This gloomy forecast could signal the end of the U.S. farming boom, which has led to record-high profits for farms and ag lenders over the past three years.
"The fortunes of the farm banks will mirror the fortunes of the farmers," says Mark Scanlan, senior vice president of agricultural and rural policy at the ICBA. "Record income in agriculture is never something you can expect to keep going forever, so farmers and bankers will have to be on their toes."
Agriculture has been one of the few bright spots in the U.S. economy since the financial crisis, as high international demand for crops — particularly from China, which in 2011 became the biggest importer of U.S. crops — and an increasing reliance on ethanol-based fuel have pushed up commodity prices. The extra income has allowed farmers to finance investments in land and equipment. Total farm debt rose by 15% from 2009 through 2013, to more than $309 billion, according to the USDA.
Farm-bank profits have risen in turn. Net pretax income at farm banks rose by about 57% from 2009 through 2012, to $3.6 billion, according to latest data from the American Bankers Association. Farm profits have been so good that even a down year is decent by historical standards, says John Blanchfield, senior vice president at the ABA's Center for Agricultural and Rural Banking. "The good news is that the 2014 projection is still better than the 10-year running average," Blanchfield says. "But it will cause a correction in the super-hot farm economy."
The hot ag economy has given many farmers a cash cushion that should help them weather a year of declining income. Bankers have also been more sensible about lending than in previous farming boom cycles, observers say. "If it's a one-year turn, most everybody will survive, because they've got cash on hand and they're not over-leveraged," says Bob Wray, the president of the Capital Corp., a Kansas investment bank that advises many rural lenders. "Right now, bankers are more worried about loan demand and margins than they are about default."
Margins and loan demand have begun to dip, ag bankers say. But the downturn in farm revenue could actually help boost demand, by forcing farmers to borrow as they deplete their cash reserves, says Blanchfield. During the boom, farmers were able to finance improvements and purchases in part with their own working capital. A downturn may force them to borrow a higher proportion of the money they invest in their farms.
Most observers expect ag-loan defaults to remain low. Nonperforming agriculture loans fell by $402 million in 2013, to $3.1 billion, and the nonperforming loan ratio fell by 26 basis points, to 1.22%, according to the ABA.
However, many ag bankers predict that their clients will have trouble making loan payments this year. Pete Haddeland, Subchapter S Bank Association Board Member and president and CEO of the $88 million-asset First National Bank in Mahnomen, Minn., says his bank's analysis shows the average debt-coverage ratio for his clients dipping from roughly 1.80 in a normal year to just over 1 this year. (A ratio below 1 means the client's cash flow is not enough to cover loan payments.)
Scott Tewksbury, president of Heartland State Bank in Edgeley, N.D., says that most of his clients "should be able to just make their payments or just miss," depending on their level of debt. Lower commodity prices mean that types of crop insurance that are pegged to crop values will pay out less in case of a bad harvest. There was a drought last year across much of North Dakota, and Tewksbury, whose $63 million-asset bank holds about 85% ag loans, is worried that this year could be worse. "Revenue guarantees are substantially down, so the risk profile of farmers and the bankers lending to them is greater," Tewksbury says. "If we have a short crop again this year, then we will have greater losses than we had last year."
Complicating matters for farmers and lenders is the farm bill that President Obama signed into law last month. Community bankers generally approved of the bill, which expands crop insurance significantly. But the bill ends direct payments to farmers. These politically controversial payments are fixed subsidies sent to farmers regardless of changes in crop prices. The USDA expects government payments to farmers to drop more than 45% this year, to $6.1 billion, largely as a result of the new law.
If the ag boom is indeed coming to an end, crop insurance and other subsidies will become more important, says Haddeland.
Despite the projections for 2014, most ag bankers and industry analysts are not overly worried, at least for the short term. "This year isn't necessarily the big concern," says Scanlan. "It's really what's the situation going to be like in 2015 and 2016." A prolonged slump may force changes to the farming price structure that will reduce banks' margins. As the ag boom has boosted profits, it has also driven up the cost of land rents, fertilizer and equipment, which will begin to pinch farmers if their incomes fall further.
Farmers and ag bankers are aware that revenue is influenced by factors that cannot be forecast accurately. For instance, corn and wheat prices, which were expected to fall, have rallied in recent weeks as the conflict in Ukraine has intensified, and a drought in Brazil has helped push up soybean prices.
This uncertainty has encouraged a wait-and-see approach among farm lenders.