Thursday, June 30, 2011

Betting the Farm: Debt Brings Risk of Losing it All

The risk for farmers is the same as that faced by the U.S. government.
It's not the debt per se, it is the cost of servicing it. Low interest rates seduce borrowers into taking on more debt than they should because the current interest cost is manageable. Should rates increase the proportion of cash flow that must go to debt service can crowd out any other use.

I touched on this problem during the run-up to the 2010 mid-term elections in "For My Republican/Conservative/Tea Party Friends: "Here is where all that Government Spending is Really Going". In a November post, "U.S. Government Debt Service to Surpass Military Outlays by 2016" we had a chart showing Federal interest payments rising from a bit over $200 billion/year to $800 billion, $600 bil. that could go toward productive purposes but instead would be used to keep the collection agency from calling.

From Agrimoney:
Large, young farmers at risk if land prices tumble

A rise in borrowings for buying tractors has raised the threat of agriculture insolvencies if the farmland market collapses, with large operations, and younger farmers, at greatest risk, America's central bank has warned.
The debt-to-asset ratio on farms run by bosses aged less than 35 has already reached nearly 40%, "a level that has signalled significant insolvency risk in the past", thanks to their greater willingness to run up debts, the Federal Reserve said.
The ratio could reach "dangerously high" levels if the farmland market suffers the kind of collapse today that did in the 1980s, the last major correction, when values halved during the decade.
With big enterprises also notable leveraged, "the number of large farmers facing insolvency could more than double, and the number of young operators [facing insolvency] could quadruple", the Fed's Kansas City bank said.
'Risks could intensify'
The bank said that the nature of debt was also behind them categorising large operations, or those with a youthful boss, as higher risk, with non-land loans  - for buying items such as tractors, combines and silos -  forming a bigger proportion of total borrowings.
"History has demonstrated that high debt levels are a concern, but high non-real estate debt levels can be devastating," the bank said.
And loans for farm equipment and machinery had been on the rise, up 73% in the January-to-March quarter, compared with the year before, according to official data.
"The industry's experience from the 1980s farm bust suggests that if the current run-up in non-real estate debt accelerates, the risks for farm bankruptcies could intensify should farmland values turn down abruptly."...MORE
From the University of Illinois' Farmdocdaily:
FOMC Policy: Potential Linkages to Farm Interest Rates
The Federal Open Market Committee (FOMC) met this past Tuesday and Wednesday. The statutory dual mandate of the Committee is to foster maximum employment and price stability. From the FOMC statement: “The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan." The Committee decided to keep the target range for the federal funds rate at 0 to ¼ percent and conditions likely warrant low levels for the federal funds rate for an extended period.

Continuing macroeconomic problems in Greece, a depressed U.S. housing market and disappointing May unemployment data raise concerns that economic growth may slow and be weaker than expected. A key question is whether this is a soft patch and just a temporary issue or is the economy actually at a tipping point with a substantial prospect for a double-dip recession as suggested by Yale economist Robert Shiller.
One implication of recent FOMC policy is the increased probability that interest rates on farm loans will remain low for the next few months. Figure 1 shows that interest rates to farmers are at historically low levels. The average interest rate on loans to farmers from banks with agricultural portfolios greater than $25 million was 3.89 percent in the first quarter of 2011. Almost 50 percent of the loans made to farmers were less than 5 percent while over 75 percent were less than 6 percent.


A potential risk for borrowers is that they became more indebted than they otherwise would have under normal interest rate environments. A general rule of thumb is that interest costs on farms should not exceed 20 to 25 percent of gross farm income. Figure 2 shows that interest expense as a proportion of value of farm production (VFP) has decreased in this decade. The median level for Illinois FBFM is less than 3 percent while 75 percent of Illinois FBFM farms are less than 5.1 percent....MORE

From the KC Fed:
Farm Balance Sheets: The Hidden Risk of Non-Real Estate Debt
(5 page PDF)