Research and Insights

Farm Credit East Mid-year Agricultural Credit Conditions Report

Farm Credit East has released the cooperative’s mid-year Agricultural Credit Conditions report indicating that while most farmers are in good financial condition in 2015, excessive moisture in key crop regions could result in problems for some producers. All eyes will be on the weather going forward, as that will be the main determinant in the yield and quality of 2015 crops. Based on current market prices, Farm Credit East is projecting 2015 net farm income to be 24 percent lower than the most recent five-year average.

Farm Credit East Releases 2015 Mid-year Credit Outlook

AgriBank Insights

Weather forecasters have declared the arrival of El Niño, complex weather patterns resulting from variations in ocean temperatures in the Pacific Ocean. The National Oceanic and Atmospheric Administration (NOAA) says the “forecaster consensus” is for a strong El Niño event that has a 90 percent chance of persisting through fall and an 85 percent chance of lasting through winter. What does this mean for major crops across America’s heartland, namely corn and soybeans? History offers some clues, as discussed in the latest edition of AgriBank Insights.

El Niño: Could This Cyclical Extreme Be Good for Corn and Soybean Production?

Shared Roots: The Federal Reserve System and the Farm Credit System
On Dec. 23, 1913, President Woodrow Wilson signed the Federal Reserve Act (FRA) into law creating the Federal Reserve System. Just 31 months later, on July 17, 1916, he signed the Farm Loan Act (FLA) into law, the first step in creating the Farm Credit System. The Federal Reserve celebrated its Centennial in 2013-2014 and the Farm Credit System will do so in 2015-16. The FRA became the template for the FLA, launching a Farm Credit System committed to serving the financial needs of agriculture and rural America.

Shared Roots: The Federal Reserve System and the Farm Credit System explores the shared common history of the Federal Reserve System and the Farm Credit System.

2014 Coordinating Committee Invited Research Papers

Funded by the Coordinating Committee of the Farm Credit Council

The System Coordinating Committee of the Farm Credit Council has long recognized and valued the important research role that farm finance and agricultural economics faculty play in shaping policy in, and performance of, our Nation’s agricultural credit system. It was this recognition that led the Committee to begin commissioning research papers from faculty from across the US. The committee has funded 21 papers on selected topics, since the inception of the project in 2012. In 2014, the program requested papers in one of four topics of interest to the Committee during this solicitation period, as follows:

  1. An in-depth examination into the agricultural finance implications of the unprecedented intergenerational transfer of ownership of farmland over the next decade, focusing on constraints caused by cyclical downturns in net farm income and land values, or related subject.
  2. An examination of the true demographics of farm ownership and transfer of same, identifying the structure of management associated with farm operations and/or emerging trends in farm ownership, renewed interest in agriculture as a career, or related subject.
  3. An examination of the potential impacts of mortgage regulations established under Dodd-Frank on the availability of credit for rural housing, or related subject.
  4. Any topic of interest to the author in the farm finance area or related to the Farm Credit System.

Following are the nine research papers that were chosen from 12 submissions and delivered to Farm Credit in the fall of 2014.

1. “Impact of Stagnant or Declining Population Growth, Changing Customer Preferences and Increased Banking Regulations on Agricultural Banks Located in Rural Counties ”

Freddie Barnard, Purdue University

Summary: Three overarching factors will likely determine the presence of a bank or bank branch facility in many rural counties in the U.S. Those factors are declining population, changing customer desires and increased regulatory costs. The ability of agricultural banks in rural counties with declining populations to address these concerns will determine which banks survive the challenges ahead. The likely decrease in the number of agricultural banks and reluctance of larger commercial banks to open a branch in rural counties with stagnant or declining population growth will provide opportunities for other lending institutions located in those, or adjacent, counties. The identification of such opportunities will enable the financial institutions that remain to better focus resources and project future lending opportunities. However, the financial product and service needs of residents in those rural counties will likely be satisfied increasingly through electronic delivery means. The adoption of computers and the use of the internet and mobile devices such as smart phones will enable providers of financial products and services, to expand their customer base and deliver financial products and services to rural counties where locating a branch would not be feasible.

2. “The U.S. Cattle Cycle and Agricultural Lender Risk.”

