Evaluating Alberta cattle feeders’ loan guarantee program

Abstract

Purpose – The purpose of this paper is to evaluate Alberta’s cattle loan guarantee program. It measures the risk premiums on lending that would accrue to banks participating in the program, estimates the value (price) of the loan guarantee, and estimates the interest subsidy provided by the program. Design/methodology/approach – A cash flow model of cattle feeding is used. The model estimates a measure of risk that is applied to option pricing models to estimate the value of the guarantee. Findings – Insurance premiums for the credit risk to lenders are 0.20 percent of the value of the loan for the entire feeding period, and 0.41 percent for backgrounding but negligible for finishing. The price of the loan guarantee estimated by the Black-Scholes model is 4.43 percent of the value of the loan and is comparable to prices estimated by the binomial model. The program provides a subsidy rate of 4.58 percent. Research limitations/implications – Charging a guarantee fee can potentially eliminate the interest subsidy inherent in the program. But this would necessitate determining the impact of the guarantee fee on the additional access to credit that has been achieved through the program. Practical implications – Different levels of risk for backgrounding and finishing imply different risk premiums on cattle loans. Therefore interest on cattle loans should reflect not only the individual farmer’s risk profile but also the nature of the feeding operation. Originality/value – This is the first paper to simultaneously estimate risk premiums on cattle feeding loans, the value of the loan guarantee provided by the Alberta Feeder Association Loan Guarantee Program, and the inherent interest subsidy.