Summer 2014 AgViews: Current Conditions Down on the Farm

By Lynn Paulson, Senior Vice President, Director of Agribusiness Development, Bell State Bank & Trust

Things clearly have changed for most grain producers since the high point of unprecedented prosperity in the fourth quarter of 2012. Most everyone knew there were likely going to be corrections to this extraordinary opulence, but sometimes it takes harsh reality to realize stark truths.

The 2014 crop conditions vary across the upper Midwest. Most areas have sufficient moisture. Many areas have too much. There will be some areas that will be filing prevent plant crop insurance claims on some of their acres again this year. With lower revenue prices, this coverage isn’t as lucrative as in previous years.

Although the crop was late getting planted in most cases, producers were able to make rapid progress in late May and early June to get the bulk of the acres seeded ahead of crop insurance final planting dates. Most farmers are well equipped to get a large amount of acres planted in a short period of time. I find, on average, that many can get about 10% of their crop planted per day when conditions are good.

Once the crop is in the ground, July and August growing conditions will play a large role in how the crop will ultimately turn out at harvest.

Our Ag Portfolio

While there’s been a well-documented economic downturn in most non-livestock ag sectors, in our ag portfolio, I’ve seen the corn and sugar beet producers in general experiencing the largest correction. By and large, these commodities experienced the largest percentage of drop in year-over-year commodity prices between 2012 and 2013.

In our agricultural loan portfolios – and those of the many correspondent banks we have the good fortune to be associated with – 2013 was not a particularly great year for crop producers’ bottom line. It’s also been a challenge to show adequate debt service coverage under realistic income and expense projections for the 2014 crop.

Ironically, many producers didn’t take a huge hit to their net worth in 2013 – in fact, a fair amount were neutral or showed a small increase in their overall earned equity. The problem was the cash flow simply could not cover their debt obligations.

It’s important to understand you can be profitable, but still not manage cash flow. The inverse is also true. You can manage cash flow (from previous year’s inventory for example), but not be profitable. Breaking even is only satisfactory if you have no term debt to service.

The net result was working capital, or liquidity, declining significantly. The top third of their balance sheet deteriorated in almost all operations. There are cases where borrowers leveraged equity in recently purchased equipment or land to build working capital back into an operation and reduce the overall size of the 2014 operating loan. But they also understand that unless over time, we have increased levels of profits, this isn’t a long-term solution. You can’t borrow your way out of debt, and you can’t spend your way into prosperity.

Liquidity or working capital is the shock absorber that gets you through the speed bumps and cycles farming invariably creates.

Essentially, there are only two ways to reduce term debt – either make money or sell assets. Ironically, both may have negative income tax consequences. Moreover, it may be an ironic twist come year end when operations may not have experienced a very good year, but will still be facing an income tax bill because of the large amount of carryover income from 2013 into 2014, and a lot of 2014 expenses prepaid in 2013 to minimize taxes in the previous year.

Unquestionably, we develop bad habits during good times and good habits during bad times.

Livestock Sector Update

It’s important to note that the livestock sector has been doing very well. Cow/calf producers are experiencing some of the best economic times ever – $1,000 calves at weaning or cow/calf pairs selling for north of $3,000 are clearly an indication of the good times. Cow/calf producers have the benefit of being able to look out about two years with a pretty clear understanding of what their price outlook looks like. Given that it takes about 30 months after deciding to start rebuilding a rancher’s herd for the first calf to go to market, there’s no quick turnaround in this business.

Cattle feeders need to be mindful of what they’re paying for feeder cattle – it’s easy for the profit margins to evaporate. Dairy is doing very well, with milk in some areas around $25/cwt. Export demand to China has been a huge driver of demand.

Having been an ag banker in the 1980s, I find it interesting and somewhat reassuring that many ag lenders seem to be quicker to understand the economic realities of the current environment than they did 30 years ago. A lot of ag lenders today – while taking the long view – are having heart-to-heart discussions with their ag customers about the impact of the current economic situation as it relates to cash flow, debt service, leverage and profitability. If they’re not, they’re maybe not doing their job.

