While many farmers have paid down debt with strong crop returns the past two years to prepare for a period of tighter margins, debt levels overall are surprisingly similar to those of 1979, a Kansas study shows. Moreover, data show that at the end of 2012, a higher percentage of farm borrowers actually had a debt/asset ratio of greater than 70% than in 1979.
Even so, the percentage of Kansas producers in this high debt group is extremely low, 3% now versus 1% in 1979, says Alan Featherstone, ag economist at Kansas State University. "I think there is more debt out there than USDA data show." He suspects that USDA data do not properly account for current liabilities.
Farmers with debt/asset ratios of 40% were higher in 1979 than 2012, but not all that much higher: 19.4% then versus 14.4% now. Illinois data draw similar conclusions. Featherstone quickly adds this: "We’re in great shape, with 2012 the third best farm income year in the last 40 years." The peak was 1973/74. Featherstone spoke at the ABA National Agricultural Bankers Conference in Minneapolis Nov. 12.
Featherstone is not predicting a repeat of the 1980s, yet he says the similarities between 1979 and 2012 are striking. "If there is a bust, it most likely would be caused by a drop in revenue than higher interest rates," he says.
Today’s historically low interest rates, a factor many say is an important contrast to the 1980s, are not as low as they first appear. While nominal rates are far lower than the do double-digits of the 1980s, real interest rates (adjusted for inflation) were 3.6% in 2011/12, higher than the 2.4% during the 1980s farm crisis, Featherstone says.
He also argues that it’s not true banks were lax in lending standards during the 1970s on average, as is often said. The average loan to appraised value was 60% in the 1980s, with two-thirds between 50% and 70%. "There were not a lot of 80% to 90% of loans to appraised value out there," he says. Today, by contrast, the maximum loan to appraised value banks will go is 65%. "I don’t see the 1980s out of line from where we are now. Lenders get a bad rap," he says.
Moreover, just a small percentage of nonperforming loans can have a major impact. In the 1980s, the default rate was only about 10%, with 75% of those defaults during a narrow window, 1984-86. "That’s a small subset," Featherstone says. "We really need to focus on the tails, bankers worst loans. If there is a bust, it will be the tails that cause it." He also notes that in the 1980s, producers who eventually filed for bankruptcy had loans that were performing for an average of 5.5 years.
In Featherstone’s analysis, if there is a repeat of what happened in the 1980s, it would require a combination of a 65% increase in interest rates and a 15.7% decrease in the value of production. Because the land market is so thinly traded, a small change can have a large impact, he explains. For example, 1% to 3% of land changes hands each year. If that percentage increases, it could create more sellers than buyers. "It doesn’t take a lot of land coming onto the market to upset the equilibrium," he says.
That could be caused by any number of factors, or a combination of them. One concern he has is older landowners who own a surprisingly large amount of Midwest farmland. If farm income looks less promising, investment funds offer greater returns, and interest rates rise so they can earn a more attractive return from CDs, "they might be looking to get out," he says. In addition, 73% to 82% of farmland buyers are other farmers, who likely will be less likely to buy land in an environment of lower commodity prices. If farmers hold back at a time when more land is offered, it could create downward momentum, he says.
One of Featherstone’s concerns is that the farm safety net is actually less than it was during the 1980s, assuming the farm bill is eventually passed that eliminates direct payments. The only real farm safety net left is federal crop insurance, but its revenue guarantees are less than they first appear. For the 2014 crop year, the guarantee could drop by $127/acre for corn, from $678 for 2013 to $551/acre with 80% coverage and an APH of 120 (average yields of 150). The cause would be a decline in prices of $5.65 for 2013 to $4.59 for 2014 (using December 2014 futures prices as of Nov. 8). The revenue protection portion of crop insurance is based on average December futures prices during February. "The perfect storm would be two good back-to-back production years," Featherstone says. "The safety net is not much of a salvation."