Farming, an essential industry segment, is a primary source of our food and related products. Many variables affect farming including, but not limited to, weather, general economic conditions, and government intervention. Farmers are experiencing a phenomenon today that is parallel to a situation that occurred nearly 40 years ago.
The last major crisis in the farm sector unfolded between 1979 through 1986. During that era, farmers suffered from commodity pricing pressures. This was due, in part, to a grain embargo enacted in 1980 by the US against the Soviet Union for their invasion of Afghanistan in 1979. The embargo caused (primarily corn and soybean) inventories to bulge in the US, thereby, eroding the price per bushel that farmers received for those commodities. Also during this period, farm sector debt doubled and interest rates reached an all-time high with the prime rate rising to 21% in December 1980.
The high interest rates combined with depressed farm revenues and the inherent use of leverage by the farm sector created a perfect storm. The Farm Credit System (“FCS”) was providing well over 50% of the capital to US farmers through direct lending as well as through credit support to commercial banks that finance agriculture. The FCS became concerned over the high number of defaults on farm loans and the erosion of collateral values caused by the high interest rates. In a state of panic, the FCS began an aggressive liquidation strategy followed by a period of tighter credit standards. This action resulted in a reduction of up to 60% in farm values in some regions.
Many farmers experienced involuntary liquidations. Income tax liabilities resulted from imputed income related to debt forgiveness. Frequently there were no remaining assets or source of income to satisfy the tax liability.
In 1986, chapter 12 was added to the Bankruptcy Code by the Bankruptcy Judges, US Trustees, and Family Farmer Bankruptcy Act of 1986. This provision was created to protect small farming and fishing businesses. The modification of the bankruptcy code was intended as an emergency response to tightening agricultural credit and a number of notable agricultural bank failures. The modification was originally set to expire on October 1, 1993, but it was extended a number of times without expiring until it was made permanent in 2005.
By the late 1980s, this crisis was fading. Interest rates subsided, trade tensions improved, new markets opened, and ethanol and biodiesel products were developed. The combined effect was a significant reduction in corn and soybean inventory levels in the US. According to Macrotrends, the per bushel price of corn lifted from $1.55 in 1985 to $4.70 in 1996 and $8.02 in 2012. Soybeans lifted from $4.74 in 1986 to $16.71 in 2012.
The rise in commodity prices resulted in higher cash rents paid to landlords and higher valuations for farmland. The USDA reflects an average value per acre for farmland in the US of approximately $600 in 1987 and approximately $3,000 in 2013. Valuations vary by region. For example, Illinois land values rose from an average of approximately $2,100 in 1987 to approximately $8,000 in 2013 according to Southern Illinois University.
US farm income in 2019 remained near lows not seen since 2002, reflecting continued weakness in the prices of crops and livestock. As a result, many operators suffered cash flow issues and struggled to get financing to plant the current year’s crop. Small and medium-sized farmers’ access to capital continues to be primarily in the form of debt. Commercial banks and the FCS became more cautious as bankruptcy filings in the Seventh Circuit (Illinois, Indiana, Wisconsin) and Eight Circuit (North Dakota to Arkansas) were at 10-year highs. As a result, new alternative lenders stepped in to support some operators.
Land is the most stable asset on the farmer’s balance sheet. Land values are impacted by commodity prices, interest rates, and the cyclical nature of farm income. Most operators try to hang on when grain prices are low, hoping to still be in business when prices increase. Efficient farmers with manageable debt levels have the flexibility to stay profitable throughout the cycle, and will not miss opportunities to buy and rent additional acres when they are available at a discount. The smaller, less efficient farmers are feeling the greatest impact of low incomes and tighter lending criteria.
Farmland is a reasonably liquid asset which makes it attractive as collateral to alternative lenders. In addition to owner-operators, farmland is a desirable alternative asset for institutional investors. If farmland becomes available, especially at a slight discount to the local market, it sells quickly. For reasons unrelated to short-term commodity price fluctuations, high net worth individuals and institutional investors buy land. It is considered a safe, long-term investment that diversifies a large portfolio.
The USDA indicated the average value of farm real estate assets (land and its attachments) accounted for over 86% of 2019 farm sector assets. According to the USDA, the average value of farm real estate increased by 7.8% in nominal terms from 2019 to 2021. However, when adjusted for inflation, the national average value of farm real estate assets increased just 1.9% during that period. The Federal Reserve Bank of Chicago indicates that real values of farmland in the Seventh District, home of the nation’s most productive farmland, have risen 23.5% between 2020 and 2021. Average values of farmland are expected to continue to appreciate during 2022.
Farm real estate debt reached $267.9 billion in 2019 and accounted for 63.8% of total farm debt. Farm non-real estate debt decreased by 2.9% in nominal terms to $151.8 billion in 2019.
As farm sector debt is forecast to continue to increase in 2022 and outpace growth in farm assets, the farm sector’s risk of insolvency continues to be at its highest level since 2002. Despite this, liquidity measures that rely on both the balance sheet and income statement have improved temporarily. This is the result of significant inflation in 2021 and 2022 which has impacted farm commodities.
Farm sector profitability measures, which improved in 2020 and 2021, are expected to moderate in 2022. The improvement is due to rising commodity prices, particularly in 2021. However, input costs (seed, fertilizer, fuel) have risen at a more rapid pace during 2022 which is expected to reduce net income.
The farm sector, today, is faced with many of the same issues that plagued the industry in the 1980s crisis such as trade tensions, inflation, pressure on earnings, and record debt levels. A difference in the 2019 cycle is that interest rates are at very low levels and alternate sources of financing have developed. While interest rates are expected to increase, they are not expected to reach the level of the early 1980s.
In 2020, higher commodity prices with only moderate input cost increases created relief for many farmers and conventional lenders. Continued inflation during 2021 and 2022 has significantly impacted farmland values, farm equipment costs, and farm input costs. The resulting pressure on earnings for many farmers will be difficult to handle. Therefore, the need for alternative lenders that have more flexibility to cope with leverage and operating losses is expected to grow.
This is an updated version of an article originally published on June 17, 2019]
©2022. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
David Onion is CEO of Chicago Capital Holdings. Chicago Capital collaborated with Mitch Kasper, founder of two successful agricultural land investment funds, to create Ag Financial Partners, LLC which offers a bridge loan product for distressed farmland. Onion has over 40 years of lending and investing experience. He began his career as an agricultural lender…
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