I also find it interesting that many ag lenders today are less hesitant than they’ve been in the recent past of either cutting a current customer loose or walking away from a new financing opportunity, if the risk profile of the deal isn’t right. A lot of bankers, but not all, are thinking more with their heads than their hearts this time around.

Farmers themselves seem to be developing a deeper understanding of their financials – if only for their own future viability. Many are stronger managers than the previous generation of producers. Understanding the numbers and using that knowledge to drive sound management decisions in the future will be imperative. Often in business, we are drowning in data, but starving for information.

2014 Outlook

For 2014, I don’t see a lot of major changes happening in most operations, other than a reduction in capital purchases in many. The cash – and sometimes the need – simply isn’t there in many operations to be making significant equipment or real estate purchases. Moreover, for many operations that have leverage and borrow a fair amount of operating money, it’s likely their lender may have put restrictions of capital purchases as part of their loan agreements.

Top-flight managers will continue to do well. Good financial discipline and management will again separate winners and losers. When everyone was making money – when it was a difference of making $50/acre or $250/acre, management didn’t seem that important. When that difference becomes losing $100/acre or making $100/acre, good management once again does matter.

Time waits for no one. Don’t let the clock be the thief and lull you into complacency. Operations need to be proactive as well as reactive.

I’d estimate that maybe 10% of producers really know what their break-even prices are on either a farm or enterprise basis for the commodities they raise. I find that somewhat concerning and something I hope will change going forward. I believe it’s hard to develop a marketing and/or financial plan if you’re always shooting from the hip.

With that somber outlook, are we in a “crisis”? I think probably not. Having said that, if we continue to face the commodity price challenges we have seen in the last 18 months for the next two to three years, all bets are off. Unless there are meaningful adjustments in the cost of production structure, there will be leveraged operations that will struggle to survive long-term with sub-$4 corn and beans in the single digits – or significant increases in interest rates – without major changes to their balance sheet and operation. Most bankers won’t be balance sheet or equity lenders for an unlimited number of years. Ultimately, we like to see loans repaid with profits, not liquidation of collateral or other non-current assets. While 2014 is still important, watch what happens in 2015 and 2016.

The majority of farm operations are strong and will survive this downturn. Those that have not had to use any downside risk management tools in their farming career could be challenged. Smooth seas never made a skillful sailor. With adversity comes opportunity. Be aware – be watchful.

Using a baseball metaphor, from 2006 through 2012, there were a number of home run years. Going forward, it’s maybe going to be small ball – singles, walks and good defense. In some sense, maybe that’s not entirely all bad. At the end of the day, $7 and $8 corn may not have been good for everyone.

Health of the Ag Sector

It seems that the main barometer of the ag sector’s health is the trend in land values. For the most part, while there has been a moderate correction of 20 or 25% in some areas –a figure the farm sector can handle – the bubble that some had predicted hasn’t occurred. In parts of our footprint, land that was selling for $7,000/acre at year-end 2012 is maybe selling for $6,000/acre now.

Corn Belt prices have leveled off as well. That said, there are always high-profile sales that catch people’s attention. A recent sale in Iowa reportedly topped $20,000/acre.

What Drives Land Prices

It’s always interesting to remember what drives land prices. Experts often say it’s driven by three main factors – commodity prices, interest rates and crop insurance, the latter having been a terrific risk management tool.
I think there may be a couple more to consider.

  • Efficiencies – When you consider the advancements made in technology in recent years, it can be mind boggling. The improvement in genetics is astounding – and it only continues to get better. Advancements in automation are amazing. Variable rate and precision seeding, GPS, auto steer, monitoring and information systems in tractors and combines create a wealth of data that has contributed to increased production and gross revenue per acre.
  • Risk tolerance – I thought about this one for awhile, but I think it’s important to consider with respect to either short-term memories of challenging economic times or not having experienced them at all – having played a role in some of the irrational exuberance that had a influence of land prices. I think many forgot that the long-term job of commodity markets is to hold high-cost producers under water long enough to move those resources from the high-cost to the low-cost producers.

