A growing risk for ag lenders
It’s a stormy late-September afternoon in northern Iowa — a common occurrence in this year of discontent for many of America’s farmers. Just outside of Fort Dodge, a bustling regional farm town of 25,000, wind and rain pound against the corrugated-metal roof of Dan Thompson’s oversized garage as he explains the latest challenges managing his 1,700-acre corn-and-soybean farm.
It’s rained more than 30 inches since his crops went in last spring, about double normal levels. The harvest began a day earlier, and early indications aren’t good. “We’re saturated. Close to 10% of our acres are flooded out, where we have nothing left,” Thompson said. “But you can’t control the weather.”
Consider it an apt metaphor for the state of farming in an era of overproduction and tariffs. Storm clouds have been gathering over America’s heartland for much of this decade, with falling crop prices and profits and rising debt levels, leaving farmers in increasingly precarious financial positions.
Worse, while farmers can tinker with their own production (subject to the weather), they are powerless to control the broader market forces that influence what they get paid.
Per-bushel prices for corn and soybeans, staple crops across the farm belt, have fallen by roughly half over the last six years. The latest wild card — a budding, potentially nasty trade war with China, the world’s biggest consumer of soybeans — has sparked another price drop and made things uncomfortable.
“Locally, we’re staring at a net-loss year. We’re going to have worked all year and not made any money doing it. And we don’t know what to expect next year,” said Thompson, sitting at a table in the shadow of his 15-foot-high combine with soft country music competing with the rain in the background. “People are living on equity. You can only do that so long before you’re done.”
Many of the nation’s 1,800-some ag lenders, their fates tied to those of their farmer clients, are feeling similar angst. Chinese tariffs on soybeans, wheat and other commodities have knocked prices down as much as 20%, adding a layer of uncertainty to planning for the 2019 planting season that promises to test the effectiveness of risk-management practices at these banks.
“When times are good, it’s easy to be a lender,” said John Taets, Thompson’s banker and regional president for the $1.5 billion-asset Northwest Bank’s ag-heavy Fort Dodge branch. “When times get a little more challenging,
you find out who’s prepared for the long haul.”
Even before the trade skirmish, some banks had been quietly scaling back their lending commitments to farmers, counseling them to reduce expenses. Some ag loans have been restructured three or four times, and equity for collateral, once plentiful, is running low. Rising interest rates make extending the terms of loans less attractive.
“Banks have been taking a much more defensive approach to ag lending,” said John Blanchfield, owner of Agricultural Banking Advisory Services in Damascus, Md.
That includes underwriting loans based on cash flows more than collateral values, moving risk off their balance sheets by selling loans into secondary markets through Farmer Mac, and stress-testing individual loans and portfolios to stay ahead of trouble.
Surveys indicate that a growing number of loan applications from farmers are being outright rejected. Expect to see more in the months ahead.
“As conditions grow more uncertain, I think we’re going to see some pain come out of this — a transition from a very easy credit environment to a tight environment where it’s tough for anyone to get a loan,” Blanchfield said.
“There are banks out there that will experience problems,” he added. “What we don’t know is how bad things will get.”
The numbers around farm banking belie the notion that trouble could be on the horizon. In 2017, 96% of ag banks made money, though the group’s total net income declined by 3.1% from the year prior, to $4.7 billion, according to the American Bankers Association.
Loan delinquencies and charge-offs remain near all-time lows, and capital levels have more than doubled over the past decade, implying that banks are positioned to handle some turbulence. “Most of the banks have been doing relatively well,” said Nathan Kauffman, an economist with the Federal Reserve.
Even so, signs of stress are showing. In 2011 and 2012, while the rest of the economy was in recession, the farm economy exploded. Crop prices soared to record levels — corn briefly touched $7.50 per bushel, while soybeans neared $18.
Equipment dealers and Main Street businesses thrived, and more than a few farmers spent some of their winters in the Caribbean. They also built up equity as farmland values climbed to new heights. Banks did well.
Since then, prices have been edging downward. Even before the tariffs, corn was going for under $4 per bushel, with soybeans in the $10 range.
Most other metrics have been moving in the wrong direction. Net farm incomes dropped more or less steadily from $124 billion in 2013 to $75 billion last year, according to the U.S. Department of Agriculture. Farm debt has increased $132 billion in the last decade, to $407 billion, while the financial assets of these borrowers — investments and bank deposits, for example — have fallen by $62 billion.
Loan quality, while still solid in most places, isn’t quite as pristine as it was several years back. Foreclosures and farm bankruptcies are ticking up. Some agricultural producers are in year three of losses, bankers confide, and likely won’t be able to hold on much longer.
The total of outstanding farm loans at banks rose 5.9% in 2017, to $106 billion, according to the ABA. But in a troubling sign, most of those were farmland loans, which jumped 7.7%.
“Farm real estate debt has increased significantly, but it’s not because farmers are buying real estate,” Blanchfield said. “It’s because banks are refinancing unpaid carryover debt into long-term debt. Some customers are on their third or fourth time. There isn’t much equity left.”
