Low Rates Spell Opportunity and Risk
"When prices are good, everyone wants to be in farming." If that old cliché is true about farmers, it is doubly true of lenders. During the boom of the 1970s and early 1980s, lending to agriculture increased as major banks, investment houses and insurance companies entered the fray. When the inevitable downturn came, many of those eager lenders disappeared. A recent news release from a major insurance company trumpeted a 30 percent increase in its agricultural loan portfolio in 2012 after a 38 percent percent bump in 2011. Does that portend a deluge of easy credit followed by a coming bust? Not likely, or at least not yet, according to longtime agricultural lenders.
"My opinion is that we are still in a period of tighter credit, but there has been some mitigation since the credit drought of 2009," suggested John Blanchfield, senior vice president, Center for Agricultural and Rural Banking, American Bankers Association. "Bankers are scouring the globe to find bankable deals. Credit standards are still high, and it is likely they will remain so for the time being."
"Lenders are concerned about farmland values getting too high and then having a crash as happened in the 1980s following a run-up in land prices in the late 1970s," said Tim Mellencamp, regional vice president, Middle Markets, RaboBank AgriFinance. "To mitigate this risk, lenders are reducing their loan to appraised value limits on farmland."
LENDING: BOOM OR BUST?
That said, the good times being enjoyed by commodity producers are having an impact, and some numbers suggest it is an effect that rivals the booming 1970s. Mellencamp reported that per the USDA, farm debt in constant 2005 dollars is significantly lower today than it was in pre-crash 1979. However, this is deceiving as this debt is concentrated within the overall farmer population. While there are a large number of farmers with little or no debt, there are still a number of farmers with very high debt levels.
Mellencamp cited a 2012 Kansas State study comparing the distribution of debt among farmers in Kansas in 1979 and 2010. The average debt to asset (D/A) ratio in 1979 was 24.6 percent versus 28.8 percent in 2010. Although this suggested a low degree of leverage on average, digging deeper should raise concern.
"The percentage of farmers with D/A ratios greater than 40 percent was 19.4 percent in 1979 and 25.6 percent in 2010," said Mellencamp. "Likewise, the percentage of famers with D/A ratios greater than 70 percent was 1.3 percent in 1979 and 5.9 percent in 2010. I believe this pattern would be similar in most other states."
Blanchfield is not surprised at what he is seeing in agriculture. "Land prices have skyrocketed in certain areas, and this along with high commodity prices has contributed to an agricultural 'wealth effect,'" he said. "Farmers and ranchers feel wealthier, so they are spending to update and expand plant and equipment, and they are looking for more ways to expand their wealth. I have had 80-year old farmers tell me that farming is fun like it has never been before."
Blanchfield admitted that agriculture is in a period of unmatched prosperity, and people are opening their wallets like never before. Suppliers are reporting record sales, and machinery and equipment suppliers are having a hard time keeping inventory in stock. These good times may be the only time in many farmers' lives where they have had the income to do things. However, Blanchfield worries about a downside where people get too used to the “good life” and have a hard time adjusting to the inevitable downturn.
"People forget that liquidity is a good thing, and it is the only thing that will cushion them from a setback, like falling commodity prices," said Blanchfield. "The next decade will be interesting to watch. Is this a peak or a plateau? Will this time be different from all the other farm booms of the past?"
IMPACT ON RETAILERS
What does this mean for full service agricultural retailers? Record low interest rates have made it easy for borrowers with low risk to find competitive rates. Although the Federal Reserve has signaled it intends to keep interest rates low, how long that will last is anybody's guess.
"I know bankers who are currently looking at customer cash flows and simulating a 4 percent to 5 percent rate increase to see if their customers have robust enough cash flow to continue making payments," said Blanchfield. "We all know that rates will go up, but none of us know when it will happen."
Mellencamp pointed out that the customers most likely to look for credit from their retailers are those with the highest risk. "Credit collections may have been good the past few years, but they should have been because crop prices were high and farm income has been strong," he said. "If crop prices fall and farm incomes decline, credit collection could become much more difficult, and agricultural retailers may end up absorbing bad debt write-offs. Best to let the lending professionals provide the credit and take this risk and stick to the business of selling farm supplies."
Blanchfield reinforced that thought, noting that most retailer-extended credit is unsecured credit. The deck is stacked against unsecured lenders if there is a financial problem. "This is an area where a farm supplier/retailer and a banker should work together," he said. "Visit with your banker about a line for indirect credit—meaning the credit is underwritten and funded by the bank, but to the customer, it appears the credit is coming from the retailer."
Those same historically low interest rates that can get a borrower in trouble are also an opportunity, noted Mellencamp, one that is welcome, given the demands of the market. "The higher inventory financing needs of ag retailers requires them to have larger working capital positions to support increased borrowing levels," said Mellencamp. "Any business with long-term debt on a floating interest rate should be looking at fixing the interest rate at today's low rates."
"For those that currently have debt, now is the time to explore opportunities to 'hedge' interest rates by seeking fixed rate loan products," said Blanchfield. "Banks have more than ample liquidity to enable them to accommodate their customers' needs."
LOOKING FOR LENDING OPPORTUNITIES
As he notes with farmers, low interest rates and “good times” are no reason to max out credit lines. "Treat borrowed capital for what it is, a way for a business to acquire assets when needed and to structure repayments in a way that best matches the cash flow of the business," advised Blanchfield. "Low rates simply mean there is an opportunity to take on additional debt if needed and the additional debt makes business sense to the business and its banker."
Although credit standards remain high, the bankers insisted that lenders are looking for lending opportunities. Mellencamp noted that credit fundamentals really haven't changed, even if the amounts being borrowed have increased with business growth and inventory value.
"Management has to have strong risk management practices in place to shield the company from inventory price risk," he said. "The decline in fertilizer prices from 2008 to 2009 caused significant losses for agricultural retailers and was a 'wake-up call' to change risk management practices."
Lending continues to be done the old fashioned way with a solid business plan, added Blanchfield. "Make it easy for your banker to say yes, by showing him or her you've done your homework," he said. "Bankers are looking for solid past performance, a business plan that covers how the new borrowing will be repaid, a track record of accomplishment, a pattern of being successful with past borrowing and the ability to handle an increased level of business complexity if the loan is for expansion."