As margins shrink, know your numbers
When it comes to farm finances, ag producers will need to spend more time sharpening the pencil in 2014.
"Producers will need to access more working capital, reduce leverage and spend more time managing risk," explains Terry Barr, senior director, Knowledge Exchange Division, CoBank.
While there are signs that farmland is richly priced, credit underwriting criteria are stronger than during the farm crisis of three decades ago.
Historically, farmland traded at a cash to rent ratio of about 15% to 18%, says Nathan Kauffman, an economist with the Federal Reserve Bank of Kansas City. Today, that ratio is up to 33% in key farm states such as Illinois and Iowa. This means investors are willing to pay $33 for every $1 of return.
The concern is that farmers have had very strong income the past few years, and going into 2014, the expectation is that incomes will be quite a bit lower, notes Kauffman. But he sees little evidence that agriculture is on the precipice of another farm crisis. Despite all the talk about Wall Street and pension fund investors buying up farmland, outside investors comprise less than 20% of farmland purchases in the bellwether state of Iowa.
Lender Concerns. "There is talk among farm lenders around tighter margins and expected lower farm income, plus concern about whether land prices have peaked and will there be a land market
correction," says Danny Klinefelter, Texas A&M University ag economist. "The discussion has been more from commercial banks than Farm Credit. Both will react even more strongly
if they start experiencing pressure from regulators."
From the standpoint of a lender heading into 2014, things are going to be more formal than ever before, says Barr. He offers farmers the following guidelines:
- Stress-test your balance sheets.
- Since working capital is king, the interest rate environment will not be the same forever. "How are you accessing debt capital?" Barr asks. "You haven’t needed it because of cash flow, but you have to recognize the realities of where you are going in the next five years."
- Know the capacity of your lending institution. "As farms get bigger, some of these small banks can’t carry it," Barr explains. "The Farm Credit system has ways of expanding and increasing your capacity without extra covenants or additional fees. Particularly as interest rates rise, every 100 basis points adds issues.
- Recognize that the financial system has changed. "When you are looking at a lender, ask if they are adjusting to the range of prices and margin calls," Barr says. "Are they adapting as ag does?"
- Be data dependent. Everything has to be backed up, Barr advises. The advantage right now for
agriculture is that balance sheets look pretty good. "That gives you a sector that can take a few punches," Barr notes.
Sharpen Up This Winter
Join us Jan. 29-31 in Chicago for our 2014 Top Producer Seminar, "Ahead of the Pack." You’ll learn from CoBank economist Terry Barr, and hear from more than 40 speakers, including investment experts and farm management specialists, climate risk economist Simon Atkins and keynote speaker Clyde Fessler, former Harley-Davidson vice president. For a full agenda and registration information, visit www.topproducerseminar.com.
For help calculating key ratios to measure your farm’s health, visit the Farm Financial Standards Council website at www.ffsc.org.