Strategic Risk Associates (SRA) has been a trusted partner of a number of Agricultural focused banking institutions over the years. Despite improvement in fundamentals and farmland values, credit quality and volatility in net farm income, and weak loan demand remain top concerns for Ag Lenders. Federal and state grants due to Covid-19 helped farms in 2020 and kept down loan demand, but increasing prices particularly in corn should lead to increased loan volumes in 2021.
As an experienced Credit Portfolio leader with over two decades of experience in this space, I felt it necessary to share some key insights that can help risk leaders understand the interplay of internal and exogenous factors, stay agile and build resilient portfolios. Through the power of our consulting credit review expertise and SRA Watchtower’s Enterprise Risk Management capabilities, we help our clients quickly assess evolving trends in the US agriculture market - putting them in the position to build and maintain portfolios with the best risk-adjusted returns.
• In contrast to what had been a quite long expansion in the broader U.S. economy, agriculture sector had been in a downturn even before the pandemic with non-accrual rates rising since 2014.
• The pandemic disrupted ag sector from March-May 2020 largely through impact to demand for food, food exports, biofuels, and farm labor.
• Conditions have improved fairly notably since April 2020, due in significant part to government payments (among the highest on record as a share of farm income), but also more recently a substantial increase in agricultural commodity prices.
• Short term outlook looks solid for non-protein Ag even as risks emanating from new strains of coronavirus, strength of USD and labor issues. In 2021, Ag Protein sector will face additional pressure in the form of higher forecast feed costs, but are expected to experience a more stable demand pattern.
• Following years of steady deterioration, various measures of agricultural credit improved in 4Q2020 driven by increases in prices as well as strength in farm real estate.
In contrast to what had been a quite long expansion in the broader U.S. economy, agriculture sector had been in a downturn even before the pandemic. U.S. net farm income had strong years from 2010 to 2013, followed by a fairly rapid decline in income along with reductions in commodity prices.
Incomes improved modestly since 2016, but during the course of the past several years, much of this had also been due to government payments. In-spite of improvement in incomes, liquidity in ag-sector stayed constrained as input costs increased at a faster pace than changes in ag prices.
In 2019, Ag sector had to deal with widespread adverse weather conditions during the planting of spring crops, with less-than-favorable conditions lingering throughout much of the growing season. It was the wettest year on record, and the cold conditions and slow planting progress hampered acreage. Harvest season wasn’t much better, and a lot of corn acreage wasn’t harvested until the following spring. Net farm income, while rising for the third year in a row, remained well below levels seen from 2010 to 2014. Lower production for corn and soybeans reduced stocks that had risen the previous year, in part, due to trade uncertainty.
The year 2020 began with solid global economic growth and a renewed sense of optimism in the agricultural sector when the US and China signed the Phase One trade agreement that sought to cool the trade tensions that had roiled agricultural markets for much of the prior 18 months. However, soon after, the WHO reported the first confirmed case of COVID-19 outside of China.
The pandemic disrupted ag sector from March-May 2020 largely through impact to demand for food, food exports, biofuels, and farm labor. As COVID-19 cases rose in different places, meat packing plants started to close temporarily as they were dealing with some of those cases in their plants. Consequently capacity utilization declined to as low as 60%. This adversely impacted demand and prices of livestock. The reduction of slaughter capacity drove a wedge between some animal prices and wholesale meat prices.
Shift from “food away from home” to “food at home” also adversely impacted demand for ag commodities.
Decline in demand for ethanol due to weak demand for gasoline adversely impacted corn demand.
The dairy sector too faced a high degree of uncertainty in 2020 as restrictions due to COVID-19, including widespread school closures, resulted in changes in dairy marketing patterns and shifts in product demand. Dairy product prices saw significant volatility during the year.
Additionally, the safe-haven status of the U.S. dollar (USD) caused it to appreciate against nearly every currency during the first six months of 2020, including rising by over 30% against the Brazilian real, providing a headwind for agricultural export goods priced in dollars.
Finally- disruption in global trade due to COVID also was adverse to farm prices.
Lawmakers and USDA responded to the challenging market conditions with several programs to offset agricultural losses and stabilize markets, including the Coronavirus Food Assistance Program (CFAP) and the Farmers to Families Food Box Program. The CFAP programs provided more than $23 billion in direct payments to help compensate farmers for losses due to the pandemic, while the Farmers to Families Food Box program linked farmers to consumers, distributing more than 100 million boxes of food to people in need. Substantial modifications were made to SNAP, WIC, and school meals programs to provide increased and more flexible delivery of benefits to persons in need as well.
Conditions have improved fairly notably since April 2020, due in significant part to government payments (among the highest on record as a share of farm income), but also more recently a substantial increase in agricultural commodity prices.
China increasingly entered the global market for grains, oilseeds and livestock products in the late summer and into the fall, leading to a surge in commodity prices and improved prospects for crop and livestock receipts. The commitment by China to greatly expand its purchases of U.S. agricultural products (and other goods) has coincided with its effort to rebuild its livestock sector after suffering the devastating effects of a widespread outbreak of African Swine Fever. Sales of agricultural commodities to China accelerated in the summer and fall, and by the end of the year the pace of corn and soybean sales to China was at or approaching new records.
Grain and oilseed markets are set to end the 2020/21 marketing year with tightening stocks in several key markets because of strong demand.
