Farm Economy Continues To Tighten

July 24, 2016

Written By Adam Buckallew

It wasn’t long ago that U.S. farmers were enjoying booming business as farm incomes for row-crop producers swelled from 2007 to 2013, propelled by record exports and strong demand for biofuels. Now on the other side of the coin, many farmers are faced with commodity prices that will make it a challenge to simply break even.

The U.S. Department of Agriculture (USDA) projects farm income to fall for the third straight year. Farm profitability has plunged to its lowest level since 2002 and the second-lowest total in more than 30 years. The USDA projection calls for farm income to fall 56 percent from its peak of $123.3 billion in 2013 to below $55 billion this year.

“Momentum in the farm economy has shifted over the past three years,” says Jeff Houts, executive vice president and chief operations officer for FCS Financial. “Farm receipts are projected by USDA to continue their downward trend although at a decreased rate of decline. With the shift in overall income trend in a downward slope, a transition period is created where many questions lead to varying levels of uncertainty in decision making for farm producers and supporting agribusinesses. Commodity price decline has made the overall size of the pie smaller. How the pie is sliced and whether it will satisfy the corresponding appetite for that related piece of the integrated ag economy is yet to be determined.”

Economists at the Federal Reserve Bank of Kansas City observed the ag economy continued to weaken in the first quarter of 2016 and expect it to remain soft throughout the year.

“The weakening has been relatively gradual over the past few years, but it has been persistent and has intensified in recent months amid mounting financial stress for some agricultural producers,” the Kansas City Fed says. “Future cash flow appears likely to remain a top concern for producers over the coming year as agricultural credit conditions, and the path of interest rates, evolve.”

The Road to Lower Prices

Why have corn and soybean prices fallen so much in recent years? The short answer is supply and demand. U.S. farmers planted record-breaking soybean crops in 2014 and 2015. Likewise, the United States has produced its three largest corn harvests the past three years. Unfortunately, crop production in the United States has expanded faster than consumption.

Cortney Crowley, an economist with the Kansas City Fed, says, on average, U.S. inventories of corn, soybeans and wheat have increased more than 100 percent since 2013, while consumption has increased just 7 percent over the same period.

“In addition to stagnant domestic demand, softening global demand and growing competition are hampering U.S. exports of agricultural products,” Cowley notes.

While U.S. farmers have been busy harvesting record crops, their counterparts in South America and the former Soviet Union have been steadily increasing their production to near-record levels. This has pushed worldwide stockpiles higher and put downward pressure on crop prices.

At the same time, the value of the dollar has risen, making U.S. agricultural exports more expensive in comparison to those of Brazil and Argentina. This has created trade headwinds, and USDA forecasts 2016 agricultural exports at $125 billion, $14.7 billion less than those from 2015.

Challenges Ahead

Despite the depressed levels of commodity prices, the cost of seed, fertilizer, herbicide and other inputs have been slower to fall. The elevated production costs are keeping farm profit margins tight, and in some cases, breaking even may be the best farmers can hope for. Consequently, farm income is expected to remain low through 2016 while farm debt grows.

The Kansas City Fed issued the results of its first quarter Ag Credit Survey on May 12. The survey shows growing concerns about the agricultural economy among bankers in the Fed’s Tenth District, which encompasses Colorado, Kansas, western Missouri, northern New Mexico, Nebraska, Oklahoma and Wyoming.

Respondents to the survey indicated poor cash flow prevented many borrowers from paying off loans from the previous year, causing them to carry outstanding debt into the first quarter. The number of farmers with more carry-over debt than a year earlier increased from 18 percent in 2015 to 29 percent in the most recent quarter. Moreover, bankers noted that more than 18 percent of loans made in the first quarter involved restructuring existing debt to meet short-term liquidity needs.

Loan-repayment rates have fallen for the 10th consecutive quarter, which the Kansas City Fed says is the longest run of deteriorating repayment rates since the early 2000s. While farm loan delinquency rates remain low, growers with significant debt may face continuing stress.

“This most recent uptick in loan demand may be more concerning because it has coincided with a period of falling repayment rates, softening farmland values and increasing collateral requirements,” the Kansas City Fed reports.

Houts acknowledges the difficult financial conditions farmers are facing but thinks change may be coming sooner than expected.

“Some agricultural businesses have already or are in the process of making adjustments which will support enhanced profit opportunities in this changing environment,” Houts says. “Many believe multiple years of challenge lie ahead of us. Rate of change is on a strong and continuing trend of acceleration. I feel this acceleration in rate of change will support a positive correction sooner rather than later based upon the strong fundamental demand position held by agriculture in the world economy.”

Although financial stress has continued to increase throughout the U.S. farm economy, Houts does not foresee the development of a farm crisis like the one seen in the 1980s.

“It appears to be a substantially different situation, and as such we shouldn’t see the same outcomes,” Houts says. “The interest rate environment associated with the debt capital required by capital-intensive agriculture is lower and appears more stable. The overall economic situation and rate of inflation is substantially different now when compared to those factors during the 1980s. Access and availability to information and the tools supporting management of the farms and ranches is historically unprecedented.

The present situation with transparency of information and the tools to support changes in operating structure and strategy are at a level producers during the 80s could only dream about.”

Managing Risk

Although outright defaults in the farm sector have been limited to date, Nathan Kauffman, assistant vice president of the Kansas City Fed and Omaha branch manager, says some producers could face difficulty financing their operations in the coming year.

“Banks are taking proactive measures to reduce risk by increasing the amount of farm real estate used to collateralize large non-real estate (operating) loans and raising interest rates slightly. Though farmland values have remained relatively strong, a poor outlook for cash flow could continue to pressure a larger share of farm borrowers in the coming year, particularly those most highly leveraged,” Kauffman says.

Houts says there will be some farmers who are better prepared than others to weather the downturn in commodity prices.

“Liquidity is a welcome and powerful tool in uncertain times,” Houts says. “Farmers and ranchers who are highly leveraged especially in financial or operational areas where material adjustments have and are already occurring (i.e., high capacity equipment, more marginal production land financed or rented) can be more vulnerable. Overall, the financial leverage of the farm sector is well-positioned. Leverage will trend higher for many, and those already carrying above-average leverage will need to aggressively manage to ensure future sustainability.”

In these turbulent times of financial stress, Houts says it is imperative that farmers have a firm grasp of balance sheets and related data.

“Know the strengths and weaknesses of your operation and don’t rely on generalities,” Houts says. “Know your breakeven and what operating strategies provide your business the best risk/reward balance. Gathering and documenting the facts of your specific business empowers you to eliminate many of the uncertainties which you can control. Facts empower management and provide a level of internal confidence which supports good decision making in externally uncertain times. Strong liquidity provides management flexibility. Operating decision anchor points like ‘break even’ and financial fundamentals are powerful in all economic scenarios.”