This year has been one to forget for the American farmer. Weather, trade and depressed commodity prices have combined to weigh on farmers’ abilities to generate income not only to support their family and way of life, but also to finance the debt they carry to operate their enterprises.
It has been a perfect storm of sorts, forcing farmers to make tough decisions as they try to get by. And many aren’t. The American Farm Bureau Federation reported that farm bankruptcies were up 24% nationwide for the 12 months ending Sept. 30, with more than 40% of those taking place in the 13-state Midwest region.
As painful as this has been for the farmers, it is also forcing a reckoning among lenders and should prompt a rethinking of their role, one that goes beyond primarily being a source of financing, and instead becoming more as a trusted adviser. Farmers, after all, are often consumed with day-to-day operational challenges, and need help thinking through longer-term decisions.
According to a joint survey released in November by the American Bankers Association and the Federal Agricultural Mortgage Corporation, better known as Farmer Mac, the top five concerns of agriculture lenders for their borrowers are, in order of most critical:
- Farm level incomes
- Total leverage
- Uncertainty around tariffs
- Trade and weather
In the end, these five concerns can be translated into a broader view of the challenges facing agriculture lenders – credit quality and loan deterioration.
From lender to adviser
Although a majority of the survey respondents indicated that they are not anticipating more charge-offs on agriculture loans in 2020, the reality is that net charge-offs reported by banks have been steadily increasing since 2016. The second quarter of 2019 saw the highest single quarter of net charge-offs on agricultural loans since the fourth quarter of 2012. Agriculture lenders will need to embrace this role of trusted adviser to ensure that farm operators are making appropriate decisions that sustain their operations.
Such decisions won’t be limited only to advising on reducing capital purchases, but also to leveraging unencumbered land to support increased debt loads on farm production loans to exploring alternative income sources that could cut down on the cash need from the farm operations.
Keeping an eye on loan balances
One way bankers will be able to gauge the health of their agriculture borrowers is by watching the loan balances, especially those loans tied to farm operations, otherwise known as the operating lines of credit.
Typically, a farmer’s operating line of credit comes due at the end of the harvest season or early the following year, at which point the line of credit in a perfect world is paid off by the income generated from harvested crops. But it is becoming increasingly common that these loans are not paid off and any outstanding balance is either rolled over into the next year’s operating line of credit or moved into a new term note and put on a payment schedule to be repaid over time.
Agriculture loan balances have been increasing steadily since 2010. When it comes to operating lines of credit, the balance increases throughout the year as farmers buy the seeds and other products necessary to grow their crops. These loan balances generally peak late in the second quarter through the middle of the third quarter as harvest begins, and they remain elevated through the end of the year before being paid down or paid off in the first quarter of the following year.
But a troubling trend has been taking place in recent years: The level of repayments occurring in the first quarter of each year has slowly been declining.
The decline in balances on farm production loans from the fourth quarter in 2018 to the first quarter in 2019 was the smallest amount reported since 2008. When this is combined with the average growth in farm production loan balances, one conclusion can be drawn: operating lines of credit are not being repaid at an appropriate level.
2020 and beyond
This ballooning debt places more responsibility on agriculture lenders to remain cautious in how they approach their borrowers. The $28 billion in aid payments farmers have received the last two years are most certainly not enough to compensate a farmer for the cost of doing business.
Even with the not-yet-signed phase one trade deal with China in place, the impact to commodities and related prices will take some time to be seen in farmers’ bank accounts. And that still doesn’t account for global commodity demands, weather conditions and other environmental factors that can impact a farmer during a growing season.
Although an uncertain future will still result in continued difficulties for the agriculture sector, it doesn’t mean that lenders should or need to forcefully tighten underwriting standards to reduce their exposure to these borrowers. Rather, an increased level of vigilance and monitoring, along with an advisory mind-set, will be the difference between helping a borrower make it through a difficult time and the borrower shutting down the operation entirely, leaving the banks holding the bill.