Planting in the red in hopes of '15 green
By Mikkel Pates
It might not be a return to the 1980s credit crisis, but another ag lender survey shows a yellow light for “slow” in the region’s agricultural pace heading into 2015.
A preliminary summary of a recent Federal Reserve Bank of Minneapolis quarterly report says the financial condition of agricultural producers continued to decline in the third quarter of 2014 — continuing trends from the August report of the second quarter. The report area includes North Dakota, South Dakota, Minnesota, Wisconsin and Montana.
“The picture is mixed, as livestock and dairy producers benefited from high output prices, while farmers suffered from falling crop prices,” says Joseph Mahon, an economist and analyst for the Minneapolis Fed.
Around the Ninth District, 69 percent of respondents in a survey of ag lenders said farm income had decreased in the three months from July to September, compared with the same period a year earlier, while 63 percent reported decreases in capital spending and 27 percent said farm household spending had fallen.
“Consistent with falling incomes, nearly a third of lenders said loan demand increased from a year ago, 30 percent said the rate of loan repayment fell and 26 percent said loan renewals and extensions increased,” Mahon says. “However, 62 percent of lenders still reported that loan demand was unchanged, while collateral requirements and referrals to other lenders were unchanged, as well.”
Interest rates had barely changed, Mahon says, while no lenders reported refusing or reducing loans because of a shortage of funds.
The outlook for the Ninth District is weak. The survey says 81 percent of lenders expect farm incomes to fall in the final quarter of 2014, while 77 percent expect capital spending to decline and 49 percent expect household spending to decline further. Fifty-three percent expect loan demand to increase, while 44 percent expect increased renewals or extensions and 48 percent think repayment rates will decline.
North Dakota State Sen. George B. Sinner, a senior vice president of ag business banking at American Federal Bank in Fargo, N.D., says the drop in commodity prices and the potential strengthening of the dollar is reminiscent of the 1980s.
Sinner, who ran unsuccessfully for Congress, says this year’s large crop will be the “saving grace” for many farmers, but most he’s talked to “are going to see some red ink and a lot of heartburn with bankers this winter because of the prices and the lifestyle to which a lot of these guys have become accustomed.”
Nationally, agricultural lending rose further in the third quarter, according to Nathan Kauffman, an Omaha branch executive at the Kansas City Federal Reserve, which is responsible for a corresponding national survey analysis.
Loans to livestock producers rose alongside sharply higher feeder cattle prices, and operating loans for working capital for grain farmers rose because crop prices have dropped to their lowest levels in five years, says Kauffman, with co-author Maria Akers, associate economist. Meanwhile, the U.S. Department of Agriculture pegs corn carryover up 68 percent from the same period a year ago.
“Although debt levels have continued to rise, profitability in the livestock sector, expectations of record yields and revenue support from crop insurance are likely to help lessen the drag on farm income from low crop prices this year,” Kauffman and Akers wrote in a Nov. 7 analysis. “However, depending on the direction of commodity prices and production costs, concerns about lower farm income and rising debt levels could intensify in 2015.”
Farmers seem to be shifting toward short-term financing and away from intermediate-term borrowing, the authors say.
“Many farmers had upgraded equipment and added on-farm storage capacity in recent years, taking advantage of high farm income and generous tax incentives,” they say.
In a recent meeting of the American Banking Association in Omaha, Jason Henderson, associate dean and director of Purdue Extension, told bankers that farmers with high-quality Indiana farmland lost a small amount of money in 2014 and can expect to lose more than $150 an acre in 2015, even with a slight decline in cash rents. The 2014 crop year will turn out OK for most farmers, he says, but tougher times will come in 2015. He notes, however, that “good managers will be very successful.”
Independent trends are sobering. USDA projections indicate negative returns to corn producers in the U.S. through 2019. Henderson says crop insurance no longer guarantees comfortable margins.
Through August 2014, combine and tractor sales were 14.4 percent and 17.3 percent below 2013 levels, respectively, according to the Association of Equipment Manufacturers.
