There may be a potential "debt bomb" sitting under the farm land market. That bomb isn't debt on farmland itself but the concentration of non-real estate debt in the hands of young operators (under the age of 35) and large operators (operations with more than $1 million in farm sales). This is according to an analysis of farm balance sheets conducted by Brian Briggeman, an economist with the Federal Reserve Bank of Kansas City.
The research points out that while agriculture's debt-to-asset ratio is near record low levels, the concentration of debt into these two groups poses a potential risk for agriculture and farmland values. "On average, large farms' total net worth is more than five times the net worth of small farms, primarily due to a larger investment in non-real estate assets. Still, large farming operations are more leveraged. On average, large farm's debt-to-asset ratios are about 30%, which is 5 percentage points higher than small farm's debt-to-asset ratios, he writes."
Briggeman also points out: "The net worth of farm enterprises with younger operators is about half of their more established, older counterparts. In addition, the debt-to-asset ratio for farm businesses operated by younger producers is nearly 15 percentage points higher than their more seasoned counterparts. Thus, of all producer types considered, large farms and farms operated by younger producers with debt are most susceptible to financial stress. The debt-to-asset ratio on farms with a younger operator averages close to 40% -- a level that has signaled significant insolvency risk in the past.
"In addition, these producers have a higher concentration of non-real estate debt," he continues. "For large farming operations and those operated by younger farmers non-real estate debt averages about 20% of total farm debt, compared to less than 15% for both small farm operations and those operated by more experienced farmers."
So what's the impact if land values drop by 10% in a single year -- the steepest one-year decline in land values during the 1980s farm crisis? Briggeman says the impact on debt-to-asset ratios and farm net worth "would be fairly uniform and modest across most producers." His research indicates the debt-to-asset ratios would rise only 1.5 percentage points for large and young operators. Net worth for all producer types would decline 7%. "As a result, a 10% decline in land values would only slightly heighten insolvency risk," Briggeman says.
But what happens if farmland values decline 50% like they did through the crisis of the 1980s? The impact is tough on all producers, as you'd expect. "On average, producers would lose 35% of their net worth, dropping producers' net worth to 2004 levels," he says. "Overall, debt-to-asset ratios for the farm sector would rise anywhere from five to eight percentage points. Financial stress would be most severe for producers with relatively more non-real estate debt. Large farming operators and younger operators with significant levels of non-real estate debt could see their average debt-to-asset ratios reach a dangerously high 40%. The number of large farmers facing insolvency could more than double and the number of young operators could quadruple."
Implications? Obviously if you pile up debt while net incomes in agriculture are rising, you're going to be in trouble when the cycle turns. As we've been telling LandOwner subscribers, use the current period of strength to pay down debt, increase working capital and lock-in long term interest rates.
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