The farm crisis of the 1980s forced lending practices to change. Prior to the farm crisis, lenders relied heavily on asset values to justify granting credit. The drastic reduction in farmland values highlighted the danger of relying solely on assets.
After the farm crisis, lenders began using cash flow-based financial measures to justify loan decisions. Although lenders rely upon cash flow measures to justify loans, they also rely heavily upon the balance sheet, specifically agricultural assets, to provide security and strength to loan decisions.
Agricultural-related assets complicate the standard accounting definitions. Traditionally, assets are grouped into two categories: current and long-term assets. The categorization of assets is based on how quickly an asset can be converted to cash. For example, crop inventory is considered to be a current asset because it can be sold and converted to cash quickly. On the other hand, land would take time to convert to cash, so logically it is considered to be a long-term asset.
Many agricultural assets fall in between these two types, so a third type, intermediate assets, often is used. Intermediate assets are considered to be those assets that have a life of three to 10 years. Machinery, breeding stock and other equipment are in this category.
The recent boom in land values and subsequent drop in commodity prices have many worried about the impacts of falling farmland values. Land value data coming from the Kansas City Federal Reserve show that land prices have leveled off and even are showing a slight reduction. Many farmers and lenders are concerned about duplicating the 1980s farm crisis because of potential declines in farmland values. Perhaps we should be more concerned with the impact of falling intermediate asset prices.
Intermediate assets are the largest asset category on the average farmer’s balance sheet. They make up roughly 38 percent of total asset values. An average farmer’s intermediate assets have grown from $337,796 in 2007 to $727,633 in 2013. This is a change of more than 120 percent. Long-term assets also have grown during the same time period but only by 84 percent.
Recent machinery sales data reveal that, on average, there has been a 16 percent reduction in the sale price of farm machinery during the past year. Recent reports show that this may be a conservative estimate.
Farmers and lenders must monitor farmland and machinery values in 2015. Low commodity prices are going to make it difficult for many farmers to have a positive cash flow. Lenders are going to have to use the strength of the farmer’s balance sheet to help support the loan justification. Throughout 2015, if necessary, the balance should be adjusted to capture the most recent asset values and provide a more accurate picture of the strength of the balance sheet.