Commodity Price Declines, Fluctuations Create Changes In Farm Financing

“Record prices, record profits, and the most lucrative times those in agriculture have ever seen.”

That’s been the headline farm story in recent times, peaking in 2013. But, the past year has seen changes.

Crop prices have declined, and cattle prices have fluctuated down before coming back up some, causing alarm among producers, and certainly their creditors.

Jim Aylward, vice president of lending for Frontier Farm Credit headquartered in Manhattan, discussed “Financing In Changing Times” at the recent Farm Profit Conference hosted by 580 WIBW Radio at Rossville.
Jim Aylward, vice president of lending for Frontier Farm Credit headquartered in Manhattan, discussed “Financing In Changing Times” at the recent Farm Profit Conference hosted by 580 WIBW Radio at Rossville.

While lower fuel prices have presented some relief, most other inputs for agriculture producers have remained at or near peak levels.

“The latest report shows that one third of the acres planted to corn and soybeans last year lost money. That’s a huge turnaround from 2013. How does that affect the future and those who loan money to farmers?” asked Kelly Lenz, 580 WIBW farm director as he introduced the lead speaker at a Farm Profit Conference in Rossville.

Jim Aylward, vice president of lending for Frontier Farm Credit headquartered in Manhattan, instantly acknowledged, “The landscape in agriculture is definitely changing.”

Nearly 200 farmers from eight counties were all ears intently concerned as Aylward continued in his power-point guided presentation: “Financing In Changing Times.”

There is considerable more commodity price volatility, as daily changes typically a few cents, now are dollars, specifically for livestock.

“Profit margins for both corn and soybeans have narrowed, as land prices have increased both to rent and own, while equipment investments are also the highest ever,” Aylward said.

Advantageous to many farm producers, there has been increased technology to help assure profitable production, but at the same time the government has increased regulations, generally adding burden back to the farmers.

A U.S. farm income graph showed net farm income at about $50 billion in the year 2000, down to about $40 billion in 2002, moving up sharply to about $90 billion in 2004, and back to about $60 billion in 2006.

Income was up and back down, during the next four years, until a notable climb started in 2009.

Net farm income hit about $120 billion in 2012, dropped slightly the next year, and then jumped to about $130 billion in 2013. “The scary thing is that farm income plummeted to about $100 billion in 2014,” Aylward evaluated the graph.

“CAP Rate” is calculated as the ratio between the net operating income produced by an asset, and the original capital cost (price paid to buy the asset), or alternatively its current market value.

A chart, shown by Aylward, indicated that “CAP Rates” in Jackson, Jefferson, Osage, Shawnee and Wabaunsee counties, which had the largest representation at the conference, have gone down in that past ten years. The five county average of 2.82, had deteriorated to 1.6, in 2014.

Average pasture values in Kansas peaked in the second quarter of 2013, at $2,415 an acre, with three sales represented in the report, but had dropped to $1,714, in 16 sales, by the second quarter of 2014, rising slightly by year’s end to $1,845, from three sales.

State pasture value average in the first quarter of 2011, was $1,438, from six sales, with lowest point on the graph, the third quarter of 2011, at $1,206 an acre, from 12 sales.

Sharper swings were revealed in Kansas’ average cropland values during the same period. Lowest average was recorded in the second quarter of 2011, at $1,887 an acre, for seven sales, with the highest average in the fourth quarter of 2013, at $3,113, from seven sales. The second quarter of 2014, had dropped to $2,359 an acre for six sales, the last recorded average on the chart.

Looking back over recent years, Aylward evaluated, “There has been record net income with extraordinary profit margins per acre, putting farmers in strong cash positions. So, they’ve upgraded equipment lines, and perhaps some farmers are over equipped, in an effort to defer income taxes.”

Likewise, farmers have prepaid long term loans, further attempting to defer taxes, and consequently they’ve chased land values upward.

Likely, certain farmers have made errors in their financial management during the lucrative times, according to the speaker.

He listed several possible errors: purchasing machinery for tax reasons only, buying the equipment at zero percent interest without notifying the lender, purchasing land out of cash flow and working capital, and financing long term assets out of short term operating money.