Gary Brester, Professor of Agricultural Economic, Montana State University

Summary: Agricultural lenders are certainly concerned about the duration of high cattle prices. Many livestock producers use intermediate-term debt to purchase breeding stock and machinery and use long-term debt to purchase ranch land. The security of such loans depends greatly upon the behavior of cattle prices over the next several years. If history repeats itself, then record high cattle prices will not exist for an extended period of time. However, if the factors that have caused current high prices do not reverse themselves, and cattle inventories do not increase substantially, then cattle prices are likely to remain at relatively high levels. Although we believe that the probability of a historically precipitous decline from record levels in the near future is small, smaller declines could certainly occur. Consequently, lenders should include such scenarios in balance sheet stress testing and capital management actions.

3. “Implications of a Low Interest Rate Environment for U.S. Agriculture”

Brian C. Briggeman, PhD, Associate Professor and Director Arthur Capper Cooperative Center, Kansas State University

Summary: The objective of this paper is to explore the implications of today’s low interest rate environment on U.S. agriculture as well as provide some talking points about how future interest rate changes might affect U.S. agriculture. The focus will be on the implications of the changing yield curve, capitalization rates, exchange rates, and commodity markets. Looking forward, interest rates will have to rise at some point in time, which could bring about a set of familiar challenges and opportunities for producers, lenders, and agribusinesses who serve U.S. agriculture. The key to thriving in a higher interest rate environment lies within some tried and true sound farm and financial management practices that have benefited many for decades.

In summary, today’s accommodative monetary policy has had an impact on U.S. agriculture. While these impacts have varied, they in general have provided an additional boost to the already favorable supply and demand fundamentals. Looking forward, interest rates will have to rise and that could have a negative and reverberating impact throughout agriculture. Following good sound business practices should help ensure today’s U.S. agricultural producer will not only survive these likely initial negative impacts but thrive in a higher interest rate environment.

4. “Financial Position and Credit Considerations of Diverse Agricultural Producers.”

Mary Clare Ahearn Senior Economist (retired), Economic Research Service, USDA. Co-Editor, Choices Magazine, Agricultural and Applied Economics Association.

Summary: An overall goal of this paper is to present a clearer understanding of the financial positions, and, hence, credit needs and financial strength of the diverse groups which comprise the agricultural sector. Such an understanding should allow the Farm Credit System to better understand how to meet the credit needs of diverse groups, while at the same time ensuring the soundness of the system by lending to producers with potential to be successful in agriculture. The ability of the FCS to meet the credit needs of small farms may be limited by the charter of the banks regarding sources of income, i.e., farm vs. nonfarm, and underwriting requirements. Looking to the future, there are likely to be nonfarm demands for the services of lenders traditionally serving agricultural interests. The Farm Credit System has clearly recognized this need and opportunity through CoBank's leadership with the Rural Infrastructure Opportunity

Fund (Executive Office of the President, 2014). Investing in rural America may well be a more effective manner in which to address the financial needs of many small farm households in rural America by spurring economic activity in local communities. A more prosperous rural America means more off-farm opportunities and greater opportunities for small farmers to meet the increasing demands for locally-produced agricultural products.

5. “Farmland Values, Farmer Equity and Equilibrium in the Agricultural Capital Market.”

Charles B. Moss, University of Florida

Summary: Farm ownership in the United States has remained one of the last bastions of the sole proprietorship. This study examines the econometric evidence that this structure fails to meet the equilibrium with broader equity markets in the United States. In particular, the study focuses on the potential division of farm assets into operating assets and farmland. Finding that neither operating assets nor farmland prices move in equilibrium with the broader stock market index, the study turns to agency theory to explain the possible reasons for this persistent disequilibrium.

6. “Dodd-Frank stress testing: macroeconomic variables and scenarios that make sense for FCS institutions.”

Dr. Jeffrey R. Stokes, University of Northern Iowa

Summary: The purpose of this research is twofold. First, a paradigm is suggested that FCS institutions might follow in developing plausible stress testing scenarios. In short, the paradigm consists of steps for identifying relevant macroeconomic variables using basic economic theory and empirical methods. Two detailed examples are provided that include the identification of plausible stress for the variables identified. In this setting, “plausible stress” is data determined and a simple rule is presented to identify levels of plausible stress. Second, since the dynamic evolution of risk ratings often plays a central role in the characterization of credit risk exposure over time, a procedure is suggested for appropriately stressing a risk rating migration matrix. A detailed empirical example for a stressed portfolio of loans to dairy producers is provided.

Conclusions: Identifying appropriate macroeconomic variables for stress testing FCS institution portfolios is a challenging exercise. In this paper, a simple farmland valuation model is developed and subsequently corroborated with simple econometrics. The analysis shows that for the farm real estate portion of an FCS bank’s portfolio, the value of farmland can be related to cash rents, commodity prices, yields, and capitalization and interest rates. As such, these variables are important for stress testing efforts by the bank.

