“History doesn’t repeat itself, but it sure does rhyme.”—Mark Twain
Farm booms always end.
How they end is the concern.
So said two Purdue ag economists, one of them quoting Twain as above, when reflecting on the long stretch of good times that American farmers—and ag bankers—have enjoyed. They made their comments during a presentation at ABA’s recent National Agricultural Bankers Conference.
Of the most recent complete cycles, two ended disastrously, noted Brent Gloy, professor and director for Purdue’s Center for Commercial Agriculture. The first disaster: the boom that ended in the Great Depression, and the second, the one that led to the ag crisis of the 1980s. The latter produced a “lost generation” in ag country where potential farmers sought work elsewhere.
Many of today’s farmers—especially the youngest—don’t appreciate how strong the last seven years have been, nor how abruptly and severely things can change, said Gloy. He and his fellow speaker, Jason Henderson, associate dean and director of the Purdue Extension, already see signs of a softening ag economy. The question may not be so much, will things slow down, as, will they level off? Or will they plummet?
While the two speakers concluded with an upbeat message and hopes for a plateau and not a plunge, they gave listeners plenty to worry about.
Too much money
In today’s low-rate environment, with many banks flush with deposits, much credit is available, said Gloy. “When there’s lots of money, you tend to get sloppy,” he said. He warned bankers to pay closer attention to customers’ financial risk practices.
Henderson said that Iowa land prices had risen 400% over the 1970s. By contrast, in the current boom land there has risen only about 300%. However, he pointed out, the recent rise has been at a time of low inflation and low interest rates.
Gloy also said that a typical ag cycle warning sign, which he’s seen, is customer movement away from borrowing directly for the farm and moving towards borrowing for “lifestyle” purposes. The latter includes items such as widespread purchases of recreational vehicles and other sources of fun and entertainment.
Challenge of tapering ethanol boost
Henderson and Gloy marshaled both statistical and anecdotal data to make their case that the latest ag boom is on its way out, and that farmers and their bankers face risks ahead.
During the run-up in land prices, for instance, many lenders have spoken of the deals being done for cash on hand, rather than on credit.
Henderson questioned whether cash still dominated, citing data from FDIC and call reports that indicate a rising level of farm real estate debt in recent quarters.
“If operators have all this cash,” he asked, “why then is farm real estate debt increasing?”
The economists believe rising requests for ag land financing indicate that the cycle is heating up.
Additional acreage continues to enter the production stream, and additional acres rarely disappear. Henderson said farmers typically have the attitude of “If you grow it, they will eat it.” However, he asked, “at what price?”
Part of the reason for the run-up in land prices has been the rising price of corn, which nearly doubled over the last ten years. However, ethanol production was a major force behind that rise, the economists pointed out, and the pressure from that need is flagging, according to statistics they cited.
From 2005 to 2010, an average of 689 million bushels had to be added to annual production to meet demand for ethanol. But it’s now estimated that only 215 million more bushels annually, on average, will be necessary to meet ethanol-based demand.
From 2015 going forward, the need for corn to produce ethanol is projected to level off. Indeed, Henderson suggested that in the absence of any legislated increase in ethanol production, corn farmers would be fortunate to hold onto the demand that they serve now.
Impact of corn on land prices
In the absence of rising demand for corn for fuel, where will demand for corn come from? Henderson suggested that would depend on what the “next China” is.
“Is it India?” he asked. “Is it Africa?” Some market must pick up in order to keep demand growing.
Rising corn prices have played a major part in driving up the price of farm land. An impact of this has been a shift in farmers’ production cost structure. Using Purdue figures from Indiana farms, Gloy showed that land and other fixed expenses now exceed variable costs.
Henderson pointed out that the Agriculture Department projects only modestly rising export growth over the next few years. Gloy said that already the Agriculture Department has projected that net farm income will fall to historical levels.
Most farm borrowers are in decent shape currently, said Gloy.
However, if net farm income falls, and current levels of debt continue, lenders have key questions to confront: Will farmers roll back their investments? Or will they ask banks to roll over their loans? If the banks agree, how many years will they be willing to roll the loans for the farmers?
Henderson worries that the current ag picture has started to resemble that of the late 1970s, when farmers planted from fence row to fence row. The economists worked through several scenarios that could lie ahead, including one where farmers will allocate more and more of their revenues to rents from landlords.
At some point, this could make their take-home look like “paying to go to work,” Henderson suggested. “Farmers will get tired of that really fast.”
Warning signs to watch for
If income falls, as projected, Henderson said, the next question is which will adjust more quickly, farm revenues or the costs of production? He said it is an open question whether farmers’ liquidity or their solvency would be impacted first. Typically, he said, liquidity slips first, but that might not be the case this time around.
One factor that could lead to a liquidity crunch is the fact that many farmers did use their own cash to buy additional land. Gloy pointed out that nearly 90% of a typical farmer’s asset base consists of land. Thus, as they put their cash into land, farmers have been pulling down their liquidity.
On the other hand, Gloy said, some of the real estate that farmers picked up during the boom was overpriced. As a result, banks that made loans based on such collateral may face a crunch as land prices fall. Conservative loan-to-value ratios will become less so as prices fall versus outstanding credit secured by the land.
A concern is that younger farmers have been especially aggressive, having known only seven years of strong results. If they have to tap “the National Bank of Mom and Dad,” liquidity issues could spread.
Another factor, besides the impact on land, are liberal policies equipment dealers have had for farmers obtaining new machinery. Gloy said “the appreciating tractor” has been seen among dealers, where they take trade-ins at values higher than machinery was sold for when new, simply to keep business flowing.
This practice denied reality, said Gloy: “Equipment deteriorates—that’s just economics.”
And, going back to land, Gloy said that two of the typical approaches used for appraising farm land can be flawed. These are the income approach—appraising based on what the land can make for a farmer—and the comparable sales method—which looks at the prices for recent sales of similar parcels. Gloy said both approaches tend to lag the markets—both tend to look backward, at crop prices or land prices—and thus also tend to accentuate trends already seen in the markets.
As a result of this, said Gloy, “take collateral values with a grain of salt.”
Warning signs to watch for
While both economists attempted to remain upbeat, hoping for a soft landing as the boom deflates, they gave bankers five places to watch as conditions cool. Gloy pointed out that even if the turndown is mild, conditions will be different because the previous seven years have been so strong:
1. Highly leveraged farms, farms with an abundance of recently purchased land. They also warned bankers about farmers who try to leverage their long-term assets to build working capital, without making any adjustment to their growth strategies nor to their lifestyle expectations.
2. Poorly managed farms.Such farms may have adequate financial strength today, but that could change as deteriorating conditions knock out some of their underpinnings.
3. Long-term cash leases and other off-balance sheet financing. In addition to such factors, which may not have been obvious earlier, the economists pointed out that farmers are known for using various methods to postpone tax liabilities. Such costs could hit in the down cycle.
4. Equipment dealers and other input suppliers. Their fate very much hinges on the fate of their farmer customers.
5. Main Street. Like the dealers, any farm community’s economy ties in with that of its farmers. How far the ripple effects will go remains to be seen.
Good managers will manage through down cycles, the economists said. However, they warned that bankers need to be judicious as credit is called for. Pouring in too much credit can magnify market impacts.