A reduction in land prices stirs thoughts of a bursting bubble

A report by agrimoney.com show that farm land values have seen their first decline in nearly 5 years falling 1% in the first quarter of 2014.  The decline was triggered by a substantial drop in grain prices at the end of 2013.  In the south central plains, dryland prices declined 1.4% while irrigated crop ground increased at a modest 4.3%.   In the corn-belt states such as Illinois and Indianan, price dropped by 4%.Tractor

At the same time, pasture land values have increased.  Falling feed grain prices which have spurred the slowdown in crop land values have conversely improved profit margins for the cattle industry increasing the value of the product produced on pasture ground.

Pasture

The questions on most farmers, ranchers, lenders, and economists minds during the recent run-up in land prices are: How high will land prices go, and will there be a bust similar to the 1980’s?  Some economists believe that an agricultural land bust similar to the 1980’s will not happen.  They cite crop insurance programs, who do a better job stabilizing revenue, as one reason such that lean years today won’t be as lean as years past.  The other main reason is that the level of indebtedness has been reduced by farmers. Current reports show that, in aggregate, farms are not has highly leveraged today as in the 1980’s and the average farm has a higher buffer for times of financial hardship.

A repot by Allen Featherstone at Kansas State University acknowledges that farms in Kansas had an average debt to asset ratio much lower than in 1979.  However, Featherstone points out that there is a higher percentage of farms in Kansas with a debt-to-asset ratio greater than 70% today than during the 1980’s bubble. The fact that more farms are highly leveraged today than before is critical according to the report since defaults typically occur within this group.  Featherstone also points out that the bubble of the 1980’s was started by a significant drop in the value of farmland production over a two year period, and that a similar drop today over a similar period of time would not be substantially mitigated by price/revenue supports.  Therefore, Featherstone concludes that it will not be leverage that will begin a bust cycle for land, but may increase the problem.

Agricultural Loans and Interest Rates 2014

The St. Louis branch of the Federal Reserve publishes quarterly reports on financial conditions pertaining to agriculture in the 8th federal reserve district which includes the northern half of Mississippi and the Delta Region.  Surveys from around the region show fixed interest rates for operating loans  averaging 5.39% on fixed loans and 5.01% on variable operating loans.  Intermediate-term loan interest rates averaged 5.65% and 5.21% for fixed and variable loans respectively. Farm real estate loans averaged 5.23% and 4.93% for fixed and variable loans.  The above interest rates were slightly higher than the same quarter a year ago where variable rates were between 4.48% for land and real estate and 4.77% for intermediate loans while fixed interest rates were as low as 4.87% for real estate loans and 5.45% for intermediate land and machinery loans.

 

Surveyed lenders expect demand for agricultural loans will be higher in 2014 than a year ago while also reporting ample quantities of loanable funds available to meet demand.  Minutes from the March meeting from the Federal Open Markets Committee were released on 9-APR-2010 where members indicated that a push to increase interest rates will not occur until at least 2015. The implication of these two conditions are that agricultural loan interest rates will remain low for all three types of loans through 2014.

Growth in Overall Farm Wealth Expected to Slow in 2014

The latest forecast from the USDA Economic Research Service predicts a slowdown in the growth of overall farm wealth in 2014.  Expectations are that overall farm debt will increase 2.3% while farm assets are expected to rise 2.4% yielding a net increase of 0.1%.  This level of wealth generation in the agricultural sector is much lower than the 1.5% growth that ag. has enjoyed over the last 10 years.  The decline in asset growth stems primarily from a decline in the growth in land values around the country, brought about by a slowdown in accumulation of agricultural land, and an expected decline in commodity prices.

Despite the slowdown in asset value growth, financial solvency is expected to continue its improvement moving to a national average debt-asset ratio of 10.5 in 2014 which is down from a modest spike of 11.8 in 2010, and the lowest it has been in about 60 years.

debttoequity

However, solvency  measured using the debt-to-asset ratio is subject to change  should land price fall.

The Return of Interest?

Interest rates as a percentage of annual agricultural expenses have continued to decline reaching a low of 2.4% for U.S. farms.  This marks a decrease of nearly 56% in interest’s contribution to total agricultural expenses since 2002 when, on average, interest accounted for 5.4% of total operating costs. This is due in part to the fact that input costs such as seed, chemicals, fuel, ect. have risen swiftly, and high commodity prices have allowed greater percentages of new land and equipment purchases to be paid for with cash. Continue reading “The Return of Interest?”