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Ag Credit Conditions Stable Despite Farm Income Shake-up

Farm incomes are down. What does that mean for overall farm credit conditions?

They've generally held steady, according to a report released this week by the Kansas City Branch of the Federal Reserve. In the second quarter of this year, two primary factors pulled against one another, yielding essentially no change in overall credit conditions despite the arrival of the long-anticipated downturn in overall farm incomes across the Fed's Kansas City district in the center of the country.

"Most agricultural bankers in the Tenth District reported solid credit conditions in the second quarter of 2014, but longer-term concerns about credit quality have begun to emerge. Although bankers reported very few past-due farm loans, loan repayment rates have weakened since last year, particularly in crop-producing regions," says Fed Omaha Branch executive Nathan Kauffman. "Credit standards, however, were little changed, and bankers indicated funds were available to satisfy a sharp rise in loan demand. Despite continued strength in the livestock sector, District farm income remained well below year-ago levels due to falling crop prices and poor winter wheat yields. Cropland values generally held at high levels while strong demand for high-quality pasture pushed ranchland values higher. With summer rains easing drought conditions, the potential for record crop production this fall could keep prices low and shrink profit margins further, potentially affecting future debt repayment capacity."

The variable most telling about the farm income downturn -- slightly lower loan repayment rates -- has variability in itself; collateral requirements and underwriting standards didn't change much, but there was slight growth in the number of loans made with a loan-to-value ratio of less than 65%. Still, the majority of loans -- operating, machinery, and real estate -- were made to farmers with a loan-to-value ratio between 65% and 80%, Kauffman says.

"Loan terms remained favorable to borrowers with interest rates holding at low levels, averaging 5.7% on operating loans, 5.5% on farm machinery loans, and 5.4% on farm real estate loans," he adds.

The slide in farm income levels has caused a rise in loan demand, but that's just as hard to nail down right now. A combination of low global prices and a challenging crop year in the U.S. Great Plains has depleted wheat farm incomes, but the full ramifications of this combination of conditions have yet to be realized.

"District winter wheat yields in Kansas and Oklahoma were well below average due to poor growing conditions from prolonged drought, followed by scattered storm damage close to harvest. Although U.S. wheat production was down, strong global production estimates kept prices subdued, limiting farm income in the second quarter," Kauffman says. "Some farmers have sold a portion of their crop at higher prices earlier in the crop year through forward contracting. In addition, support for 2014 farm income could come from crop insurance prices that were set earlier this year at higher levels. If prices remain low through harvest, some farmers may also decide to store grain at harvest and wait for prices to rise before selling."

Another variable that's further decoupled from the farm income slide is farmland values. Historically a value that's slow to react to downward moves like the one underway in incomes today, farmland values stayed afloat in the second quarter of 2014.

"Although still above year-ago levels by about 6%, the change in nonirrigated and irrigated cropland values from the first to the second quarter of 2014 was less than 1%. Ranchland values, however, were still rising, supported by demand from the livestock sector for high-quality pastures," Kauffman says. "District ranchland values increased more than 2% from the first to the second quarter of 2014 and remained a little more than 9% above year-ago levels. Current trends in farmland values were expected to continue for the rest of the growing season with cropland values holding at high levels and ranchland values rising further."

Moving forward, most of the ag bankers surveyed in the Kansas City Fed's latest survey said they expect credit conditions to stay about the same as they have in the last quarter. But the variability in the factors that add up to the overall income equation will likely start to snap closer to the lower trend.

"While past profits and crop insurance may help mitigate shrinking margins in 2014, financial stress for crop producers could mount in 2015 if net returns do not improve. In addition, should a large fall harvest keep prices low through the beginning of next year, crop insurance might not provide a comparable level of revenue protection in 2015," Kauffman says. "Looking forward, loan quality may become more of a concern beyond 2014 if repayment rates come under additional pressure from declining profit margins."


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