In some ways, farmers are victims of their own success. They’ve evened out their revenue the only way they can: using genetically modified seeds and other technology (and some luck with the weather) to squeeze more bushels out of an acre. (Per-acre corn yields have risen from 80 bushels to 180 in the last three decades, and are closer to 200 in Iowa.)
Boosting production might solve the individual farmer’s short-term problems, “but when everybody has more yield it creates more supply, which drives down prices and exacerbates the problem,” explained Jayme Ungs, an Iowa-based ag team lead for U.S. Bank.
Presently, silos and bins across the Midwest are stuffed full of grain, waiting for a rebound in prices — and adding to the surpluses. “If we can’t increase demand, we’re stuck,” Ungs said.
Some fear the table is being set for a replay of the devastating 1980s farm crisis, when overproduction, a global recession and high interest rates led to a drop in exports. Prices and farmland values imploded, and hundreds of ag banks failed.
The title of a session at last March’s Kansas Ag Bankers conference reflected the concern: “How is this farm crisis different from the ’80s and what lies ahead?”
For now, the biggest differences are lower interest rates and debt-to-asset ratios among farmers, and higher land values, said Allen Featherstone, a Kansas State economist who spoke at the session. “It’s not a crisis yet, but there is definitely the potential for a crisis,” he said in an interview.
‘A cloud over everything’
To stave off trouble, bankers have been more proactive about communicating with their customers, helping plan family budgets and reviewing farm strategies. They are also counseling farmers not to make commitments that can’t be met.
The tariff situation makes those conversations more complicated. Farmers live at the intersection of yield and price, supply and demand, and 50% of the U.S. soybean crop is exported — most of it to China, which accounted for about $12 billion in soybean exports last year.
When Beijing retaliated against tariffs on Chinese products with targeted tariffs of its own on U.S. soybeans, pork and other farm products, it had the effect of removing demand, sparking an abrupt 20% drop in prices for U.S. soybeans.
“Agriculture is usually the first casualty of any trade war, and this is no different,” said Ernie Goss, an economist at Creighton University in Omaha, Neb.
This is Trump country, and farmers are guardedly supportive of the tariffs — provided they aren’t in place for long. Many had bumper crops this year and locked in pricing on portions of their crops in the spring. They should be able to survive 2018 in good stead.
The big concern is 2019. As this fall’s harvest wraps up, farmers and their bankers are having their annual face-to-face discussions about the next year’s crop.
Most farmers need to buy their seeds, fertilizer and other inputs by the end of the year for tax and logistical reasons; bankers use the time to renew lines of credit, help with budgeting and get a general read on the health of the operation.
The goal is to determine a break-even price on whichever crop will be planted, based on the costs, and then see how profitable it might be. Ideally, they formulate a marketing plan that includes some forward sales in the spring.
A little informed guesswork typically goes into the process, rooted in price and yield forecasts from universities and the Chicago Board of Trade, but in this environment no one knows for sure what will happen.
Some analysts predict a protracted standoff. If that happens, will the government add to the $12 billion in emergency aid it is providing this year to affected farmers?
Others say China is so reliant on soybean imports to feed its population that it could buckle. “The farmers will make a fortune when this is over,” Trump tweeted in September.
A new trade agreement with Mexico and Canada in September was greeted as a good sign in farm country.
But complicating matters further: An updated farm bill that will make changes to farm subsidies, crop insurance and other government payments, slated for approval by September, remains stuck in conference committee.
Throw it all together, and a sense of deer-in-the-headlights paralysis has spread through farm country. Farmers like Thompson don’t know what to plant and are delaying their decisions as long as possible. Bankers have little visibility on cash flows and little basis for approving loans.
The tariffs “have put a cloud over everything,” said Shan Hanes, chief executive of the $90 million-asset Heartland Tri-State Bank in Elkhart, Kan., and chairman of the American Bankers Association’s Agricultural and Rural Bankers Committee.
Hanes said 75% of his bank’s loan portfolio is direct ag, with the rest ag-related. His clients have survived recent low prices thanks to two consecutive years of perfect growing conditions and high yields.
“The challenge is that you can’t really put together a cash flow for next year,” Hanes said. “You can’t count on double production again. You don’t know about government payments. And you don’t know about the tariffs.
“You need to be able to defend those loans to the examiners, and without firm numbers, they say you have to operate like it’s zero,” he said. “There are too many unknowns right now. That’s not good for the farmers or the banks.”
The anxiety being felt in the Midwest doesn’t necessarily extend to all parts of the country. Kent Steinwert, CEO of F&M Bank, a $3.5 billion-asset ag bank in Lodi, Calif., said his bank’s farm clients in the central valley are suffering few ill effects from recent sluggish pricing or the threat of tariffs.
“We have virtually no problems in our portfolio today. Our clients are profitable,” he said.
