Financing young, beginning farmers will continue to prove tough
By Larry Dreiling
Attracting and retaining the next generation of farm operators has been a persistent struggle in U.S. agriculture, according to a recent study by Nathan Kauffman, an economist at the Federal Reserve Bank of Kansas City, Mo.
That struggle is likely to continue into the foreseeable future, Kauffman said.
It’s not as recent a struggle as one might think, as over the past century, productivity gains in U.S. agriculture have led to the consolidation of farm enterprises into larger operations, which in turn have limited the opportunities for farm ownership and triggered an exodus of young farmers from the industry.
The high fixed cost of capital has generally kept young and beginning farmers, similar to their peers in other businesses, in securing financing for capital-intensive operations due to lower levels of equity and wealth, which creates higher risk. That risk requires higher collateral to secure their note.
“Rising land values, which increase the fixed costs of agriculture, only intensify the challenges of financing,” Kauffman said.
Despite many programs to assist young and beginning farmers with financing for agricultural enterprises and land, recent data indicate that fewer of today’s young and beginning farmers own land than in the previous decade.
“This shift raises questions about the structure of agricultural policies that support the new generation of farmers as they acquire land, especially if their decisions about ownership are driven by market-related factors,” Kauffman said.
A few of these factors include older baby boomer farmers are reaching retirement age, new technologies and increased productivity have boosted economies of scale, in turn shrinking the number of farm operators. In addition, rising production costs have intensified the financial needs of agriculture, which can serve as a barrier to entry for young and beginning farmers.
Kauffman’s report stated that during the past century, the average age of farm operators has steadily increased. From 1940 to 2007, the average age of farm operators rose from 48 to 57, with those 65 and older being the fastest-growing group, according to the Census of Agriculture.
Farm operators tend to be older than non-agricultural business owners. In 2007, 56 percent of principal farm operators were older than 55, compared with a third of all self-employed nonfarm workers.
Along with the rising age of farm operators, the productivity of U.S. agriculture has steadily improved. Technological advancements have allowed farmers to expand their acreage while using less labor.
“In addition to the long-term trend, the age of farm operators tends to shift cyclically with agricultural prosperity. During prosperous times, the average age of farm operators has held steady as the number of young and beginning farmers increased along with rising profits,” Kauffman said.
“For example, during the farm income booms of the 1940s and 1970s, the share of farm operators younger than 35 increased, in contrast to the declines for the rest of the century.”
Over the past decade, U.S. agricultural production costs have risen at the fastest pace since the 1970s. Increases in seed and fertilizer costs have driven up annual U.S. corn production costs by roughly 8 percent since 2006. In addition, livestock production costs have increased sharply with higher livestock and feed costs.
Prosperity that extended into 2008, however, fueled a rise in agricultural lending activity, Kauffman’s report stated.
“Rapid gains in land values from 2004 to 2008 strengthened farm balance sheets and boosted farm household wealth levels. Expanding wealth levels tend to spur agricultural investments, and as a result real estate lending has surged in recent years,” the report said.
“At the same time, farmers intensified their non-real estate investments. For example, combine and four-wheel-drive farm tractor sales rose approximately 20 percent annually from 2006 to 2008. Farmers also increased their purchases of other farm equipment, including grain bins, irrigation systems and machine sheds.”
Following a period of prosperity, the financial crisis significantly affected agricultural credit conditions. A collapse in commodity prices and farm incomes in 2009 contributed to a decline in farmland values and a fall in loan repayment rates, Kauffman’s study said.
The recovery from the recession and financial crisis during 2010 and 2011 has, through rising crop prices, lifted farm incomes and farmland values to record levels. “In addition, loan repayment rates rebounded due to soaring farm incomes, and returns at agricultural banks steadily improved. The persistence of farm profitability into 2012 appears to have altered agricultural lending as more banks competed for high-quality farm loans,” Kauffman said.
“With increased competition for farm loans, low interest rates, and rising investments in agriculture, some banks began lowering collateral requirements in 2012, boosting agricultural lending activity.”
But, through all these good times, young and beginning farmers are finding it more difficult than ever to obtain financing, because they face the opposite fate—needing more collateral to buy farmland and operating—due to their smaller equity stakes and higher liabilities.