“There has sometimes been an undisciplined pursuit of more,” Aylward said.

Always concerned about paying taxes, certain farmers have wrongly deferred maintenance and proactive livestock and crop management in down cycles.

Being a career specialist in agriculture lending, Aylward insisted, “We know farmers who have used more than three different sources of credit, sometimes selecting a lender on interest rate only, and not communicating with their lenders during both the good times and bad. These could all be serious financial errors in farm management.”

Admitting there have been increased family living costs, the speaker insinuated that as income on farm incomes went up, there was more spent on luxury living.

Advising farmers not to commingle living and business expenses, Aylward said, “Reducing excessive family living withdraws from the business can improve the margin.”

In making farm loans, Frontier Farm Credit considers the “Five Cs” of potential borrowers: “character, capital, capacity, collateral and conditions.”

“In addition, lenders will utilize your credit bureau reports as a verification of financial statements and repayment history,” Aylward said.

The “ultimate question,” he asked, “How do you position your operation to withstand the challenges and changes facing us today, and yet take advantage of the opportunities that exist long term?”

According to the speaker, “It’s all about strategic thinking, planning and positioning.”

A “strategic approach” has three steps: efficiency, working capital and management of marketing and risk.

Looking forward this year, Aylward advised, “Calculate realistic crop production breakeven levels, then develop a crop marketing plan with realistic price expectations, while carefully analyzing choices for the new farm program, and utilizing a sound crop insurance strategy.”

He recommended paying attention to cash rental rates and land costs. “Buying farm land is a critical decision,” Aylward warned.

Farmers should still look for ways to reduce production and overhead expenses, and be cautious of machinery and facility investments, especially for non-farm business.

“Always keep the current cash position of the farm business strong, be careful about prepaying long term debt, and don’t forget about family living and non-farm expenditures,” Aylward emphasized.

Most important to the speaker: “Communicate with your ag lender.”

“It’s essential for farmers to think beyond the moment. A key to managing cycles is a balance; dealing with the current situation, with thinking, planning and deploying resources today for tomorrow’s reality and opportunities.”

When to “buy or not to buy” is the question, Aylward posed three more questions: “How long will you own it? Can you afford it? Do you have adequate risk bearing capacity, the working capital, for the low part of the cycle?”

Interest costs have been record low, but what might be considered a small increase can be a significant expense on a land loan. If a farmer has purchased a quarter section of land for $3,000 an acre, creating a debt of $480,000, cost for a loan borrowed at 5 percent interest would be $90 per acre. The acre cost would jump to $126 for a loan at 7 percent interest.

Considering financial strategies for the changing times in agriculture, Aylward said, “This is not an environment to be highly leveraged. It’s important for farmers to thoughtfully manage how debts are structured.”

He suggested farm borrowers “migrate towards an accounting system capable of tracking accrual earnings.”

Insisting that interest rates are “possibly the opportunity of a lifetime,” Aylward urged: “Fix long term rates.”

In order to build and maintain working capital, Aylward said, “ Farmers should consider the cycle you’re in, and the needs of your business for the next ten years.”

“There is a short term cost to holding liquidity, but will the long term gain more than off-set that?” he asked.

A chart showed long term interest rates back to 1790, when the cost was 7 percent. Rate was 11.5 percent in 1842, dropped to 3.71 percent in 1900, and a low of 2.09 percent in 1945.

Highest record interest rate was 14.14 percent in 1981, down to 2.87 percent in 2008, and near that level since then, and at present. Wars, economic depressions, and world situations have notably influenced interest rate variations though history.

Summarizing his thoughts on profitability in agriculture production for the future Aylward said, “Maintain a competitive position by being a low cost producer in your enterprise, while migrating towards an accounting system capable of tracking accrual earnings, to derive your cost per unit, and breakeven.”

Farmers can management risk by utilizing crop insurance, options for selling production or purchasing inputs and locking in low interest rates.

“Maintain a strong financial position with maximum risk bearing capacity using working capital as the first shock absorber. Be careful prepaying long term debt, know your cash flow and breakeven. This is not an environment to be highly leveraged in,” Aylward reiterated.

“We hope you position yourself for success in 2015, and that you are in control,” he concluded.