With crop prices at near-record lows, farmers are earning less, borrowing less, and taking more time to repay bank loans. In fact, agricultural lenders fear many of their customers will be out of business next year.
"This is probably the toughest period for commodity prices I've seen in a while-maybe ever," said B.A. Donelson, president of First State Bank in Stratford, Texas.
"I don't think we can be optimistic," added Dennis Meier, senior vice president of First National Bank of Yuma (Colo.) "There's going to be a cleansing."
If conditions do not improve, farmers could quit the business in droves, glutting the market with land and equipment. Because those assets are collateral, banks could be engulfed by worthless loans.
Observers are concerned that some lenders may not be taking the problems seriously enough.
"Bankers could be surprised at how little those loans are worth," said Russell Lamb, an economist with the Federal Reserve Bank of Kansas City. "I'm not sure community banks are on top of what's happening and how bad things can get."
Projections from the U.S. Department of Agriculture look grim: Weak commodity prices will reduce farm income as much as 7% this year. Corn, wheat, soybean, and hog farmers will be particularly challenged as overproduction further depresses prices.
And unless prices rebound, farmers will be reluctant to take out new loans. The USDA estimates that total outstanding loans to farmers will fall to $169 billion this year-the first drop in more than a decade.
Meanwhile, loan delinquencies are on the rise. According to the Federal Reserve Bank of Chicago, 63% of the district's agricultural banks reported a decline in repayments during the first quarter. That's up from 27% in the first quarter of 1998.
"Everybody's gloom-and-doom about agriculture," said David Kohl, professor of agricultural finance at Virginia Polytechnic Institute and State University.
Prof. Kohl said some parts of the country have been especially hard hit. Grand Forks, N.D., for example is still recovering from floods and crop disease that struck two years ago.
"It's like a country western song gone bad," he said.
Bankers, economists, and industry observers maintain that the latest downturn does not compare to the farming crisis of the 1980s, when farmers were heavily in debt and inflation and interest rates were on the rise.
But the way farmers handle the latest downturn may reflect lessons learned in the 1980s. During that crisis, many farmers held on to their operations until all of their equity was gone. This time, many may call it quits sooner, when their investments still have value.
"The customers that made it through the '80s will tell you when it's time to pull the plug," Mr. Kohl told a group of bankers at a recent seminar in Colorado Springs. "They're saying they don't want to lose their retirement income."
Despite criticism, bankers said they are prepared, should farmers pull up stakes. Many plan to advise some customers to sell or scale back.
"You have to be tough," said Mike Maudlin, president of $42 million- asset Security Bank in Idalou, Idaho, who advised some farmers to sit out the 1999 growing season rather than lose money on seed and fertilizer.
Mr. Donelson of $125 million-asset First State Bank said farm failures are an inevitable part of economic downturns. "It's never nice to see anybody go out," he said. "But we do this every cycle."
And even if some farmers leave the sector, there will still be lending opportunities. Mr. Meier of $32 million-asset First National Bank expects farmers to sell their land to megafarm conglomerates, which would also have credit needs.
"We will probably just make larger loans to the larger producers" by sharing credits with regional super community banks, he said.
To prepare for the expected fallout, many bankers are hedging their risk, protecting themselves by guaranteeing more farm loans through the U.S. government. Applications for loan guarantees from the USDA's Farm Service Agency have skyrocketed in the last six months.
Other banks, such as Country Bank U.S.A. in Cando, N.D., are requiring farm borrowers to buy crop insurance.
Banks are also quietly adding to their loan-loss reserves and making it clear to producers that they must reach certain income goals to qualify for operating loans next year, said John Blanchfield, manager of the American Bankers Association's agricultural banking division.
"Bankers have a good business sense about this," Mr. Blanchfield said.