This year appears to be a sanguine one for farm finances, with high projected farm incomes in 2013 projected to keep U.S. farm debt and leverage low. Yet longer term projections suggest that farm incomes could fall dramatically in 2014, according to a new study by the Federal Reserve Bank of Kansas City.
Today, an increase in farm debt may signal the beginning of another turning point in farm debt and leverage, the study says. After rising less than 1% annually since 2008, farm debt outstanding at commercial banks rose roughly 5% in the fourth quarter of 2012 for both real estate and non-real-estate debt. Similarly, Farm Credit System lending for real estate mortgages and production and intermediate-term loans rose 5.7% during 2012.
"If agriculture’s historical wealth effect holds true, farm enterprises might use existing wealth to finance and smooth investment spending, sowing the seeds for another round of debt accumulation," KC Fed economists say in "The Wealth Effect in U.S. Agriculture," published in May in "The Main Street Economist." Rising land values historically have supported stronger farm investments even with lower incomes. During less profitable times, instead of allowing investments to fall with profits, farmers tap their existing wealth to finance and maintain their capital investments near previous levels. Lenders can also contribute to the wealth effect by being more willing to lend to farm enterprises that have greater levels of equity to use as collateral for loans.
Of concern is that debt could increase at the same time incomes decline. The study notes that long-term projections suggest that U.S. profits are expected to retreat over the next decade. With a return to more normal weather patterns, a rebound in U.S. crop production is expected to expand inventories and reduce crop prices by 2014. At the same time, stronger global crop production and slower demand growth from exports and ethanol is projected to weigh on crop prices and profits. For example, after averaging $580/acre for the past two years, USDA projects net returns above variable costs for corn production to fall below $350/acre by 2014. That’s a decline of 44%. When combined with other types of agricultural projection, USDA projects U.S. farm incomes to fall 20% to 25% below 2013 highs during 2014 and remain near these levels over the next decade. Moreover, the Federal Reserve indicates that interest rates could begin to rise during this period of lower incomes.
The good news is that while debt accumulation appears to be on the increase, farm debt ratios remain historically low. "Debt accumulation on par with the 1970s could pose future risk to farm finances," the economists say. Looking to the most recent farm boom, after peaking in 1973, total farm sector debt rose 43% or 5.3% per year by 1980. When debt increases absent the income to support it, havoc can ensue. For example, farm assets fell 45% between 1980 and 1986.
This time around, while farm investment has accelerated, farmers generally appear to have been conservative in their capital investments, at least when compared with past farm booms, the study notes. After adjusting for inflation, average annual capital expenditures per farm have been lower than 1970s levels. In addition, farm capital expenditures now account for a smaller share of farm profits than past farm cycles.
Over the past two decades, average annual farm capital expenditures have equaled roughly 40% of average annual returns to farm operators, down from 80% during the 1970s farm boom. However, capital expenditure data is only available through 2011 and farmers, especially crop producers, earned record high profits and enjoyed record wealth gains the past two years.