A flood of news stories during a three-week period this spring in print and online media bore worrisome headlines like these: “Ag economists fear bubble forming over borrowing” (Omaha World Herald); “Trouble on the farm: ‘We face a grim future’” (CNBC); “Are farmers next to be hit by debt?” (MarketWatch).
A common source for each of these stories was a paper from researchers at the Federal Reserve Bank of Kansas City, “Farm Investment and Leverage Cycles: Will This Time Be Different?” The authors are Jason Henderson, who at the time was vice president and branch executive for the bank’s Omaha office, and economist Nathan Kauffman. Henderson has since moved to Purdue University as associate dean of the College of Agriculture and director of Purdue Extension, and the paper is included in the bank’s second-quarter Economic Review.
“With booming farm profits, farmers have made a range of real estate investments, building new structures such as grain bins and machine sheds and improving productivity through expanded pivot irrigation and tiling,” the economists wrote. “In addition, non-real-estate investments have soared as farmers purchased new vehicles and upgraded their equipment and machinery. As measured by capital expenditures, farm investment since 2006 has risen at its fastest pace since the 1970s farm boom.”
As reflected in media accounts, this surge in farm capital investment has raised concerns that farmers may repeat the mistakes of the 1970s, when a wave of capital investment led to an overleveraged farm sector, according to the Fed officials. “Historically, farm investment has strengthened as farm booms matured and remained high even when profits began to fade,” they wrote. With shrinking profits, farm enterprises have tapped their wealth to smooth and continue financing their investment spending, leading to expanded farm leverage, they added.
“Over recent years, in keeping with the pattern of past farm booms, elevated farm profits have enabled farmers to keep leverage ratios near historic lows,” the article continued. “But historical trends suggest that the strong wealth effect in the agriculture sector, coupled with low interest rates, could lead to an accumulation of excess debt. This scenario could be a recipe for another financial crisis in U.S. agriculture.”
During past farm crises, the rise in farm debt ratios was driven by falling asset values, Henderson and Kauffman pointed out. “From 1920 to 1923, the jump in the debt-to-asset ratio was driven by a drop in farmland values and a 20 percent decline in farm asset values, as farm debt levels held steady. From 1980 to 1985, the debt-to-asset ratio rose above 20 after farm assets fell by 40 percent and farm debt declined by 15 percent,” they wrote.
Given the current record-high farmland values, farm debt ratios are now near historic lows, according to the Fed study. The USDA projects the 2013 farm sector debt-to-asset ratio will decline to 10.2, driven by a 6.3 percent increase in farm asset values and a 1.8 percent increase in farm debt. “If the debt-to-asset ratio were to rise to 20 for the farm sector as a whole, the rise would have to be driven either by farm assets' falling sharply or by farm debt's soaring,” the authors warned.
Although today's farm leverage ratios are historically low, they explained, the concentration of farm debt raises the risk of farm bankruptcies even in prosperous times. While average debt-to-asset ratios were similar in both 1979 and 2010, other studies show, almost 6 percent of Kansas farm enterprises had debt-to-asset ratios above 70 in 2010, compared with only 1.3 percent of Kansas farm enterprises in 1979. The USDA has indicated that when debt-to-asset ratios for the individual farm enterprise rise above 40, the enterprise can become vulnerable to solvency problems.
Henderson and Kauffman concluded that the stage is set for another possible cycle of rising leverage in the U.S. agriculture sector. “Over the past decade, farmers have increased their production capabilities through capital investments and, as a result, agricultural supplies are projected to rebound. Rising supplies, coupled with higher production costs, are projected to cut farm profits by 2014,” they wrote.
“Historically, declines in farm profits initially have not triggered a reduction in capital investments as farmers tapped their wealth to finance and smooth their capital investments over time,” the researchers continued. “That past pattern suggests that, in the current cycle, both real estate and non-real-estate investment by farmers might continue to remain high, even when profits decline, as long as farm wealth remains elevated and interest rates remain low. During the 1920s and 1980s, farmers accumulated debt and many faced bankruptcy when farm profits plummeted, farm land values declined, and interest rates rose sharply.”
The economists questioned if, amid projections of lower farm incomes in coming years, along with high levels of farm wealth and low interest rates, farmers will maintain their working capital or will leverage their farms. “History has shown that significant increases in farm leverage can set the stage for deleveraging cycles and farm busts. Whether the current farm boom simply fades — or busts — will depend on how farmers finance their investments and how far leverage rises,” the writers suggested.
Maybe — just maybe — this time will be different, in spite of the headlines.
Bill Poquette is editor-in-chief of BankNews.