PR - USING THE FINANCIAL RATIOS ROA AND ROE TO PREDICT FARM LOAN DEFICIENCY RATES

Abstract

Agricultural loan delinquency rates cannot be fully explained just from an examination of farm profitability. During a period from 2009 through 2010 the agricultural loan delinquency rate nearly doubled in the United States, while at the same time farmer profitability was also increasing. Part of this increase can be explained by examining the relationship between the financial ratios ROA and ROE. Whenever, ROA is greater than ROE, farmers are earning a rate of return on all their assets that is lower than their cost of borrowing. We find that the percentage of farms with this adverse relationship of ROA greater than ROE increased prior to the delinquency rate increasing and thus could explain why delinquency rates increased from 2009 through 2010. Because the increase in the percentage of farms with ROA greater than ROE happened several years before it was reflected in the agricultural loan deficiency rate, banks could use this relationship between ROA and ROE as a predictor of when a farm might have a delinquent agricultural loan.

Keywords: ROA, ROE, Lending, Delinquency, Loans, Farmers