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Rise in farm real estate delinquencies ‘could signal future sales’

Kansas City Fed agriculture economist Cortney Cowley explains to Agri Investor how its most recent Ag Finance Databook demonstrates challenges the US faces due to a surging national economy.

Delinquencies on commercial farm real estate loans during the second quarter surpassed those for all bank loans for the first time in almost 20 years, according to the Federal Reserve Bank of Kansas City.

In the latest edition of its Ag Finance Databook, released earlier this month, the Federal Reserve Bank of Kansas City presented results of both a third-quarter survey of commercial lenders and an analysis of relevant second-quarter data regulated banks are required to submit to the Federal Reserve.

The report showed a more than 30 percent increase in overall non-real estate farm loans and a year-on-year doubling of loans larger than $1 million during the third quarter, as interest rates rose across loan sizes. It labelled the third-quarter increase in farm lending the largest since 2002 and highlighted notable changes in the timing of loan demand.

“The typical seasonal pattern of reduced loan volumes from the second quarter to the third quarter was also much less pronounced,” wrote the report’s authors. “The volume of non-real estate loans decreased less than 3 percent from the previous quarter, compared with an average decline over the last 10 years of 14 percent.”

Perfect storm of everything

Cortney Cowley – an agricultural economist at the Omaha branch of the Federal Reserve Bank of Kansas City who was among those who worked on the report – told Agri Investor that although conversations between producers and bankers typically occur during the fourth quarter after harvest, this year fluctuations in ag commodity prices likely encouraged many to consult their bankers a bit earlier.

Despite the fact that overall farm loan delinquency rates remained low, the Fed wrote that delinquencies on farm real estate loans continued their recent trend higher during the second quarter of this year. Though it is the first time in nearly 20 years that delinquencies on such loans surpassed delinquencies for all bank loans, Cowley said she has long expected such a development.

Until recently, she explained, it had been seen as a bright spot for the overall ag economy that, although there had been lower repayment rates on farm loans loan since mid-2013, delinquencies on those loans continued to decline through early 2016.

“As farmland values have remained stable, it’s given bankers and borrowers in the farm sector more opportunities to restructure and give them more time to see if things will turn around,” Cowley said. “We knew that if we continued to see lower farm income, lower repayment rates, higher demand for farm loans – this perfect storm of everything – that we might eventually see delinquency rates increase.”

Pricing uncertainty

Elsewhere in its report, the Fed highlighted that the increase in non-real estate farm lending was driven largely by increased demand for operating loans.

Cowley said she had noted with some surprise that in its most recent forecast, the USDA predicted a decline in 2018 farm income driven largely by increasing production expenses, rather than a decline in revenues. She explained that both readings demonstrate how strength and inflation elsewhere in the broader economy is helping raise farmers’ housing, fuel, and interest costs just as they face prospects of declining revenues.

“I think that there’s probably a little bit more uncertainty because the farm bill hasn’t passed yet, and perhaps the fact that the decline in the second quarter we saw in a lot of commodity prices might have caused additional concern to producers because that was a decline that wasn’t really expected,” Cowley added.

Mixed signals

The report’s implications for farmland values in the near term appeared mixed.

Cowley said that though the report’s reading of some strength in land values was surprising, she suspects that prices in North Dakota, Oklahoma, Texas and the Mountain States may have received some support from knock-on effects of an increase in oil prices that took place while the data were being collected.

“A lot of the anecdotes we hear from bankers that answer these district-level surveys show that there’s just not a lot of farm coming up for sale,” said Cowley “Whenever we see farmland increasing instead of decreasing, we call bankers and a lot of times the answer we get is that they haven’t had a lot of land sell.”

Although the report does highlight a prolonged downturn in the ag economy, Crowley stressed the underlying data reveal a wide distribution of borrowers that includes producers that own their land and remain in a strong position.

Still, also within that distribution are others for whom rising costs and a mixed outlook have encouraged a more cautious approach to borrowing that could facilitate land sales. Cowley said she is currently working on a report based on a survey of lenders regarding farmers’ working capital requirements that asks about the percentage of borrowers likely to sell assets over the mid and long term.

“We have seen those numbers increase slightly from last year; bankers expecting a slightly higher percentage of their farm borrowers to have to sell assets in order to improve working capital,” Cowley said. “It’s still a pretty small percentage, similar to delinquency rates, but when we start to see creep in those numbers, those are signs of additional stress.”