7. “The Subtle Demographic Trends Reshaping American Agriculture Long-Term Trends in Farm Demographics, Debt Use, and Land Ownership: Implications for the Financial Needs of U.S. Farming.”

Brent A. Gloy and David A. Widmar, Agricultural Economic Insights, LLC and Purdue University

Summary: The examination of the demographics, land ownership and control, and debt use practices of U.S. farmers leads to several important implications for the Farm Credit System. First, it is clear that the farm population continues to age. Given that the second largest demographic group in the sector is between 54 and 65 years of age, the average age of farmers will likely continue to increase in the coming years. At some point this trend will likely run its course.

The data indicate that the current farm population is as heavily skewed toward older operators as any time in history. While modern technology allows farmers to work longer there is clearly a limit to this trend. It is also true that there are a number of multi-operator households and that some of these operations likely have transition plans in place. However, it is also likely that there will be a large transfer of asset ownership and control in the coming decade.

It is important to be clear that we are not in any way suggesting that the U.S. will run out of farms of face any kind of “crisis” related to food production. The data simply suggest that there are considerable numbers of older farmers that are going transition from agriculture. Some of these farms already have other generations farming with them, while others may not have a successor. Regardless, this will create change and opportunity. Significant amounts of real estate will change hands, some through inheritance some through sales, but nonetheless there will be change as this demographic group continues to age.

8. “The Impact of Unallocated Equity on Agricultural Cooperatives”

Phil Kenkel, Regents Professor and Bill Fitzwater Cooperative Chair, Oklahoma State University

Summary: This paper has highlighted an important trend in the profit retention and capital structure of U.S. cooperatives. Our survey was one of the first efforts to understand the value that cooperative members place on revolving allocated equity and how their ownership of allocated equity influences their involvement in the cooperative. The results were intriguing and highlight the need for further research. While our results were similar across board members and the small sample of member respondents, a larger sample of member responses would be beneficial. Investigating the level at which members might liquidate a cooperative is very sensitive, which makes it difficult to get assistance from cooperative CEOs and board members in soliciting responses from cooperative members. In the coming decade, an unprecedented intergenerational transfer of farm management and farmland ownership will occur. In tandem with this transition, there will be a transition in the active membership in agricultural cooperatives. Younger producers may have different perspectives on the cooperative value package. It will be essential for cooperatives to educate these younger members on the cooperative’s alternatives in profit distribution and equity creation. It will be equally important for cooperatives to understand the importance that those producers place on access to the cooperative infrastructure, patronage and equity. Cooperatives should focus on financial structures that meet those needs while allowing the firm to compete effectively.

9. “Mortgage Lending Compliance Structure Pertaining to Dodd-Frank and the Availability of Credit for Rural Housing”

Dr. Greg McKee, North Dakota State University and Dr. Albert Kagan, Concordia College

Summary: Rural residential real estate loans are 2.9 percent of the total Farm Credit System loans in 2013. This percentage has been consistently in the 3 percent range since 2005 when this category became a reported item in the Uniform Call Report. This loan category is the fourth largest loan type within the FCS; however the percentage has been unchanged since 2005. This may indicate that rural residential real estate loans are not viewed as a risk diversion item across the System.

The degree of concentration of this loan type further supports the assumption that many ACAs do not pursue these loans as a risk mitigation product. Study participants from the Agricultural Credit Associations that agreed to be interviewed for this project expressed three consistent views with respect to rural residential real estate loans. The first view is that the infrastructure needed by an association to enter this market is expensive and requires to be continually updated. The second consistent observation was that this market segment has certain competitive dynamics that are not present within other components of an ACA’s portfolio. The third view mentioned by the ACA participants was the limited market segment (FCA definition of potential loan borrowers), the investment in an associations stock and oftentimes the constraint of the moderately priced valuation.

2013 Coordinating Committee Invited Research Papers

The System Coordinating Committee of the Farm Credit Council has long recognized and valued the important research role that farm finance and agricultural economics faculty play in shaping policy in, and performance of, our Nation’s agricultural credit system. It was this recognition that led the Committee to begin commissioning research papers from faculty from across the U.S. The committee has funded 12 papers on selected topics, since the inception of the project in 2012. In 2013, to expand the available data surrounding the demand for capital, how it can best be delivered to potential users and how the risk of providing it can best be managed, the System Coordinating Committee invited scholars to develop and submit research reports addressing the following topics:

  1. Assessing the capital required to execute the unprecedented intergenerational transfer of ownership of farmland over the next decade, or related subject
  2. Assessing the capital required to facilitate the increased food production that will be necessary to meet the nutritional demands of an expanding world population, or related subject

Following are the seven research papers that were chosen from 10 submissions and delivered to Farm Credit in the fall of 2013.

