Credit crunching farm style
By Nancy Jorgensen

Able to stave off the early rounds of economic downturn, will the ag economy follow commodities on a slide?

Today’s Farmer talked to a team of agricultural lenders about how the credit crunch will affect farmers. Generally, they predict it won’t have a huge impact. Still, our team says you may experience more scrutiny on cash flow at a time when margins are tightening. You may also face higher interest rates over the long term. Read on to learn what you can do to attract credit.

1. How has the credit crisis affected farm lending?

Oldvader: The crisis hasn’t had a major impact on farm lending at this time. We have access to debt capital, and we will continue to fund loans as needed. Some larger agribusinesses could find it more difficult to obtain capital, and we’re seeing higher interest rates on long-term loans. Until now, the yield curve was relatively flat—that is, longer-term interest rates were not much higher than short-term rates. As the Federal Reserve Bank tries to bring credit stability to the market, short-term interest rates may actually go down in the near future, while the gap between mortgage interest rates and operating loan rates will widen.

Bodenhausen: The primary effect will be a more careful and probably conservative cash flow analysis as a result of the large variations in commodity prices and the considerable increase in input expenses. The situation is so volatile at this time that it’s difficult to speculate on interest rate movement. Short-term interest rates will likely be slightly lower for the coming production year. Longer-term rates will stay steady or increase as government infusion of capital into the monetary system will potentially result in inflationary pressure on the economy.

Coons: Our bank has always maintained conservative underwriting practices. While our regulator only requires a 6 percent capital position, we maintain 12 percent. We’re in good shape, and this crisis won’t have a big effect on us. I went through the ag crisis of the 80s, and I learned that there’s a reason we have rules. But the crisis affects everyone to some degree.

2. Has your bank been affected?

Oldvader: Government intervention in the banking industry has been helpful in providing some stability to the current financial dilemma. Any action to take the emotion out of the market has value to the ag lending community. However, we are naïve to think that as we fly into this storm, we won’t be impacted. We don’t know all the repercussions, but we may see more regulation, more disclosure requirements, and borrowers may have to provide more information.

Bodenhausen: There’s been little effect on us at this time. I see no way we will benefit from government intervention except from restored public confidence. The primary impact on community banks will be an increase in the cost of providing Federal Deposit Insurance Corporation (FDIC) coverage for our customers’ deposits, and probably increased regulation. We have not experienced any erosion of funds out of concern for safety of deposits.

Coons: The banking crisis actually led some people back to us. It’s built trust in community banks, and we’ve seen an increase in deposits. Intervention in the large banks will significantly increase our FDIC premiums, which will affect our profits. We base our interest rates on our cost of funds, and that will drive up rates. Also, home mortgage lending may be more challenging as we try to determine home values.

3. How can ag producers attract financing?

Oldvader: You need to provide complete financial information, including an up-to-date balance sheet showing assets and liabilities; tax records to establish historical earnings and expenses; and a business plan that includes marketing strategies along with income and expense projections. It’s crucial for producers to know their break-even point today. You should also consider risk management tools such as crop insurance and revenue protection. Additionally, producers should take a strong look before planning capital purchases—the current environment is not conducive for purchases like large equipment. Farmers generally require two types of financing—organic, which funds current operations, and expansion. We’ll see organic financing needs go up, but less financing for expansion. A lot of farmers took higher incomes seen in the last two years to make capital purchases, so hopefully they can ride out the storm in this area. We have a very astute customer base, and we’re seeing farmers becoming more conservative, pulling in their horns.

Bodenhausen: Risk is increasing as we deal with higher input costs and volatile commodity prices. Farmers need to continue to improve their business skills with regard to cash flow analysis and to understand their coverage ratios at various commodity price levels.

Coons: First and foremost, cash flow. Do you have the ability to pay your bills? When it comes to buying land, can you afford to make your payments if you have a crop failure? You need reserves such as crop carryover. We’ve seen land sell around here for as high as $4,000 an acre—there’s no way to farm that much out of the ground. In addition, farmers have to keep interest as a percentage of expense in line. In the 80s, we saw farmers with 18 to 30 percent of their expenses going toward interest; we like to see that stay in the teens. Also, marketing savvy is a big concern. Many customers have used futures and hedges to lock in prices, but it’s more difficult these days, especially with the huge margin calls we’re seeing. I see a lot of farmers reach a profitable price for their crop, but pass it up waiting for the high. You should know your cost of production, and try to lock prices that will assure a profit. Most of our customers use crop insurance, and they’re using it more than in the past. Now revenue protection is available, too. Look for ways to trim costs without trimming yields.

4. Will it be difficult for farmers to get seasonal credit in the spring?

Oldvader: At Farm Credit, we have been financing agriculture for more than 92 years, and we understand the cycles in agriculture. We don’t change our policies every year. Input suppliers and processors, however, may not be able to attract the capital they need to extend credit to their farmer customers as they have in the past. It’s not so much whether they can get financing, but how much it’s going to cost. We may see them stay within their core business and closely monitor accounts payable.

Bodenhausen: I do not think it will be a problem in our area.

Coons: Our standards haven’t changed, but the situation for some customers has changed. Most of our customers have had some loss to rainfall this past year. This year will test whether crop insurance will come through.

5. What’s your forecast for farm profitability?

Oldvader: Generally speaking, 2008 will be a good year for production agriculture. Most of the income, however, came from crops. The livestock industry did not enjoy that feeling of prosperity. Forty percent of our loan portfolio is dedicated to the livestock industry, so it’s a very important segment to us. Larger farms are becoming more specialized, but the majority of our customers still handle both beef cattle and row crops. It doesn’t take a rocket scientist to see tightened margins ahead for 2009. Lower commodity prices will create some breathing room for livestock producers. Input costs are going down, reflecting softening energy prices. However, it will take time for that to filter through the producer’s income statement. If you go back 10 years, U.S. net farm income averaged $55 to $60 billion, compared to $92 billion projected by USDA for 2008. We may find our way back to more historic levels.

Bodenhausen: Early indications are that most operations will have very good profits. Grain will be better than livestock.

Coons: Our crop profits were the best ever in 2007, and farmers carried some of that crop over into 2008. The problem is, for 2009, the carryover won’t be worth as much, and they’ve already paid high input costs. The cattle industry is already struggling. But I try to stay away from forecasts; I used to be a farm broadcaster, and my boss always told me I was better at reporting the markets than predicting.

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