The U.S. agricultural economy continues to face mounting pressure and is expected to remain soft through the year, according to Nathan Kauffman, assistant vice president and Omaha Branch Executive of the Federal Reserve Bank of Kansas City.
Kauffman, writing in the KC Fed’s latest Ag Outlook, said U.S. farm income has continued to decline, and is expected to remain low across the country. “Prolonged weakness in the farm sector primarily has been driven by several consecutive years of low crop prices and persistently elevated input costs, while recent weakness in the livestock sector also has been a factor,” he said.
Data from the Federal Reserve Bank of Kansas City’s Survey of Agricultural Credit Conditions indicates farm income in the Kansas City Fed District began to decrease in mid-2013. Since then, more bankers have reported further declines, and the fourth quarter of 2015 was the 11th consecutive quarter of lower farm income in the District.
Among 190 survey respondents, only three bankers indicated farm income was higher than a year ago, whereas 166 reported income had declined. Moreover, 81% of respondents indicated they expect income to be even lower in the next quarter.
The need for financing, and the potential for future financial stress, has continued to increase throughout U.S. farm country. Kauffman says he expects loan demand in the Tenth District to increase again in the first quarter of 2016, which would be the third consecutive year in which lending needs in the farm sector increased relative to the previous year. “Similarly, bankers responding to the fourth quarter survey indicated they expect loan renewals and extensions to continue to accelerate. Conversely, the rate at which loans are repaid at agricultural banks in the District was expected to soften further,” he says.
Strong loan demand
Persistently strong loan demand at agricultural banks has been coupled with reports of increasing use of USDA Farm Loan Programs through the Farm Service Agency (FSA). From 2013 to 2015, FSA loan volumes increased more than 40%. Consistent with bankers’ recent anecdotal reports of increased use, about 55% of FSA funds available for operating loans had already been used from October 2015, the beginning of the FSA fiscal year, to mid-March.
“Bankers noted the increased use is due, in part, to an effort to mitigate risk connected to an increasingly pessimistic outlook for future cash flows,” Kauffman writes.
Pessimism about cash flows and profit margins appears to be the main factor driving the weak outlook in the agricultural economy, whereas interest expenses have remained low. Higher interest rates generally exert downward pressure on farmland values, but other factors also may be important in the current outlook for farm real estate. Specifically, private sector forecasts of long-term interest rates suggest cash rents may need to fall significantly to have a sizable impact on farmland values in the Corn Belt.
Kauffman says there could be some support for lower farmland prices within the current economic situation. In March, the Blue Chip Economic Forecast for the U.S. 10-year Treasury rate was 2.7% for 2017. “The capitalized value of farmland, calculated by dividing cash rents by the 10-year Treasury rate, has tracked rather closely with the actual value of farm real estate over time,” he says.
Applying the Blue Chip Treasury rate assumption for 2017, Kauffman’s estimates shows that a 25% drop in cash rents (equivalent to the largest two-year decline in Iowa during the 1980s) would lead to a farmland value decrease of 18% from the recent peak.
“A drop in farmland values of this magnitude in the Corn Belt would be notable, but it would be unlikely to trigger widespread concerns about solvency in the sector overall,” Kauffman says. “An 18% drop in farmland values nationally, for example, would push the U.S. farm sector debt-to-asset ratio to 16.1 from USDA’s current projection for 2016 of 13.2, holding debt levels constant at levels forecast for this year. This would also be a noteworthy rise in the debt-to-asset ratio but still well below levels observed during the farm bust of the 1980s.”