“These market forces suggest that an alternative model of land ownership for young and beginning farmers may emerge, despite policies geared toward land ownership,” Kauffman said.
“Along with less experience, young and beginning farmers typically have less farm equity. In 2011, farmers younger than 35 had roughly 20 percent less equity per farm than the average across all farms, according to a USDA report. As a share of total assets, farm liabilities of these younger farmers were more than twice that of all farmers.”
As a result, the debt-to-asset ratio of farm enterprises managed by operators younger than 35 was more than four times higher than enterprises managed by operators 65 or older, Kauffman said. In addition to the higher real estate debt burden, non-real estate debt was sharply higher for young and beginning farmers. Non-real estate debt was three times higher for farms managed by young farmers, compared with other farms in 2011.
But you can’t blame banks for being tight-fisted when it comes to lending to young and beginning farmers.
“With lower levels of equity and higher debt ratios, young and beginning farmers present a distinct risk for lenders. Farmers with higher debt ratios have less capacity to repay loans in the event of a downturn in incomes,” Kauffman said.
“The risk of default rises with higher debt ratios and insolvency issues begin to appear when the debt-to-asset ratio for individual farms breaches 40 percent. With higher debt ratios, young and beginning farmers are rationally perceived as a more risky group on average.”
Higher debt ratios
In a recent survey of commercial banks in the Federal Reserve’s Tenth District, based in Kansas City, Mo., bankers reported having higher collateral requirements for young and beginning farmers who typically have higher debt ratios. According to the bankers, young and beginning farmers have higher debt-to-equity ratios compared to other farmers.
“Commercial banks reported making fewer loans to young and beginning farmers and required higher levels of collateral relative to other farmers. Yet, bankers also indicated that loan repayment rates were higher for young and beginning farmers, which may be an outcome of more selectivity in initial lending and support from federal programs,” Kauffman said.
Fed banker survey comments also indicate farmers with limited equity, such as young and beginning farmers, are more challenged to purchase farms when rising land prices increase the fixed costs of agricultural production.
“With agricultural production’s large fixed costs, high collateral requirements are a barrier to entry for young and beginning farmers with limited equity available as collateral. As land prices continue to climb, this obstacle is becoming more pronounced,” Kauffman said.
According to the Tenth District survey, a significant number of bankers reported making fewer loans for land purchases to young and beginning farmers relative to existing farmers—possibly because of tighter lending requirements, limited equity, or a combination of both. In fact, many bankers indicated that young farmers often required assistance from family members or friends to start their farming operation.
From 2001 to 2007, the Farm Credit System’s loans to young, beginning and small farming operations roughly doubled, according to a 2012 report by the Farm Credit Administration. By 2007, more than half of U.S. farmers younger than 35 years old were full owners of farmland, Kauffman’s report said.
From 2007 to 2011, however, the trend toward full ownership for young and beginning farmers reversed sharply. By 2011, only 36 percent of farmers younger than 35 were full owners of farmland as production costs continued to rise and land values dramatically surged.
“Many farmers still aspire to own the land they farm. Yet, in contrast to previous decades, a growing number of younger farmers is renting land before incurring the fixed costs associated with land purchases,” Kauffman said.
“A rental strategy for land and equipment could become the standard business model of the future for young and beginning farmers in the United States. Leasing already is in wide use in other industries.”
Leasing common practice
The Equipment Leasing and Finance Association reports that approximately 80 percent of U.S. companies lease some or all of their equipment. By avoiding or deferring significant fixed costs, a leasing strategy may be less risky in the event of a downturn in the farm sector.
In turn, policies geared toward land ownership may also evolve as market forces alter the landscape for young and beginning farmers in U.S. agriculture.
“Record high prices present a mounting challenge to young and beginning farmers who want to purchase farmland. Higher prices for land and fixed expenses appear to be shifting the structure of farm enterprises managed by young and beginning farmers from an owner-operator model to a renter-operator model,” Kauffman said.
“Current federal and state policies support the owner-operator model in U.S. agriculture. However, the structure of farm enterprises in the future may continue to develop into a renter-operator model, especially if market forces continue to drive up fixed costs of production.”
Larry Dreiling can be reached by phone at 785-628-1117, or by email at email@example.com.