Business is good at most ag banks these days. The last year has seen some of the sharpest gains in profitability of any commercial banks in the country, according to a new report.

Despite increases in regulatory costs, which are higher for smaller banks after the passage of Wall Street and consumer protection regulations passed in the last year, profitability was higher for agricultural banks in the second quarter (1.13% rate of return on assets) than it was for all FDIC-insured banks (0.85% ROA), according to University of Illinois ag economist Paul Ellinger.

"Profitability at agricultural banks has exceeded all banks and banks concentrating on commercial or mortgage loans through the financial crisis and economic downturn," Ellinger says. "Moreover, 96% of agricultural banks were profitable in the second quarter of 2011. This level of bank profitability has increased from a low of 61% in the second quarter of 2009."

Through the recession and economic downturn, banks have seen problem loans skyrocket. Ellinger says that hasn't been the case in the ag lending sector, though. Though there are still more than there were before the downturn, there are fewer than half the problem loans at ag banks than commercial lenders.

Though stability like this is good for the ag lending sector now, it could come back to haunt banks down the road, Ellinger adds. The main reason ag banks are so healthy now is the strong profitability of their customers. And, because of that, borrowers are paying on loans at almost record-high levels.

"Improved borrower profitability has also presented a challenge for many lenders in agriculture. Borrower repayment rates on agricultural loans have remained high and deposit levels at banks have increased. Loan-to-deposit levels at agricultural banks have dropped significantly since 2008," Ellinger says. "Given that growth in loan demand has slowed and returns on federal funds, government and agency securities are at all-time lows, profit margins at banks will likely decline.

"The profitability of agricultural sector has certainly contributed to the improved profitability and strong loan portfolios at agricultural banks," he adds.