11/11/2009 7:55:00 AM Agriculture credit crunch expected in 2010
By Mike McGinnis
As the Obama Administration and Congress create liquidity, encouraging financial institutions to get credit flowing, commercial banks and farm credit system regulators are aggressively working to mitigate risk.
That's the message Dr. Danny Klinefelter, Texas A&M Extension economist, gave participants of a Chicago Mercantile Exchange webinar Nov. 2.
Klinefelter says the U.S. agricultural credit lending industry is going to be facing mergers, adopting tougher loan regulations to mitigate risk, and forcing foreclosures in livestock and grain operations in 2010.
"Regulators absolutely drive how lenders operate. The hammer (the regulators) have a lot more clout than the lawmakers jawboning from the bully pulpit," Klinefelter says.
Bank failures, FDIC losses, and higher limits on insured deposits prompted FDIC to recommend that bankers prepay their premiums for the next three years.
In addition, Congress and regulators are recommending higher minimum capital requirements to mitigate risk.
"When you increase the capital requirements, it restricts how much a lender can be leveraged," Klinefelter says.
Return to Normal Margins
Another main driver of change for ag credit lending will be the return to 'normal' margins in the livestock and grain sectors.
Following a few years of flush years in grain production, a return to normal margins is expected this year. As it continues to force foreclosures and voluntary exits from the livestock industry, a return to normal margins could force out some in the U.S. grain market, Klinefelter says.
Because of falling farm net income, Klinefelter says the grain farmer who didn't sell grain forward, catching higher prices, could see difficult days ahead.
"I think the debt-to-asset ratio of the ag sector, historically low right now, is not as good of a leading indicator as the debt-to-income ratio. It's misleading," Klinefelter says. "Historically, even when farm incomes dropped as they did in 1977, asset values increased, partially from inflation. But when the Farm Crisis hit in 1981, the debt-to-income ratio was showing trouble for the farmer four years ahead of that drop in assets."
Measuring Severity
How severe problems will depend on what happens to land values, interest rates, and net farm income, Klinefelter says.
In 2008, U.S. net farm income was $87 billion, and is estimated to drop to $54 billion for this year.
"I think if we drop below $50 billion, the U.S. ag sector will see serious problems," Klinefelter says. On land values, if they fall by 30% or more, we have big problems. Because land is 87% of a farmer's assets, this figure will be closely watched. On interest rates, I don't think the economic recovery has enough legs under it to be pushing interest rates higher."
Meanwhile, though they have been through tough times before, U.S. hog producers are hurting because it is taking more capital than ever to get their livestock to market.
Dr. Steven Meyer, Paragon Economics, told the webinar participants the current market environment is putting significant strain on hog farmers.
"At least dating back to the 1970s, in the past downturns, at least it didn't cost us so much money to lose money," Meyer says. Because this lower market has seen an increase in cost of production, it has put a tremendous strain on capital resources for both producers and their lenders."
Now, this same scenario of higher production costs is hitting grain producers, Dr. Meyer says. "As the corn industry faced an increase in corn demand, for things like ethanol, land rents were pushed higher and input prices jumped. This is causing a ratcheting up of capital requirements for grain producers across the board. In fact, we have seen some capital suppliers leave the agriculture industry."
Winners vs. Losers
As competitive markets take a foothold in agriculture, producers are urged to improve risk management skills. Remember, a competitive markets function is to drive the economic return to the average producer to breakeven through supply and demand responses.
"This means, the top end farm operations are profitable and growing, the average are hanging in there, and the bottom end are losing and exiting the industry," Klinefelter says. So, farm operations need to keep changing and getting better to stay away from the back end of the pack."
Mike McGinnis is Agriculture Online's Chicago Markets Bureau Chief. Article reprinted with permission of author and publication.