Reportedly, about 83% of the real estate loans at Farm Credit of America have fixed rates which, if applied to farm real estate loans in general, should help cushion interest rate shocks – at least in the short term.

A couple of demographics to watch: highly leveraged young farmers and large farm operations that have taken on a lot of debt (more than 50% debt load) in recent years.

While we need to learn from the past and prepare for the future, we can’t ignore the present. Not one of us can change yesterday, and no one has tomorrow promised, so get a hold of reality and spend some of your time doing the best you can do today.

A good ag banker is never more important to an operation than during challenging times. If you don’t currently do business with us and you’re interested in a second opinion, give us a call. We have terrific ag bankers who understand your business and will give you an honest, but respectful, assessment of your operation.

The Problem With Water

There’s been There’s been a lot of national publicity in the last year or so regarding the major drought going on in the Southwest – mainly California. All one has to do is go into the grocery store and see what a lot of fresh produce is selling for to see first-hand the impact.

Water is one of those finicky things. It’s a big problem if you have too much and a big problem if you don’t have enough.

The reality is most of the world is short of fresh water. In the U.S., nearly half of all crop revenue grows on just 16% of the land that is irrigated. The remaining 84% (farms not irrigated) produces just over 50% of the crop value. Nebraska and California lead the U.S. in percent of acres irrigated with 15.1% and 14.2% respectively.

The Ogallala Aquifer that serves as the major source of irrigated water for the middle part of the country covers about 174,000 square miles. It has 30% of the nation’s irrigated groundwater. It’s estimated that by 2060, it will be 70% depleted.

China has major water issues, as well as about 20% of its arable land being too polluted to farm. It has about 20% of the world’s population,
but only about 7% of the world’s water resources. About half the rivers in China have gone dry in recent decades.

So, China is doing a few things. They are undertaking some enormous dam projects, trying to manage and conserve as much of their water as possible. They also appear to be outsourcing much of their food needs to the rest of the world, as well as looking for farmland abroad. When China’s large pork producer acquired Smithfield Foods, it also acquired 100,000 acres of farmland in Missouri, Texas and North Carolina. They have also acquired land in Australia, Chile and Africa.

The S&P Global Water Index has outperformed the gold and energy indexes over the last 10 years. Bank of America says that the $600 billion business of water will grow to $1 trillion in the next six years. When you consider that only a scant 2.5% of the water on the planet is fresh, and that only a fraction of that is drinkable, it’s easy to understand why it’s a precious commodity. There is no substitute for water.

In agriculture, as in life, it’s all about trying find the right balance.

Government and Conservation

I believe that farmers and ranchers were the first conservationists. The Environmental Protection Agency (EPA) is trying to put what appears to be overreaching regulations in place through the Clean Water Act and redefine what “Waters of the United States” really encompass, for example. There appear to be significant negative and unintended consequences to the agricultural community in all of this. Stay informed on this matter – it’s potentially a huge issue.

When I consider the improvements farmers and ranchers have made in soil and water conservation over the last couple of decades, it’s impressive.

No one has a larger vested interest in taking care of land than farmers and ranchers. As farmers and ranchers, we’re terrific stewards of the land. Farmers and ranchers understand that if you take care of the land, the land will take care of you. They understand that we don’t inherit the land from our ancestors; we borrow it from our children.

When you drive through the countryside in the fall, for example, and see all the crop residues left on the fields to limit erosion, it’s amazing. Just a couple of decades ago, it was a sign of a good farmer to have his fields as black as could possibly be. No more. It’s a win-win situation for everyone.

It’s easy for those not associated with agriculture to point a finger at farmers as the cause for so many environmental issues. Since 1982, the soil erosion rate on U.S. cropland has been reduced by more than 40%.