On the plus side, booming livestock profits are expected to continue, and positive signs include the increases in world populations, emerging economies and purchasing power. The debt relative to income remains very strong in the agricultural sector, but farm debt is rising and debt is somewhat concentrated. Farmers have increased proportionately their debt in real estate in recent years.
Henderson says low crop prices will hit some groups first.
“Young and beginning farmers. Livestock versus crop farmers,” he says. “Any crop farmer that did OK in the last seven years. Anyone who’s purchased land, equipment or acquired land at high rents — alpha dogs and alpha pups.”
Brent Gloy, an agricultural economist, former Purdue professor and farmer from Grant, Neb., predicts farmers will survive but rents won’t adjust enough to guarantee profitability. Rents are “sticky” and won’t adjust downward fast.
“The margins are going to be really tight, and some of them will have losses,” he says.
Gloy and Henderson say U.S. farmers saw increased input costs of 8.7 percent in 2011, 9.2 percent in 2012, and estimated increases of 3.3 percent in 2013 and only a 1 percent decline in 2014, despite lower returns.
David Kohl, professor emeritus at Virginia Tech, tells lenders they need to encourage borrowers to increase business and nonbusiness revenue, and decrease expenses, including family living, and restructure debt service.
Kohl says the big factors in the coming years is a slowing of emerging nations’ economies, a softening of the ethanol and biofuels mandates, the central bank stimulus, the inefficient infrastructure in emerging nations and weather vagaries in the northern and southern hemispheres.
He says the “easy money” has been made in the grain industry but agrees with Henderson that “top flight managers” will continue to earn profits. He notes farmers are in a game of chicken with landlords over rent levels.
Looking at the national scene, Allen Featherstone, an agricultural economist from Kansas State University, said there is more debt out in the country than is generally acknowledged.
Farmland prices were susceptible to two boom-bust cycles in the past century — the 1920s and 1930s, and 1973 to 1986. He says the drivers are economic shocks that justify higher land and commodity prices, and then increased use of leverage and a “herding effect” on the way up and then the way down.
“The herding effect gives you higher highs, and then lower lows than would be justified in the market,” he says.
Featherstone says national survey results indicate ag lenders and commercial bankers are expecting land values to decline in the next two to five years. Forty percent more lenders think real estate interest rates are going up then down in a one-year outlook and 80 percent expect them to go up in the next two to five years. Bankers see similar trends for operating interest rates, Featherstone says.
Increases in interest rates would hit farmers the hardest in the strengthening of the U.S. dollar and the tightening of the export market, Featherstone says. With the reduced interest rates, farmers are paying off their loans more quickly, and a higher percentage goes to principal versus interest rates, which is a positive factor. He says farmers have done a better job of protecting themselves from interest rate moves by using longer-term fixed interest loans.
Farm debt levels jumped more in 2013 than in previous years, up 9 percent from 2012, which was up 6 percent from 2011, Featherstone says. Farmers will be able to pay their interest and debt for awhile, he says.
“The default risk is low, but it was in 1979,” Featherstone notes. “The debt-to-asset is lower in 2013 than in 1979.”
The average period before real estate loans defaulted in the last cycle was 5.6 years.
In the last bust, the inflation-adjusted interest rate was 2.41 percent, while the average interest rate cost is 3.47 percent for loans made in 2012 and 2013. So today’s “real interest rate” is higher than in the past.
“The nominal cost is lower, but the real cost is higher,” Featherstone says. “Amortized loans at lower interest rates pay more principal early in the loan, reducing the possibility of loans going underwater.”
Featherstone says crop insurance revenue guarantees reset each year and offer less protection than perceived.
“If the price continues to drop, the guarantees drop,” Featherstone says. “The farmer has to manage more risk for the 2015 crop than he would have for the 2013 and 2014 crops, simply because those guarantees are going to be lower.”
The guarantee is 10 percent lower for both soybeans and corn, he says.
Farmers will take a loss before the government programs kick in.
“Most farmers are pretty good for a one-year situation, but if they’d end up with a couple of years of loss in a row, the liquidity they have will disappear pretty quickly,” Featherstone says.