A judge's decision to remove price supports for milk has clouded the future for dairy farmers and the banks that lend to them.
In October, a federal judge in Minnesota invalidated a law allowing the U.S. Department of Agriculture to decide how much dairy processors must pay for milk. While an order enforcing the decision has been stayed pending appeal, farmers and lenders are bracing for upheaval.
"The whole system is under attack," said John M. Blanchfield, manager of agricultural banking and rural development at the American Bankers Association. Until the situation is resolved, he said, "it's going to be difficult for dairy farmers to predict or plan what their cash flow is going to be, and that's going to cause a lot of concern among lenders."
Bankers said they are monitoring the situation but will wait for a final ruling before taking action.
"At this point, we haven't developed a strategy to deal with it," said Charles W. Bucknam, president and chief executive officer at Lyndonville (Vt.) Savings Bank.
"Whatever happens, there's going to be a higher degree of demand on community bankers to have the expertise to finance these operations," said William Waldvogel, vice president of Chetek (Wis.) State Bank.
Exactly how much dairy farmers owe to banks is unclear. But according to the U.S. Department of Agriculture's Economic Research Service, the average dairy farm carries $161,462 of debt, most of which is owed to banks.
Milk price supports date from the 1930s. The rules were established, in part, to protect farmers from being underpaid by dairy processors and to ensure that consumers got steady supplies of milk. The challenge to the law came from midwestern dairy farmers who claimed it prevented them from charging higher prices, even when demand for milk rose.
Not all dairy farms are affected by federal milk price supports. In 1996, Congress enacted what's called the New England Dairy Compact, which essentially allows a commission to set milk prices in the six New England states.
If price supports are lifted, one side effect could be further consolidation of the dairy industry. Since 1993, the number of U.S. dairy farms with annual gross sales of at least $50,000 has dropped 22%, to 85,704. Dismantling price supports-a safety net for many small farms-could accelerate the decline, leaving fewer farm customers for banks.
"It's hard to tell whether this is good or bad," Lyndonville Savings' Mr. Bucknam said.
Consolidation could lead to larger farms, which would mean more opportunities for banks, he said. But larger farms would likely need larger banks.
"This sort of business is the bread and butter for many traditional, small-town independent banks," said Edward Lotterman an agricultural economist at the Federal Reserve Bank of Minneapolis. "When you start talking about $1 million or $1.5 million loans, they're going to get bypassed."
Despite the volatility in the dairy industry, banks are apparently in no rush to stop making dairy loans. Mr. Waldvogel of Chetek State Bank said that as long as dairy farms make money-their net income is up 14% since 1992, according to USDA statistics-his institution will continue to be an active lender.
And Mr. Bucknam is so bullish on Vermont's dairy industry-especially since formation of the New England Dairy Compact-that he plans to expand dairy lending throughout the state.
"Our feeling is that consumers will continue to want the product and that the market will find some way to justify paying for it," he said.