Can we do better? Of course we can. But it doesn’t take an act of Congress and other agencies to accomplish. It’s ironic how uncommon common sense has become.

As fewer and fewer Americans have ties back to the farm to understand the realities of the industry, it gets to be a larger challenge to educate and inform the general public. The Food and Drug Administration (FDA) for example, wanted beer makers to stop selling the mash left over from the beer-making process to ranchers and dairy farmers, but rather take it to a landfill. Interestingly, there doesn’t appear that there’s ever been a problem with brewer’s grain. FDA is looking to revise the proposal.

Farmers and ranchers need to be their own advocates and spokespersons to the general public. It’s a public relations battle that can be won – but it will take an effort by many. Don’t be apathetic – we’ve seen what farmer/rancher apathy did for the recent Farm Bill.

In North Dakota, there will likely be a Clean Water, Wildlife and Park Amendment that will be voted on later in 2014. As I understand it, this amendment would take 5% of the oil extraction tax and earmark it for wildlife and other conservation programs.

There’s a lot of money at stake – estimated to be $300 million each biennium – or about $5 billion over the next 25 years.

This will likely evoke a lot of passion and debate from both sides of the issue.

The main point of the opposition, it seems, is the 13-member advisory board that has limited oversight and the concern that a lot of these dollars could go to buying up land and competing against private landowners.

The advocates seemed to be promoting conserving land and wildlife for future generations.

Stay tuned – this is going to generate a lot of interest and a lot of money to promote the positions of each side the last couple of decades, it’s impressive.

GMO and Our Food Supply

There continues to be a big push for GMO labeling. Vermont recently became the first state to pass a law requiring labeling by July 2016. Other states may soon follow suit. While I believe this casts a really wide net and will have numerous unintended consequences, I do believe that for the sake of consistency and interstate commerce there will be a need for a national standard in this area.

In the last issue, I talked a little bit about the benefits and value of GMO (genetically modified organisms) in the production of farm commodities.

Not everyone agreed with me, which I have no problem with. Everyone has an opinion and everyone interprets data and information differently.

The FDA and other industry groups say there is no material difference between foods produced with genetic engineering (the anti-GMO folks also have studies they point to that take a differing view). The reality is that a significant segment of the American population believes through either media information or other avenues that there is value in this type of disclosure, and labeling will protect the consuming public.

It would be a mistake for the agricultural community to dismiss this concern and issue. Whether this is a real threat or just a perceived one, never forget that perception is reality to many.

It’s estimated that GMO ingredients are found in about 80% of processed food in America, and we’ve been eating this food for the last 20 years. Moreover GMO has been used for some time in insulin production, cheese making and proteins for hemophiliacs.

There’s a lot of misinformation out there on this issue. It’s time to set aside the emotion, separate the wheat from the chaff and have solid, scientific based information to base claims on. It seems no claim is a lie. It reminds me of a Seinfeld episode with George’s famous line, “Jerry, it’s not a lie – if you believe it.”

It’s still important not to forget all the benefits world-wide GMO grain production has created and what the consequences of not having it would be in terms of feeding an ever-increasing world population. Moreover, non-GMO produced products are not without risk. It’s good for all involved to deal in facts and to consider unintended consequences.

For those who are absolutely against food that contains GMO ingredients, maybe there are other options to explore to meet your expectations in this area – maybe there are opportunities there as well.

Call Us

Continue reading the AgViews newsletter or learn more about how a Bell State Bank & Trust ag lender can help you with the financing you need to keep growing.

Lynn Paulson

If you’re ready to talk about your financial needs, call Lynn Paulson to start the conversation.

701-298-7138

800-450-8949

 

2 Responses to this post...

  • Brian Haugen on Jul 27, 2014 at 5:50 pm #

    Lynn,

    Great analysis. Thanks for keeping us “former farmers” up to speed!

    Brian Haugen
    Cole Papers

  • Bell State Bank & Trust on Jul 28, 2014 at 8:45 am #

    Thanks for the great feedback, Brian. We have passed your comments on to Lynn.

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