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Credit conditions remain solid despite lower farm income

By Larry Dreiling

Most agricultural bankers in the Federal Reserve Bank of Kansas City District reported solid credit conditions in the second quarter of 2014, but longer-term concerns about credit quality have begun to emerge, according to a report by Nathan Kauffman, Omaha Branch executive and Maria Akers, associate economist.

“Although bankers reported very few past-due farm loans, loan repayment rates have weakened since last year, particularly in crop-producing regions. Credit standards, however, were little changed, and bankers indicated funds were available to satisfy a sharp rise in loan demand,” the economists said in their report, issued Aug. 14.

Despite continued strength in the livestock sector, District farm income remained well below year-ago levels due to falling crop prices and poor winter wheat yields. Cropland values generally held at high levels while strong demand for high-quality pasture pushed ranchland values higher. With summer rains easing drought conditions, the potential for record crop production this fall could keep prices low and shrink profit margins further, potentially affecting future debt repayment capacity.

Ag credit conditions

Credit conditions at agricultural banks remained sound in the second quarter and were expected to hold steady during the growing season. Some survey contacts pointed out that several years of strong profitability in the crop sector have bolstered the financial position of many farmers and could provide a measure of protection against a forecasted drop in income for 2014.

“Indeed, bankers reported very few past due farm loans in the second quarter and anticipated that the majority of farm loans in their portfolios would have no significant repayment problems this year,” the economists said.

“Bankers felt that a small portion of farm loans, less than 10 percent, may have minor repayment issues, but that these issues could be remedied easily. As a result, very few farm loans were expected to require workout negotiations or forced liquidation of assets.”

However, following the sharp drop in crop prices in late 2013, some bankers noted a dip in farm loan repayment rates. While repayment rates have fluctuated across the District, the largest declines have been in states heavily dependent on crop production, particularly in Nebraska.

“In contrast, loan repayment rates in Oklahoma strengthened in the second quarter along with improved profitability in the cattle sector,” the economists said.

“In addition to softening repayment rates, bankers also reported a rise in the number of loan renewals and extensions over the past year. Still, loan repayment rates and loan renewals and extensions were expected to hold steady in the coming months.”

Despite the deterioration in farm loan repayment rates in some areas, bankers reported little change in underwriting standards in the second quarter. Collateral requirements on farm loans generally held firm and loan-to-value ratios remained relatively conservative.

“On average, bankers reported about half of their agricultural loans, including operating, farm machinery and real estate, had a loan-to-value ratio between 65 and 80 percent,” the economists said.

“Furthermore, about one-third of their agricultural loans were made with a loan-to-value ratio less than 65 percent. In addition, loan terms remained favorable to borrowers with interest rates holding at low levels, averaging 5.7 percent on operating loans, 5.5 percent on farm machinery loans and 5.4 percent on farm real estate loans.”

Farm income and loan demand

Demand for farm operating loans rose alongside lower farm income in the second quarter. District winter wheat yields in Kansas and Oklahoma were well below average due to poor growing conditions from prolonged drought, followed by scattered storm damage close to harvest.

“In fact, the National Agricultural Statistics Service reported winter wheat yields were down 26 percent from last year in Kansas and fell by 45 percent in Oklahoma. Although U.S. wheat production was down, strong global production estimates kept prices subdued, limiting farm income in the second quarter,” the economists said.

Heavy rains in June were typically too late to help the winter wheat crop but enhanced growing conditions for corn and soybeans. Strong summer storms produced record rainfall and eased severe drought conditions in many parts of the District, boosting production estimates for fall crops and improving pasture conditions for cattle grazing.

“In fact, the U.S. Department of Agriculture projected 2014 corn yields at a record 167.4 bushels per acre, 11 percent higher than the most recent 10-year average. However, the potential for record yields weighed on prices, and futures markets for December delivery of corn were trading close to $4 per bushel at the end of June with further declines in July,” the economists said.

“Furthermore, USDA estimated the cost of production would be more than $4 in 2014 for a typical corn producer with an average yield of about 150 bushels per acre.”

The timing of price movements is also important for revenue expectations. Some farmers have sold a portion of their crop at higher prices earlier in the crop year through forward contracting.

“In addition, support for 2014 farm income could come from crop insurance prices that were set earlier this year at higher levels. If prices remain low through harvest, some farmers may also decide to store grain at harvest and wait for prices to rise before selling,” the economists said.

Most bankers surveyed acknowledged a connection between the strength of the farm economy and Main Street business activity in rural communities. While half of survey respondents felt a strong farm economy was supporting further economic growth in their areas, 40 percent saw signs of weakness in the farm economy that was also dampening Main Street business activity.

Overall, bankers noted lower levels of household and capital spending in the second quarter compared with last year and expected further declines in coming months.

Farmland values

Despite lower farm income, cropland values generally held steady in the second quarter.

Although still above year-ago levels by about 6 percent, the change in non-irrigated and irrigated cropland values from the first to the second quarter of 2014 was less than 1 percent. Ranchland values, however, were still rising, supported by demand from the livestock sector for high-quality pastures. District ranchland values increased more than 2 percent from the first to the second quarter of 2014 and remained a little more than 9 percent above year-ago levels.

“Current trends in farmland values were expected to continue for the rest of the growing season with cropland values holding at high levels and ranchland values rising further,” the economists said.

“Gains in farmland values, however, continued to vary by state. After posting some of the largest increases in farmland values during the past several years, annual value gains for Nebraska cropland in the second quarter were the lowest in the District.”

Farmland value gains have also moderated in Kansas and Missouri, although several years of drought in Kansas supported higher values for irrigated cropland. Bankers in Oklahoma and the Mountain States of Wyoming, Colorado and northern New Mexico reported the strongest year-over-year gains in farmland values in the second quarter due in part to land lease revenues from energy production and easing drought conditions.

Looking forward

Agricultural bankers reported credit conditions held relatively steady in the second quarter, but also noted some emerging risks due to lower farm income. While past profits and crop insurance may help mitigate shrinking margins in 2014, financial stress for crop producers could mount in 2015 if net returns do not improve.

“In addition, should a large fall harvest keep prices low through the beginning of next year, crop insurance might not provide a comparable level of revenue protection in 2015. Looking forward, loan quality may become more of a concern beyond 2014 if repayment rates come under additional pressure from declining profit margins,” the economists said.

Larry Dreiling can be reached by phone at 785-628-1117 or by email at ldreiling@aol.com.

Date: 8/25/2014

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