“There could be some short-term pain in the large crops like corn and soybean, but in the long-term the U.S. will be better positioned to export something as simple as broccoli or avocados,” Steinwert added.
Banker, friend, marriage counselor
What’s the same most everywhere is the ag bank business model, which appeals for its setting, simplicity and the strong bonds it elicits. The institutions average around $100 million in assets, and some are much smaller.
The relationships are often intimate, which allows for meaningful conversations, but also makes delivering bad news more difficult. Everywhere, it seems, the ag bank is central to the community’s life.
At the Bank of Newman Grove in Nebraska, farmers regularly stop in to check the latest crop prices posted by the teller window. An old rain gauge on the one-story building’s roof feeds into a handmade vial and is considered the bible for local measurements.
“You can go on the internet, but people still want to know what the bank got” for rainfall, said Jeffrey Gerhart, the $30 million-asset bank’s owner and CEO.
To Gerhart, a fourth-generation banker who learned the business around the family dinner table, the definition of ag banking is simple: “If you’re my farm customer and you do well, I do well. If you get into trouble, I get into trouble,” he said. “And if enough of my clients get into trouble, I’m in big trouble.”
The aw-shucks facade and blue jeans attire mask the complexities of a business dominated by variables beyond anyone’s control.
Ag bankers serve as community leaders, the rudder to help farmers through patches of tight liquidity, financial advisers and business mentors, and even informal marriage counselors. Many host conferences with outside speakers to build relationships and educate their clients.
They must know the value of the dollar, the nuances of crop insurance and other government programs, tax laws, growing conditions in other parts of the world and anything else that affects farm profitability.
Surprises occur frequently. This summer, for example, Chinese tariffs on hogs dropped prices to 28 cents per pound from 55 cents, causing widespread alarm. Then a deadly African swine fever epidemic began sweeping the globe, and prices rebounded to 45 cents.
“Sometimes the unknowns can work in your favor,” said Jim Myhra, a Fargo, N.D.-based director of farm and ranch management for U.S. Bank. “The banker has to be on top of that.”
Communication is crucial. Hanes makes a point to schedule loan renewal meetings for weekends or nights, when he can meet with the entire family around the kitchen table to discuss the family finances. “One of our most critical roles is making sure the husband and wife are on the same page,” he said. “When prices dip, divorces go up.”
Thompson, the farmer, frequently calls Taets to bounce around ideas. “I have no problem calling John and saying, ‘Hey, I’m thinking about doing this. What do you think?’” Thompson said. The topics range from money management to equipment purchases or even farming strategies.
“He sees things that are working, or not working, for other growers, and helps me decide what to do,” Thompson said.
The nature of the business means that ag bankers must constantly walk a tightrope between wanting to help their customers, oftentimes friends from church or other local organizations, and doing what’s right to protect the bank and satisfy regulators.
Lender liability is another concern. Farmers sometimes want to be told what to do, but giving direct advice can open the bank to legal action if it turns out to be wrong. Better, they say, to refer back to budgets and let farmers make their own decisions.
“The ag banker is a highly revered counselor to many farmers, but they don’t want to even appear to be offering management advice,” Blanchfield said.
Those heart-to-hearts have been getting more strained as commodity prices have declined, and the tariffs have introduced a new level of uncertainty that will add to the unease if things aren’t settled.
Taets sent early renewal forms to his ag clients in October. Around Thanksgiving time, he or one of his bankers will visit each client’s home to plot a budget and game plan for next year.
“We’ll go through last year’s production, their capital needs and financial information to figure out profitability. If they’re having challenges, do we need to restructure? What do we need to do to make sure their operation is viable?” Taets explained.
Tough love is the order of the day. Ungs said his team has been doing more “sensitivity analyses” with farm clients, shocking their cash-flow projections to get everyone on the same page and help tweak expenses and crop-insurance levels.
“Smart bankers are challenging their customers to think more about profitability. ‘Here’s where you think you’ll be for the year, but what if yields are down this much or prices fall below a certain level?’ ” he said.
“The tariff situation is a wild card, because we have no control over it,” Ungs added. “It could last longer than people think, so we have to make some assumptions around it and plan for the worst.”
The worst-case scenario looks something like this: A prolonged trade war leads to further price declines. More land owners — 30% of farmland is owned by nonoperators, such as local professionals or private-equity firms, which rent it to farmers as an investment — exit, causing land values to decline further.
Farmers need more working capital from banks to make up for the pricing shortfall, but lack the collateral lenders need to satisfy regulators because of falling land values.
Some might borrow from elsewhere — say, the captive finance arms of equipment makers, which could get them into more trouble. Others fail or are forced to sell, perpetuating the cycle.
“The real concern is liquidity,” the Fed’s Kauffman said. “To what extent do the reductions in working capital translate into bigger problems for banks?”
Even if the trade war is settled quickly, the long-term forecast for the heartland looks stormy. Bankers should keep their umbrellas ready.