Published: October 16, 2008 04:52 pm            

Farm Programs: Financial crisis impact on agriculture

Originally published in the Oct. 17, 2008, print edition.

The financial crisis in the United States and globally has garnered most of the media and political attention in recent weeks.

We have seen a dramatic downturn in the stock market, an increased level of uncertainty in world financial markets and general financial fear among many segments of the U.S. population.

Some analysts have even compared the current U.S. negative financial situation to the 1929 stock market crash and the Great Depression that followed in the early 1930s. While most financial experts do not feel the U.S. economic situation is quite that dire, most agree that the United States is facing one of our biggest financial challenges in decades.

There has been plenty written and reported about the overall potential impacts and solutions to the current U.S. financial crisis, but what about the impacts to agriculture, farmers and rural communities?

First of all, let’s have a little history lesson about the banking and financial industry. In 1933, after the stock market crash of 1929 and the during the Great Depression, President Franklin Roosevelt and Congress implemented the Federal Deposit Insurance Corp. to protect individual bank deposits up to $100,000. The recently passed $700 billion federal financial bailout bill (H.R. 1424), passed by Congress and signed by President Bush, increased the FDIC bank deposit protection limit to $250,000 per individual through the end of 2009.

Another piece of legislation passed by Congress in 1933 for the protection of bank depositors, also made a clear distinction between “commercial banks” and “investment banks.” This legislation basically restricted commercial banks from offering the same financing services of higher risk investments offered by investment banks, and restricted investment banks from the more typical commercial bank lending.

However, many of the restrictions for commercial versus investment banking were lifted or changed by Congressional legislation in 1999, which allowed many of the large investment banks to expand their portfolios, and ultimately enter into the sub-prime real estate lending, which has been a key factor leading to the current financial crisis.

The good news for most farm families and other residents of the Midwest is that their banks and financial institutions are not greatly involved in the sub-prime lending situation, and have not been as directly impacted by the current U.S. financial mess.

Most local banks in rural areas of the Midwest are doing quite well, and are still making loans of all types, including agriculture, commercial, consumer and home mortgages. In general, independent community banks tend to be a “bit more cautious” in their approach to granting loans and required documentation than some of the national-type lenders, which helps avoid some of the extremely high-risk type loans.

However, the overall impact of the downturn in the U.S. economy is likely to be a factor in the ability of families and businesses to repay existing loans, to secure new credit and for future loan requirements at financial institutions. Many local banks and financial institutions are seeing their sources of financial resources get tighter and more expensive, which could lead to credit becoming a bit tighter and more expensive to customers in the future.

Overall ag economy

At a time when much of the overall U.S. and Minnesota economy is struggling, the ag economy has remained quite strong in 2007 and 2008, especially in the Midwest. The U.S. Department of Agriculture is now estimating total U.S. farm income for fiscal year 2008 (ended on Sept. 30) at $95.7 billion, which is about 10 percent above the 2007 farm income level of $86.8 billion, and 57 percent above the 10-year average for U.S. farm income of $61.1 billion.

Net cash income for 2008 is expected to increase by 16 percent above 2007 levels, due to the higher-than-expected grain prices for carryover 2007 crop inventories. Gross cash receipts from crop production in 2008 are estimated to be 60 percent higher than 2006, while gross receipts from livestock production have only increased by 6 percent during the past two years.

Part of the strength in the agriculture sector is being driven by large growth in ag export markets, which have grown by 40 percent from September 2007. Part of the growth in the export markets was due to a relatively weak U.S. dollar in 2007 and earlier in 2008.

The biggest increase for U.S. ag exports has been in China and India, where rapidly improving economies have resulted in a much larger middle-class population with more spending power. Exports of livestock sector products have increased by 33 percent in the past year, which has helped stabilize U.S. livestock prices, and helped minimize negative profit margins.

Most experts expect strong export demand for U.S. ag products to continue into 2009; however, strength in the U.S. dollar and a weakening global economy could tend to reduce export demand in the year ahead.

The bad news for Midwest farmers is that production costs are increasing at a faster rate than gross farm receipts, which could lead to problems down the road. The USDA estimates total crop-related expenses in the United States for 2008 at $52.4 billion, an increase of 36 percent or $13.7 billion over total crop expenses in 2007.

For the 14 major crops grown in the United States, fertilizer expenses in 2008 have increased 175 percent since 2002, while seed expenses have increased by 72 percent, and pesticide expenses have increased by 29 percent, during that same period. Much of the rise in seed costs can be linked to the rapid biotechnology advancements in the seed industry, which have greatly enhanced crop yields.

Farm fuel prices are currently 39 percent above 2007 price levels, which were 15 percent higher than 2006 fuel price levels. Land rental rates in the Midwest are expected to increase 10 to 25 percent for 2009, compared to 2008 rental rates, and to be 50 to 100 percent above land rental rates three or four years ago. Land rental rates in most areas have been increasing steadily in recent years; however, at much smaller annual rates of increase compared to 2008 and 2009.

