a decline in residential mortgage activity that did not strengthen again until the fourth quarter of 2011.
‘I can tell you that for the first two months of this year, compared to the same two months in 2011, the dollar volume of mortgages closed has increased 40 percent,’ says Lynn. ‘The main reasons include improving unemployment rates, housing affordability at an all-time high and a surprising increase in new construction – starts for new homes over the last 90 to 120 days have been steadily increasing.’
Another entity helping to keep the mortgage market of rural America liquid has been the Federal Home Loan Bank System, says Blanchfield. ‘Its advanced programs allow banks to pledge their home mortgage portfolios in exchange for lendable funds.’
A community bank that is trying to fund a loan portfolio with just deposits creates an interest-rate mismatch because deposits are short-term and highly volatile. It is difficult to lend for long term with short funding.
‘The Federal Home Loan Bank provides long-term advances that allow community bankers to better match the mortgages they are funding,’ says Blanchfield.
‘We do fixed-rate loans that are sold off to the Federal Home Loan Bank of Chicago,’ says Citizen First's Nottestad. ‘We service all our Federal Home Loan Bank loans, because if there is a problem, the borrower likes to talk to their local community banker. They don't want to have to call New York or Los Angeles.’
Citizen First also does some portfolio lending, Nottestad adds, which is not uncommon for community banks. However, the trend has been toward secondary market participation.
‘If you are a community bank and you want to participate in the secondary market, you need to be two things,’ says Blanchfield. ‘First, you have to be highly efficient, and second, you must have fairly high levels of volume. If you are not efficient and don't have the volume, the secondary market may not work for you. Community banks make a full range of products available, but not all of the community banks are set up to be efficient secondary market participants.’
Rural resales
The other distinctive aspect of rural market lending is the nature of its resale market.
‘In recent years, 90 percent of lending activity has been private, person-to-person resale, and that's quite a bit above the U.S. market overall,’ says Dienhart. ‘Typically, you will get about 10 percent new-home sales, 20 percent real estate owned (REO) property or distressed sales, and then less than 70 percent regular resale. That regular resale is so dominant in these areas is really speaking to the heart of stability in these markets. There's not a lot of new-home activity development, and they don't have as much foreclosure activity as urban areas would.’
Another sign of the stability is the fact that in rural areas, home buyers still opt for a considerable down payment in the purchase process. There wasn't a lot of 5% down and 95% financing in these markets. Indeed, the Hanley Wood data shows striking consistency: From 2005 through 2011, the amount of a transaction financed stayed between 75.60% and 80.69%. In 2011, it was 78.48%.
According to Dienhart, 50.7% of homes purchased in the heartland during 2010 were acquired in cash transactions.
The market is changing, however. According to the Hanley Wood data, back in 2005, 96% of transactions in rural America were regular resale, with 1.9% REO and 1.6% new. In 2011, the regular resale slipped down to 89%, with REO sales jumping to 8.5% and new-home sales climbing to 2.4%.
Hanley Wood also reports that back in 2005, 85% of mortgage loans were conventional, with the Federal Housing Administration (FHA) at 5%, private-party lenders at 9% and U.S. Department of Veterans Affairs (VA) at 1%. By 2011, the conventional mortgage slice of the rural lending market slipped to 71%, FHA climbed to 10%, private-party lenders jumped to 16% and VA loans moved up to 3%.
In 2005, the average transaction price of a home in rural America stood at $114,690. While other areas of the country experienced serious housing price deflation, in rural America, prices climbed steadily, reaching $150,532 by 2011.
On the other hand, some things don't really change that much in the heartland. Back in 2005, the average amount financed for a new home was $121,404. That number declined in the years 2006 through 2010 and rose to $120,335 in 2011.
‘The Midwest ethic of borrowing only what you need and not getting wild has kept us from going in the direction of some of the country's larger cities, including Chicago,’ Nottestad says. ‘Midwest values and work ethic kept us in relatively good shape.’
Steve Bergsman is a freelance writer based in Mesa, Ariz.
