The other day at the South Dakota Ag Banking School, I was listening to my fellow lecturers Bob Craven and Dale Nordquist from the Center for Farm Financial Management at the University of Minnesota. They discussed some of the trends concerning profitability of farms on the FINBIN financial data base with 60 bankers from around the country listening intently.
After stellar financial performance from a net farm income standpoint from 2009 to 2012, median net incomes are moving back to levels observed in the period between 2003 and 2008. In that era, median net farm income for the average group was typically in the $40,000 to $60,000 range. There were strong profits from 2009 to 2012, in the $120,000 to $190,000 range. Data from 2013 shows the median net income was back to approximately $42,000. The low 20% of producers, after coming off consecutive years of positive median net farm income, are now returning to negative median profits of approximately negative $60,000. The top 20% of producers’ median income, which has been approximately $450,000 to $700,000 in recent years, has declined to approximately $250,000 median net farm income.
What are the implications of this data? First, one principle that I teach in lending schools is that farm profitability issues usually result in cash flow concerns in about two to three years. In other words, low profitability is often an early warning sign of impending financial issues. In this database, cash flow issues will usually occur in the low 20% of producers first, followed by the average producers.
The key will be whether 2014 and 2015 will yield similar negative financial results. If so, financial liquidity reserves will be reduced to critical or negative levels, requiring refinancing of negative margins utilizing equity or additional collateral. This readjustment will require the cooperation of the lenders and regulators that oversee these institutions as well. If credit tightens, particularly on the operating side, then a financial crunch will begin. This will be followed by adjustments in asset values and the possibility of adjustments in cash rent.
In a sense, this financial asset value adjustment will be different than the 1980s. In the 1980s, it was a credit bubble and farms were more financially leveraged. Today’s economics and financials more often look like an asset bubble fueled by low interest rates, agricultural exports, few other opportunity investments, and lots of equity and cash. Thus, any financial adjustment will be much slower, unless an unusual event occurs.
That being said, slipping profitability exhibited by the FINBIN data is one of the first signs adjustments may have to be made into the future. However, it will require a continuing trend to accelerate momentum in asset value correction.