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Bearish Signals = Prepare for Shrinking Margins

As we close out a discontented winter of Midwestern cold, California drought, and gloomy USDA forecasts, those of us old enough to remember farming in the bad old 1980s can reflect on times that are still better today.  We can make a modest suggestion: Don’t count on unusually favorable outside forces continuing. 

They didn’t in the early 1980s, when the stars aligned against farmers and ranchers with too much debt and too few assets. Commodity oversupply and falling prices hurt, but not as much as Fed Chairman Paul Volcker’s war on inflation. The Fed raised short-term rates to 20% in 1981, corralling inflation from 13.5% that year to 3.2% by 1983. That was the year I arrived at the Lincoln Journal Star, where I covered the collateral damage in rural Nebraska. There was plenty: 

• Families who expanded to bring in a new generation, only to lose the farm. 

• Sandhill ranchers angry over losing stock in an insolvent Valentine Production Credit Association. 

• Farm community reaction to the tragic death of Grand Island-area farmer Arthur Kirk, gunned down by a state patrol SWAT team after resisting sheriff’s deputies who were serving foreclosure papers. 

That makes the winter of 2014 seem balmy and cheery.

So how are you doing, and what’s next?

Economist Nathan Kauffman, Omaha Branch Executive for the Federal Reserve Bank of Kansas City, sees a lot of remaining strength in the farm sector after some great years. 

“The amount of wealth that’s been generated is substantial,” he says. 

One measure, the current ratio, looks great, according to USDA data through 2012. It’s a ratio of current assets divided by current liabilities. It’s cash and assets, such as unsold grain in bins, that can be used to pay bills and short-term loans. 

A rule of thumb is to have twice as many current assets as liabilities, or a current ratio of 2. At the end of 2012, most farmers (45 and older) had ratios of about 4, and the oldest (65 and up), who remember the 1980s well, had ratios approaching 8. 

Of course, you know that the value of any unsold grain in the bin today is a lot lower than at the end of 2012. Still, Kauffman doesn’t see anything remotely like the 1980s looming.

“To think that a crisis might start to emerge in 2014, it’s probably not likely,” he says. He is more concerned about 2015 and 2016, especially if interest rates start to rise. 

Shortly after talking with Kauffman, USDA released a sobering 10-year projection for commodity prices. For corn, this year’s likely average price of $4.50 (around break-even for many) will be the highest in the decade, with corn bottoming at $3.30 in 2015-2016, then struggling back to $4.20 by 2023. You can take comfort knowing that USDA projections aren’t really forecasts and are often wrong. Futures are less bearish, as University of Illinois economist Darrel Good has pointed out.

Still, you know that inputs aren’t falling as fast as prices, leaving potential margins slim. “It’s kind of back to the basics this winter,” says Ed Kordick, commodity services manager for Iowa Farm Bureau Federation. “Know your costs. Plan out your marketing. Know the tools you’re using.” 

He sees margin management as vital again. If you can cover inputs with forward sales, do it. “I think you might be more likely to lock in some margins that are less than you’ve seen recently,” he says. If possible, “cover costs with a floor and at least you know you’re going to be farming next year,” he adds. 

That hardly means overaggressive marketing, however. He suggests using options and minimum price contracts for now – “kind of a hold-your-powder risk-management strategy.” 

Jim Knuth, senior vice president of Farm Credit Services of America based in Omaha, views the changes you’re seeing in the land market and farm economy as a soft landing from the boom that peaked in 2012. The Farm Credit System lender is focusing on its borrowers’ per-acre production costs and their working capital (such as the current ratio, another measure of ability to pay debts and bills). “We’re talking to every customer about these concepts,” Knuth said earlier this winter when he spoke at the Land Investment Expo in West Des Moines, Iowa. 

In a grain market that is less volatile, “good marketing decisions may be made in cents – not dollars – in 2014,” he told farmers and landowners. He also urged them to “take proactive steps to adjust to the new realities.”

For some Farm Credit Services of America borrowers, that has meant reamortizing mortgages for recent land purchases. He says many farmers buying land planned to pay off loans in 10 to 12 years. They’re now extending mortgage terms, often to 25 years, a more typical number. “That’s OK. Now we’re readjusting,” Knuth says. “It’s good for the farmer and doesn’t cause problems for the lender.”  

Before the 1980s debt crisis, neither farmers nor ag lenders were as strong as they appear now. Like most others, I hardly expect history to repeat exactly.  Yet, those sometimes dull concepts of working capital and margin management have more luster now. Current land and machinery sales already reflect producers’ common sense about lower spending in the face of what Kordick calls “a stay-in-the-game kind of year.”

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