World corn and soybean ending stocks are projected at multi-year lows as are U.S. ending stocks of corn, soybeans, and wheat. The 2020/21 U.S. season average prices for both corn and soybeans are projected at 7-year highs, and these strong prices have supported the entire grains and oilseeds sector.
The Phase One Economic and Trade Agreement signed by the United States and China on January 15 of last year re-opened to U.S. producers an important market that had been disrupted by ongoing trade tensions for much of the last 18 months. While exports to China were surging, U.S. agricultural sales to Mexico, Japan, Korea and other major trading partners worldwide also remained strong, providing further support to rising prices. Agricultural trade has proved resilient in the face of a global economic contraction. In addition, a rebound in motor gasoline consumption is expected to boost demand for ethanol and further support corn markets.
In 2021, livestock and poultry sectors will face additional pressure in the form of higher forecast feed costs, but are expected to experience a more stable demand pattern. Overall livestock and poultry prices are forecast higher in 2021 due to economic growth and rising exports, despite higher anticipated year over year growth in production. However, the sector does continue to face risks due to new strains of coronavirus and stronger value of USD as compared to currencies of some developing countries.
The agriculture sector has struggled with shortages of farm labor for years, but quarantines and closed borders may exacerbate the problem. Farmworkers have also been disproportionally affected by coronavirus. Many are undocumented and about 10% are in the US on H-2A visas which allow foreign workers – mostly from Mexico – to do seasonal work in the US. Infection rates in many US agricultural counties have been high as workers live in cramped quarters and some lack PPE. Another risk is the impact of the virus on senior farmers. The average age of farmers in the US is over 65 years, which puts many at higher risk of suffering severe effects if the virus is contracted. The fact that agricultural operations are largely rural does somewhat insulate farmers from contracting the virus.
By the end of 2020, and despite the dramatic rise at the onset of the COVID-19 outbreak, the U.S. dollar depreciated against all ten of the next most heavily traded currencies. Despite its weakness against major currencies, the U.S. dollar remains strong against the currencies of many developing countries, including several important competitors in agricultural trade (Brazil, Argentina, Ukraine).
While current conditions in the sector reflect the uncertainty and volatility associated with the extreme events of the last year, the long-term global demand outlook for U.S. agricultural commodities remains favorable. The longer-run outlook reflects decades-long trends in income growth and shifting dietary patterns toward an increasingly diverse set of crop and animal products, especially in developing countries. More generally, a rising global demand for more varied diets and increased animal as well as plant protein consumption continues to stimulate demand for feed grains and soybeans.
On the other hand, a number of pandemic-related factors are expected to curb global meat consumption, including restaurant closures, reduced consumer buying power, and general wariness following COVID-19 outbreaks at meat processing plants. Worldwide per-capita meat consumption is estimated to have dropped nearly 2% in 2020, according to the UN. Increasing focus on ESG and carbon emissions from ag processes may also result in higher costs and shift in consumer demand impact AG Protein sector.
Following years of steady deterioration, various measures of agricultural credit improved in 4Q2020. On average, farm loan repayments increased for the first time since 2013 according to regional Federal Reserve surveys of agricultural lending. The rate of loan repayment increased from a year ago in across the country except TX/LA, with the fastest pace of increase reported in Minnesota, Montana, North and South Dakota, Wisconsin, Michigan, Iowa, Illinois and Indiana.
An increase in farm income in the fourth quarter appeared to be a primary driver of the recent strength in agricultural credit conditions. Similar to loan repayment rates, farm income was higher than a year ago across the country. With better financial outcomes in 2020, capital spending plans of farm borrowers also strengthened in the fourth quarter and were expected to increase in all Districts in coming months.
Overall, credit conditions have improved with some of the increases in prices lately, but farm real estate markets have provided some significant support as well. Farmland values to cash rent ratio has risen substantially partly driven by low interest rate environment.
Farmland values and cash rents remained strong across most states. Although drought seemed to put some pressure on farm real estate markets in the Mountain States, values for non-irrigated cropland increased in all other states in the 4Q2020. Gains were strongest in the Upper Plains and Corn Belt, where farmland values rose by 8% in North Dakota and 9% in Northern Indiana. Cash rents on non-irrigated cropland also increased moderately.
Ag Producers continue to hold bullish perspective on farmland values according to Ag Economy Barometer published by Purdue University. The short-term index (expectations regarding next 12 months) rose during March 2021 to a reading of 148 more than doubling the index since bottoming out in April 2020 at 72. Producers’ long-term farmland value expectations (expectations over next 5 years) also rose during March 2021 to a reading of 157 and matching the index’s all-time high reached in December 2020 and 22% above the May 2020 low of 129.
Alongside better farm financial conditions and lower debt levels, delinquency rates on agricultural loans declined from a year ago. Non-accrual rates rose on farmland and ag production loans from 2014 to 3Q2020 before declining in 4Q20, which was a notable reversal of the previous trend.
The farm sector’s debt-to-asset ratio and debt-to-equity ratio are forecast to reach 13.9 and 16.1 percent, respectively, continuing their slow climb from the lows achieved in 2012. Across the sector, historically low interest rates make managing debt less burdensome and expensive than in decades prior; however, the financial situation of farm varies regionally and by production focus, with nearly 8% of crop farm businesses and 6.1% of livestock/animal product farm businesses forecast to have debt-to-asset ratios exceeding 40%.
(Source – Bloomberg 04/09/2021)