Agricultural Finance Review

Purpose – This paper aims to identify factors that affect agricultural mortgage default and prepayment.

Design/methodology/approach – Using a sample of farm credit system loans, prepayment and default are modeled as competing risks with potentially non-stationary covariates using a statistical/econometric technique called survival snalysis (SA).

Findings – The analysis suggests that the primary drivers of prepayment and default are the rate of interest charged by the lender at origination and the borrower's current ratio at origination. Tests of the existence of a geographic effect indicate that despite bank management belief to the contrary, branches may not be homogeneous.

Research limitations/implications – This analysis would be improved if more data were available in an easily obtainable manner to control for unobserved heterogeneity. Unobserved heterogeneity or incomplete specification within a model can be problematic. Inferences among regression coefficients can be problematic in that the estimates have inflated variances and unreliable test statistics. In addition, more frequent measures of the time-varying covariates could be obtained to improve upon the SA models presented above. Future analyses could also incorporate other sections of the agricultural credit association portfolio, as well as a comparison to variable rate notes. One other logical next step would be to obtain loan collateral values to obtain estimates of the exposure at default, and the loss given default, or the estimates needed for the advanced internal ratings based approach described in the Basel Accords.

Originality/value – This paper provides a method for lenders to measure and model mortgage termination, an important consideration for risk managers when determining capital adequacy described in the Basel Accords.