Are Rising Farmland Prices Returning us to the 1980’s?
Thursday, August 18th, 2011
If you are going to buy additional farmland, how will it be purchased? Will it be a cash outlay from recent profits, or will it be partially debt-financed with the help of a lender? If it is the latter, given the lofty land values of recent months, what is the vulnerability to farmers, to lenders, and the lending system, should the unthinkable happen?
The agricultural economy weathered the Wall Street storm, in part because many farmers had used recent profits to retire debt, and recessionary times did not have deep roots in farm country. Higher commodity prices have kept many farming operations above water, unlike the 1980’s when debt-financed farmland went back to the lender. Writing in the current issue of Choices, an electronic magazine on agricultural economic issues, Kansas City Fed economist Brian Briggeman says current conditions may seem like the 1980’s. That is causing many to wonder if today’s land values are a bubble. He says one difference is that rising farm real estate debt today is concentrated among fewer borrowers and fewer lenders, but the lenders are in a strong financial position than they were 30 years ago.
In the 1980’s higher debt levels were a function of the rising farmland values, and lenders were relying on higher land values from year to year to serve as the higher collateral values to support the loans. Briggeman says, “A global recession and a fight against rampant inflation in the 1980s slashed demand for agricultural products, raised the value of the dollar, and sent agricultural exports and incomes plummeting. As a result, real farmland values dropped more than 40%.” He says that forced farmland sales, which resulted in bankruptcies that reached record levels by 1987. The additional result was stress among lenders, with 400 bank failures and a $4 billion loss for the Farm Credit System.
Debt levels have risen in recent years, which the USDA says is $132 billion, but lenders say is $141 billion, with 33% of farmers reporting some level of farm debt. Briggeman says, “While large farming operations with more than $1 million in farm sales only comprise 1.4% of the entire farm sector, they hold 20% of total farm real estate debt. Fortunately, these large farm borrowers—who also account for 30% of total agricultural production—have ample farm income with which to repay their sizable amount of farm debt.” But he also says 52% of the farm real estate debt is held by livestock producers, and losses in livestock markets create repayment problems.
The economist says the ability of lenders to absorb farmland value shocks is better than it was in the 1980’s, but financial vulnerability of livestock operations and low margins for biofuels producers have created concerns. The profitability of lenders fell beginning in 2008, more so for agricultural banks than the Farm Credit System, due to the exposure of banks to the housing crisis and mortgage finance issues. Briggeman says both banks and Farm Credit appear to be well capitalized and in a position to withstand a financial shock, there has been an increase in the number of loans that are not performing and returning interest. He attributed those to falling livestock incomes, particularly in dairy and poultry, and problems for ethanol plants. He says both banks and Farm Credit have raised their loan loss reserves to cover potentially bad debts.
“Agricultural lenders are well positioned financially to withstand a decline in farmland values today. Admittedly, trying to predict the impact of falling farmland values on a lender’s farm loan portfolio is difficult,” says Briggeman. And he adds that it is nearly impossible to predict a debt crisis. However, with USDA’s prediction of a 20% increase in net farm income in 2011, Briggeman says lenders’ profitability will likely rise, since they are now cash flow lenders instead of collateral lenders.
But Briggeman says lenders still face significant challenges if there is a rapid and sustained fall in farm income from such issues as falling commodity prices, falling demand for products, commodity price volatility, a rise in US exchange rates, changes in farm and energy policy, and global unrest from high food prices or inflation. He says both farmers and lenders must be in a position to manage those risks, “Managing future stress stemming from a farmland value drop may well depend on lenders and producers holding ample liquidity reserves and keeping debt levels low.”
While farmland prices have risen, so has debt that is used to finance farm real estate purchases. The debt is more concentrated than it was in the 1980’s due to livestock and biofuels margins. Lenders have been able to manage their financial challenges, but a shock to the system cannot be predicted, and both farmers and lenders have to be able to manage the financial risk posed by debt-financed farmland values that continue to rise.