KC Fed: Mounting Pressure in the U.S. Farm Sector

April 13, 2016 11:50 AM

In a special report from the Federal Reserve Bank of Kansas City, Nathan Kauffman outlines the weakening in the nation's ag economy in the first quarter of 2016 and says that weakness "is expected to remain soft through the year."

"The weakening has been relatively gradual over the past few years," he continues, "but it has been persistent and has intensified in recent months amid mounting financial stress for some agricultural producers. Future cash flow appears likely to remain a top concern for producers over the coming year as agricultural credit conditions, and the path of interest rates, evolve."

Kauffman states pessimism about cash flows and profit margins appears to be the main factor driving the weak outlook in the agricultural economy, whereas interest expenses have remained low. "Despite strong loan demand and an increase in the federal funds target rate in December, interest rates on most farm loans have remained historically low," he says.

"In fact, interest expenses for U.S. corn producers accounted for only 9¢ per bu. of production in 2014, the latest year for which data are currently available. In contrast, the average monthly change in corn prices was nearly 40¢ per bu. in 2015. Indeed, the average daily change in corn prices of 8¢ per bu. in 2015 is roughly equal to total annual interest expenses on a per-bushel basis, suggesting that commodity prices and production expenses are likely to outweigh potential near-term concerns about higher interest rates," he observes.

Higher interest rates generally exert downward pressure on farmland values, but other factors also may be important in the current outlook for farm real estate, he states. "Specifically, private sector forecasts of long-term interest rates suggest cash rents may need to fall significantly to have a sizable impact on farmland values in the Corn Belt. In March, the Blue Chip Economic Forecast for the U.S. 10-year Treasury rate was 2.7% for 2017. The capitalized value of farmland, calculated by dividing cash rents by the 10-year Treasury rate, has tracked rather closely with the actual value of farm real estate over time. Applying the Blue Chip Treasury rate assumption for 2017, a 25% drop in cash rents (equivalent to the largest two-year decline in Iowa during the 1980s) would lead to a decrease of 18% from the recent peak," he says.

"A drop in farmland values of this magnitude in the Corn Belt would be notable," he says, "but it would be unlikely to trigger widespread concerns about solvency in the sector overall. An 18% drop in farmland values nationally, for example, would push the U.S. farm sector debt-to-asset ratio to 16.1 from USDA’s current projection for 2016 of 13.2, holding debt levels constant at levels forecast for this year. This would also be a noteworthy rise in the debt-to-asset ratio but still well below levels observed during the farm bust of the 1980s," he concludes.