2016 Mid-year outlook; shows corn and soybean prices taking their toll on operations

2016 Mid-year outlook; shows corn and soybean prices taking their toll on operations

Bumper crops are going to force producers to cut operation costs.

Fallen prices for major commodities such as corn and soybeans continue to take their toll on the financial wherewithal of many producers across the 15-state AgriBank District, which includes the nation's heartland from Wyoming to Ohio and Minnesota to Arkansas. In the following Q&A article, Jerry Lehnertz, senior vice president of Credit at AgriBank, discusses how producers are navigating this environment.

 

Q. As we begin the second half of the year, how would you sum up what's going on in the farm economy, particularly in the 15-state AgriBank District?
A. Many producers had hoped there would be an event or series of events, such as adverse weather, an uptick in global demand or more favorable currency exchange rates that would create better economics in the crop farming space, particularly for corn and soybeans. Although there have been some isolated areas impacted by less than ideal weather, the weather premium has been taken out of market. We've seen prices for both corn and soybeans drop dramatically, as much as 25 percent, in June and July. That has tempered optimism in terms of pricing.

By and large, the crop condition looks good, and that's supported by the USDA's (WASDE) ongoing reporting. If we continue to have good weather, we're going to have another large corn crop and maybe a record soybean crop in terms of overall bushels produced. It seems counterintuitive, that that should be viewed as a bad thing, but increasing prospects for a big crop is going to further challenge crop producers to reduce costs.

Recently, there was some concern about the impact of Brexit (the United Kingdom's vote to exit the European Union) on U.S. agriculture. That has turned out to be somewhat of a non-event. But it has strengthened the dollar a bit, which is bad for exports, which further crimps demand, not only for raw commodities but also for animal protein products.

 

Q. What's the good news about lower commodity prices?
A. The good news is it makes for very reasonably priced inputs for livestock producers. Poultry, beef, swine and dairy will benefit from not only lower, but perhaps much lower, commodity prices. That said, throughout many of those industries, new processing capacity is expected to come on line in 2017 and 2018.  Although lower corn and bean prices will result in near-term benefits, there may be some challenges unless something creates demand or otherwise tempers supply in order to move commodity prices higher. In the recent past, we experienced a number of things that tempered supply, including the 2012 drought, PEDv (porcine epidemic diarrhea virus) in the swine industry, avian influenza in the egg industry—all things that no one hopes will be repeated.

 

Q. What could be demand drivers?
A. Over the past 10 years, ethanol (corn) and China (soybeans) were the key demand drivers. I don't know anyone who tracks these more closely than I who knows what the next significant demand driver will be for either crops or animal protein. We continue to see demand from the rising middle class in developing countries such as China, but they need to have the ability to pay for our products. We're dependent on their economies and their ability to buy our products.

 

Q. Farm Credit lenders have seen a slight uptick in adverse loans, but credit quality remains extremely strong by historical standards. What does that tell us about borrowers' positions?
A. Since we first anticipated today's challenging cycle several years ago, all the things we've said about our farmers—that they had strong balance sheets and good working capital to weather a storm—were true. We haven't seen a dramatic decline in credit quality. What we have seen in terms of declining credit quality thus far primarily resides with producers that have experienced price adversity but didn't enter this period with strong balance sheets or working capital. In the third or fourth year of the cycle, we expect to see a more pronounced decline in the credit quality numbers. I'm not predicting that, but it's something we're keeping an eye on.

 

Q. Other than the outliers, what are other producers experiencing in terms of their financial strength?
A. For many producers, balance sheets are weakening, working capital is weakening, and cash flows are strained, with the exception of a very small number of producers who, for a variety of reasons, haven't been impacted by that. Soon we'll have updated information on land values and will be able to confirm if our expectation for modest contraction is, in fact, occurring. That's important, because land is an important line item on a farmer's balance sheet. It allows producers to rebalance debt and create working capital. At some point, a strong balance sheet becomes weak if you're incurring losses for three or four consecutive years.

 

Q. How are producers coping with the current environment?
A. American farmers have been and continue to be very resilient. They adjust to a changing environment. Regrettably, some producers won't make it through this down cycle, but the ones that do will be will have great opportunity. The very best producers—prudent, creative risk-takers—look at this as an opportunistic time. They've been able to maintain strong balance sheets and liquidity, and they're going to expand their operations as others go out of business. This could be the environment that springboards them into greater success.

 

Q. What are key things producers are doing to maintain their financial health?
A. We are seeing farmers who are tactfully renegotiating land rents and negotiating harder on input costs. We're also seeing a willingness to let go of non-producing or under-producing assets to create working capital and/or reduce debt. That could mean selling an 80 or a 40, or selling excess machinery or equipment. Machinery and equipment were very easy to accumulate in recent years, when many farmers were looking to manage tax liability by buying depreciable assets. In addition, we're seeing much greater emphasis on intensity of management. For example, a farmer asks, "How do I squeeze the next bushel of corn out of an acre of land?" However, one could argue that mentality further compounds the problem.

 

Q. How are Farm Credit lenders working with customers to help them navigate the current environment?
A. Farm Credit Associations have been have been very proactive in terms of deploying resources (knowledgeable people) to farmers that are in a more distressed state. A big component of this is being candid with borrowers around what reasonable actions are. In many cases those are very difficult decisions and actions. These actions often involve rebalancing debt to bolster working capital and/or reduce principal payment requirements. They could also involve refinancing, since borrowers still have the opportunity to lock in historically low interest rates. Discussions may also center on controlling costs, adjusting the make-up of balance sheets, or selling assets. Most borrowers respect and are receptive to that very type of candid discussion.

The focus has been on commodity prices—in the minds of many producers, if the price of corn were $4.50 to $5 per bushel vs. $3 to 3.50 per bushel, a lot of problems would be solved. However, hope—thinking that things might be better next year—is not a plan. Farmers and lenders need to work together to take proactive steps to navigate through today's environment.

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