Fertilizer costs have seen the most dramatic increase in the past two years, due to rapidly rising oil prices and strong demand for fertilizer products throughout the world. Anhydrous ammonia, the primary source of nitrogen fertilizer for corn production, has risen from about $400 per ton for the 2007 crop, to an estimated $1,100 per ton for the 2009 crop. Similarly, the prices of both phosphate and potash fertilizer have more than tripled in the past two years from near $300 per ton in the fall of 2006 to near $1,000 per ton in 2008.

In addition, many suppliers have required farmers to pay for their 2009 fertilizer supplies in the summer of 2008, forcing producers to borrow funds for crop input costs much earlier than normal, which will increase their 2009 interest expense.

According to the latest USDA data, U.S. livestock producers have incurred an increase of $9.8 billion in feed expenses in 2008, a 25-percent increase above 2007 feed costs. Over the past three years, total feed costs in the United States have increased by $20 billion, or 71 percent, which helps explain why profitability in most segments of livestock production has been in the doldrums for most of 2008. Profitability challenges are likely to continue in most of the livestock sector in the coming months.

Grain markets decline sharply

Corn and soybean prices have dropped dramatically in recent weeks, both on the Chicago Board of Trade and at local grain markets.

Currently, there appears to be a lot of uncertainty in the grain markets, partly related to speculator positions, 2008 production levels, and the overall weakness in the U.S. economy. CBOT December corn futures opened at $4.16 per bushel on Oct. 13, which compared to a close of $5.15/bu. on Sept. 29. CBOT corn futures have dropped more than $1.30/bu. since mid-September and more than $3/bu. since mid-June.

CBOT November soybean futures opened at $9.26/bu. on Oct. 13, which was a drop of more than $1.68/bu. from the closing price of $10.94/bu. on Sept. 29. CBOT soybean futures have dropped over $4/bu. since late August and about $7/bu. since early July.

A bigger concern with the recent dramatic drop in grain prices may be for profitability and cash flow projections for the 2009 crop year. The cash price for harvest delivery in 2009 in southern Minnesota on Oct. 13 just over $4/bu. for corn, and below $8.50/bu. for soybeans.

With the dramatic increase in crop input costs expected for 2009, some analysts expect break-even crop prices at “trend line” yields for 2009 to be $4.50 to $5/bu. for corn and near $9/bu. for soybeans. If that is true, the recent sharp drop in grain prices may have pushed 2009 harvest corn and soybean prices to break-even levels, or lower. This could be an issue in the coming months, if grain prices do not rebound after harvest.

Strategies for 2009

As we look ahead to 2009, U.S. crop revenues are likely to remain strong; however, rapidly rising crop input and land costs will reduce profit potential, and add more risk to 2009 crop production.

The livestock sector is also likely to remain volatile, with varying profit potential during the next 12 months. The short-term operating credit needs for agriculture are likely to increase in the coming year, and the cost of credit may increase slightly. Credit availability for agriculture should remain good for farm businesses that are on a solid financial base. However, credit could get tighter if the overall U.S. and world financial situation continues to worsen, especially for farm businesses in a higher-risk financial position.

Following are some financial strategies for farm businesses to consider during these highly volatile and stressful financial times.

• Keep the “current position” (cash available) segment of the farm business strong.

   • It may be better to use excess cash revenues from 2008 to pay down short-term farm operating debt, rather than to make extra payment on term loans.

   • Use excess 2008 crop revenues to prepay 2009 crop expenses.

   • Pay attention to the level of “working capital” and the “current ratio” on your farm financial statement. If there is a big decline, it could signal some concerns.

• Be cautious of machinery and facility investments for the farm business.

   • Be cautious of the use of available cash for these investments (see above “bullet”).

   • Make sure that the investments have a potential financial return to the business.

   • It may not be wise to purchase upgraded farm machinery late in 2008, just to avoid paying added income tax.

   • Remember that the term loans set up to finance these investments will require payments for several years, and need to be factored into future cash flow budgets.

• Be cautious of buying expensive farmland.

   • There is likely to be a lot of farmland for sale in the coming months. Don’t get caught up in the hype of “Buy now, because they don’t make any more farmland.” Make sure that any land purchases are financially sound for you.

   • Shop around before settling on a farm purchase, as you may be able to find a comparable farm, as far as land quality and production capability, for less money.

   • Compare the cost of owning the land to the likely land rental rates.

   • Be cautious of the use of available cash for land investments (see above “bullet”).

• Look at ways to control expenses and reduce financial risk.

   • Fine-tune your grain marketing plan, based on your cost of production.

   • Take advantage of early order and pre-payment discounts for seed, fertilizer, fuel, etc.

   • Be cautious of excessive bidding for land rent, and consider flexible lease contracts to address volatile crop prices and profitability (if landlord will agree).

   • Livestock producers need to look at opportunities to lock-in feed expenses and other input costs, in addition to locking-in profitable market prices.

   • Avoid risky non-production investments, even if they are agriculture related.

• Communicate with your ag lender.

   • Meet with your ag lender early to discuss your farm operating credit needs for 2009.

   • Discuss planned machinery and equipment purchases, and potential land purchases, and the projected cash flow impacts on the farm business.

   • Discuss your grain and livestock marketing plans.

   • Discuss any financial concerns early, either farm-related or non-farm, while there is still time to make adjustments.

        

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