1. “A Stochastic Simulation of Intergenerational Farm Transfers.”

Devin R. Peterson, Lead Author and Graduate Assistant, Texas A&M University; John L. Park, Professor and Extension Specialist, Texas A&M University; David J. Leatham, Professor, Texas A&M University; Camille G. Peterson, Graduate Assistant, Texas A&M University

This study evaluates eight succession methods and the ensuing capital requirements under risk and uncertainty in order to execute an intergenerational farm ownership transfer. This is done from viewpoints of the lender, owner-operator and successor, in an effort to provide findings that will help these three groups effectively plan for future capital needs, examine risk level inherent in the decision, and compare the feasibility of various transfer methods.

2. “Finance Implications of Intergenerational Transfer of US Farms.”

Freddie Barnard and Elizabeth Yeager, Purdue University

This study evaluates three methods for the intergenerational transfer of capital assets, measuring and analyzing the repayment risk for each. Because inadequate financing or an inappropriate mix of financing can be a major contributor to the failure of the intergenerational transfer of capital assets, this study aims to identify the transfer method/s that present the lowest risk.

3. “The Future Global Food Situation and Its Financial Implications for US Agriculture: Is This Time Different?”

David Freshwater, University of Kentucky

This paper examines three possible scenarios regarding the future global food situation, analyzes the implications for the finance industry and predicts which scenario will prevail.

  • A future with a fixed stock of farmland where producers compete for the land as a way to capture the higher profits brought about by an expanding demand for farm outputs.
  • A scenario that sees the global demand for agricultural products increasing and resulting in higher market revenue. Here, the fixed stock of farmland requires that increases in output come mainly from the biological revolution, which allows each acre of land to produce more and not from Total Factor Productivity.
  • A world where the recent interval of high prices overlaps with increased commodity output resulting in an overcapitalization and supply of commodities, as well as a return to depressed commodity prices.

4. “Credit Demand in the Face of Changing Farm Policy.”

Barrett Kirwan, University of Illinois

This paper examines the response of credit demand to greater crop insurance coverage. Between 2005 and 2011 federal crop insurance experienced several expansions - subsidies to enterprise units increased substantially and coverage expanded to include several more commodities. The author uses these expansions in the federal crop insurance program to establish the effect on farm debt.

5. “Farm Credit System Lending and Global Food Demand: Evidence from the Past Two Decades.”

Valentina Hartarska and Shelley Shen, Auburn University

This paper evaluates the extent to which food prices affect farmers’ use of agricultural credit. Specifically, the authors study the relationship between global food prices and agricultural loans by the Farm Credit System institutions. They also account for credit supplied by commercial banks because together the FCS institutions and the commercial banks extend the vast majority of operating and real estate backed loans to US farmers.

6. “Finance Implications of Intergenerational Transfer of US Farms.”

Dr. Ani Katchova, Associate Professor, University of Kentucky

This paper identifies the mechanics and dynamics of farm transitions and land ownership in US agriculture. The author examines the transition matrices of farms entering and exiting agriculture, and farmer turnover in existing operations. Land ownership changes are identified using a time series approach that tracks the same farms over time and identifies changes in ownership. The author uses short- and longer- horizon projections of the trends over the last decade going forward to obtain the expected proportion of farm transitions and their land ownership turnover. These projections indicate the capital and financing needs for farmers transitioning into agriculture.

7. “Economic Development in Indian Country: An analysis of and the case for diversification into food and agriculture.”

Vince Logan, Janie Hipp and Stacy Leeds, University of Arkansas School of Law

This study provides an introduction to Indian Country and intergenerational farmland issues. These issues include current efforts to address intergenerational transfer issues, current Indian Country involvement in food ventures and food export, and its potential role in feeding an expanding world population. The authors look at issues regarding the current state of agriculture in Indian Country, including a present census of food production; an analysis of food, nutrition and healthy living; and an analysis of the gaming and energy economic impact paradigms for lessons on what to do differently with agriculture development. The paper also presents a series of tools needed for Indian Country Food and Agriculture Economic Development, as well as recommendations for how to develop agricultural professionals in Indian Country.