Bankers should focus on the future
Wall Street may slog along for the next seven years, but it could prove to be an opportunity for Main Street bankers as America moves away from a nation of spenders to a nation of savers.
So says Dr. David Kohl, professor emeritus of agricultural and applied economics at Virginia Polytechnic Institute. Kohl delivered his annual talk on the ag economy at the American Bankers Association National Agricultural Bankers Conference, held recently at San Antonio, Texas.
"We've reached an inflection point in our economy," Kohl said. "We are either going to reinvent ourselves, find the new engines of economic growth and re-emerge or move into a more European type of economy. You'll also see Asia, particularly China, rise up."
Agriculture could be pivotal as one of those new engines of growth, he said.
"To some people, agriculture is considered a small sector, but has a huge footprint, both economically and politically. There's food, feed and fuel. The biological and life sciences," Kohl said. "If you come from a large bank, I know that some perceive ag to be a very small part of the economy. Don't bet against it. Ag is going to be a major engine of growth for this economy."
The U.S., Kohl contends, has been the world's economic driver for about 100 years. For about 150 years before that, Europe was the power, but for 500 years before that, China was the world's economic driver.
"As we move toward the year 2025, you will see China as very strategic, very methodical," Kohl said. "We had $1.4 trillion in the U.S. generated as stimulus. When you really look at it, $3.2 trillion has been placed in stimulus, mostly from the Chinese. What happens when the training wheels come off? How will we be able to sustain ourselves?"
In the ag economy, Kohl noted that the first decade of the new century saw a change where the livestock sector replaced the grain sector as agriculture's most troubled industry.
"We're also top-heavy in real estate," Kohl said. "Eighty-seven percent of all farm debt is in real estate. In 1984, it was about 74 percent. I like Warren Buffett's comment about real estate. 'When the tide goes out on real estate, we'll see who's negative.' We'll see who's negative on cash flow, liquidity and on profitability.
"Real estate has covered up a lot of mistakes. We are extremely, extremely vulnerable there."
Examining the debt to asset ratio of American business, production agriculture looks very low, Kohl said. The problem is that it is concentrated onto few producers that generate a lot of revenue.
"You could have third party risk at a local level," Kohl said. "I have a nephew in upstate New York who does custom work for some area dairies. These are big farms. His accounts receivables have gone way up.
"Learning that, I'd tell every bank to go in and scrub their portfolios for third party and counter-party risk. Find out how deep are the tentacles of risk in your bank. Think about if one business goes down, consider how it affects others on your list."
While Kohl told the bankers to act locally to manage risk, he also told them to think globally, as well.
"Consider this. Two years ago, if you wanted to buy a new combine or tractor in North America, you were put on a wait list," Kohl said. "That was because the silk suits in places like the Ukraine were buying those combines and finally turning their old collective farms into very modern operations.
"When Putin decided to invade Georgia, the day that happened, Deere stock fell from $87 a share to $35. Don't try and tell me global economics don't affect you. You have to plan for volatility at the extremes."
With 5 percent of the world population, the U.S. holds 29 percent of world GDP. The question Kohl asked is will this amount, and the 3.5 percent annual growth we see, be sustainable.
"The Euro sector has 7 percent of the world population and 29 percent of the world's economy. They made a quicker comeback than we did," Kohl said. "But, already, Britain has fallen back. Germany is teetering. Add Japan, with the second largest economy, and you have two-thirds of the world's economy, with just one out of every six people."
Kohl contends the ag sector needs to look at the "BRIC" nations of Brazil, Russia, India and China to get a good handle on the future.
"They are 18 percent of the world's economy. We have to keep our eye particularly on China," Kohl said. "China's growth rate is 8.9 percent. You start seeing that growth rate go above 10 percent and you'll see farm prices stay strong. If these countries fall below 3 percent growth, you'll see oil collapse and commodity prices become soft."
China is using this growth to make large investments in the southern hemisphere, buying commodities and rare metals, Kohl adds.
"Rare metals are used in high technology," he said. "They go into everything from computers to aircraft engines. They control 93 percent of the sector."
Along with foreign control of the metals sector, the U.S. must continue to be concerned with its dependency on foreign oil, Kohl said.
"Eighty percent of farm expenses are linked to oil," Kohl said. "We have to worry about the value of the dollar, geopolitical risk and weather when considering energy costs. I can see a 30 percent risk of oil going above $100 a barrel next year, a 50 percent chance of it heading below $50 and a 20 percent chance of it hovering around $80 per barrel."
Because of that, producers should take a stair-step approach to buying inputs.
"Tell them, 'Don't put your eggs in one basket,'" he said.
Land values have gone up in 80 of the last 100 years, Kohl said. It's likely that prices will continue to go up because of fear and greed.
"Higher interest rates are your black swan in this," Kohl said. "This is the first year in 21 years that land values have declined. One rule of thumb is when land values fall it takes two years for cash rents to correct themselves."
One of the biggest mistakes producers have in buying land is a lack of liquidity, Kohl said.
"If you buy land, you better have liquidity," Kohl said. "Even though farmers are much more disciplined about liquidity than they were in the 1980s, they still need a lot of work. Even though money is cheap right now, I say payback can be hell."
Kohl urges a rule of thumb of a 50:50 debt to asset ratio to determine borrower liquidity. Anything less will put a banker at risk.
"Remember paradigms shift but principles don't," Kohl said. "Be old school. Look at liquidity. That is very important. Just don't forget character of the borrower. Character is very important in lending."
Larry Dreiling can be reached by phone at 785-628-1117, or by e-mail at firstname.lastname@example.org.