With lagging income, some beginning farmers may run into trouble meeting debt-service ratios
"I am not a pessimist," Michael Boehlje, a professor of agriculture at Purdue University, told an audience of farmers and bankers huddled at this week’s Federal Reserve Bank of Chicago conference. "I am bullish about farming in the long term. But I am also very concerned about the next three to four years."
Boehlje painted a picture of a cyclical industry on the verge of a downturn. Noting that the last four agriculture booms have been followed by two busts and a soft landing, he predicted that this time around the industry could be heading for a soft landing. "We’ll have a [25%] decline in income then a small recovery," he projected, adding that he thinks corn prices will fall below $4 this year.
"I am not concerned about debt–to-asset ratios. But I am worried about repayment capacity," he said, adding that some farmers, particularly beginners, may also have trouble meeting debt service ratios. Given the working-capital challenge, Boehlje told the bankers in attendance not to insist that farmers put more capital into their land.
"I am worried about bumps in the road," he said, adding that an ag downturn may have started this year had it not been for the influence of weather and crop insurance payments. "I don't want farmers to become roadkill."
Full-on agricultural busts, he said, typically result from collapsing demand, particularly for exports, which account for about 25% of U.S. ag income. Though economic growth in China and India may continue to fall in coming years, the decline won’t be enough to cause a market collapse. Similarly, demand for corn to produce ethanol may fall in coming years but not by enough to crater producers.
Farmers can expect interest rates to rise steadily for the remainder of the decade -- a 200 to 300 basis point increase over the next six years, according to Federal Reserve Board projections -- which will hurt the capital-intensive industry. "That’s a pretty large percentage increase when you consider that rates are three or four percent," said Boehlje.
But the bigger challenge may come from agricultural expansion throughout the world during the most recent up-cycle. "We’ve added an additional 147 million acres under the plow in the last 8 years," said the economist, adding that land that goes into agricultural production rarely comes out. "We’ve got to figure out how to absorb it."
In the meantime, Boehlje expects agricultural land values to fall by 15% over three years. The price-to-earnings ratio on farmland, which is traditionally in the 20% neighborhood, has climbed to more than 30%. "I’m going to be frank with you—that scares the hell out of me."
"We need to move into pause mode. We need to take up a big collection and tell every realtor to go on vacation for a year....We’ve got to get this market to go into pause mode."
Equipment dealers are even more vulnerable to a downturn, said Boehlje. Inventory of used equipment continues to build at many farm equipment dealerships, even as manufacturers move new models through the pipeline. It isn’t clear whether existing tax incentives for buying farm equipment will be continued into 2014.
"We lost 25% of our retail machinery dealers in the 1980s crash," he said, noting that some survived only by shipping excess equipment to South America. "Bankers should put them on their watch list. The common denominator was too much used equipment."