AGRICULTURAL INCOME AND FINANCE -- SUMMARY February 27, 2001 February 2001, ERS-AIS-76 Approved by the World Agricultural Outlook Board -------------------------------------------------------------------------------- This SUMMARY is published by the Economic Research Service, U.S. Department of Agriculture, Washington, DC 20036-5831. The complete text of the report will be available electronically about 1 week following this summary release. -------------------------------------------------------------------------------- Demand for Farm Credit Moderates, and Farm Lenders Continue To Show Caution Financial institutions serving agriculture continued to experience improved conditions in 2000, and further gains are expected in 2001. Farm financial conditions remain stable because of large government payments and greater off-farm income. Generally favorable conditions experienced by farmers during 1990-98 helped strengthen the financial condition of most farm lenders. But net cash farm income, which measures cash available from sales after paying cash operating costs, declined from an annual average of $58.1 billion in the favorable years of 1996-97 to $55.5 billion in 1999-2000, even with sizable government assistance. Net cash income was $54.6 billion in 1999 and is expected to be the fourth highest on record at $56.4 billion in 2000. But farm sector challenges persist. Continued low prices for many key agricultural commodities and weather problems in some regions have generated concerns about the ability of farmers to repay new or existing loans. Many of the concerns focus on producers' ability to obtain and retain production credit. In 2001, farm lenders will be dealing with a clientele whose net cash income performance is forecast to decline 10.1 percent or $5.7 billion, some $4.1 billion below the 1990-2000 average of $54.8 billion, assuming no additional government assistance. While the national picture appears secure, regional and sectoral problems exist. The impacts of this decline in income will not be evenly distributed across all U.S. farm operations. Low commodity prices continue to depress farm operating incomes, but widespread effects on farm lenders have yet to materialize. The position of agricultural lenders reflects the generally healthy state of farmers' finances in recent years. All major institutional lender groups except the Farm Service Agency (FSA) continue to experience historically low levels of delinquencies, foreclosures, net loan chargeoffs, and loan restructurings. These aggregate farm lender indicators will remain favorable barring a sustained increase in farm financial stress. The duration of the current commodity price declines remains unknown, but there is little indication of a problem in the national farm lender performance data to date. However, there will be a lag before any significant farm financial stress would appear in the national data. Total farm business debt at yearend 2000 is estimated at $180.6 billion, up 2.4 percent after increasing 2.1 percent in 1999. The dollar volume of farm loans outstanding increased for all lender categories, except the FSA. Farm loan volume held by commercial banks and the Farm Credit System (FCS) increased 3.3 and 3 percent, respectively. Together, commercial banks and the FCS held 67.4 percent of all farm debt at the end of 2000. Commercial banks have gained farm debt market share for 14 of the past 16 years and now hold 41 percent of outstanding farm business debt. FCS market share during the same span dropped for 9 of 10 years before increasing 5 of the 6 years during 1995-2000 to 26.4 percent. The expected 1.2-percent increase in farm business debt in calendar 2001 will be the ninth consecutive increase. Nonreal estate loans are forecast to increase about 1.2 percent compared with 1.3 percent growth in 2000. Real estate loans are expected to increase about 1.3 percent compared with a gain of 3.3 percent in 2000. Commercial bank total farm loans are projected to increase 1.8 percent, while the FCS' total farm lending is expected to edge up only 0.3 percent. The expected increase in total debt of about $2.2 billion during 2001 will follow a 1992- 2000 expansion of $41.4 billion or 29.9 percent. Some $16.8 billion (40.4 percent) of this increase came in 1997-98, as farmers were optimistic following the planting flexibility allowed by the 1996 Farm Bill and the relatively high commodity prices of 1996-97. Farm debt at yearend 2000 was still 6.8 percent ($13.2 billion) below its 1984 peak in nominal terms. The outlook for 2001 indicates that loan demand will be moderate because commodity prices are expected to remain low, and weak export demand will persist. Farm operators and lenders learned during the farm financial crisis of the 1980's that ill-advised borrowing cannot substitute for adequate cash flow and profits. In addition to gains in farmland values, cautious borrowing has helped keep the farm sector balance sheet sound. Farm sector equity growth continues, but at a much slower pace than during the 1990's. The 2001 forecast of moderate increase in debt thus suggests modest levels of new capital investments financed by debt and a relatively low incidence of farms borrowing their way out of cash-flow problems. Adequate levels of working capital, emergency government support, and off-farm earnings are helping to hold down new borrowing. Expected 2001 price and income levels and uncertainty about export demand will cause farmers to be cautious concerning debt use. In fiscal 2001, farm exports are expected to rise to $53 billion from the recent low of $49 billion 2 years ago, but are still well below the 1996 peak. Congress enacted four pieces of legislation between October 1998 and January 2000 that increased farm program spending. Government assistance has been important in stabilizing farm income, particularly for grain, soybean, and cotton farms. Total direct government payments to farmers were $12.2 billion in 1998, $20.6 billion in 1999, $22.1 billion in 2000, and are projected at $14.2 billion for 2001. Farmers received an annual average of $8.8 billion in direct payments during 1990-97, but this increased to a yearly average of $17.3 billion for 1998-2001. The 1998-2001 ongoing total expected direct payments of $69.1 billion is reducing the demand for credit and helping maintain farmland values. Farmers have been maintaining or improving their balance sheets by applying some of their additional government payments to existing debt. Actual changes in farm business debt both in 2000 and 2001 will depend heavily on the timing and extent to which farmers use these payments to reduce outstanding loan balances. Agricultural lenders continue to be relatively cautious in extending agricultural credit, as the farm loan portfolio losses of the early to mid-1980's are a recent memory. Many lenders have moved to improved measures of repayment capacity rather than cash flow alone to assess the ability of farmers to handle a given level of debt. Although the current situation does not merit the label of crisis, the persistence of low commodity prices in 2001 will aggravate cash-flow problems for farm businesses. About 24 percent of all farm businesses with annual gross sales of $50,000 or more are forecast to have debt repayment problems in 2001, up from 20.5 percent the previous year. The Economic Research Service analysis shows that overall farmer use of net repayment capacity is forecast to rise to 64.7 percent in 2001, up from 59.5 percent in 2000 and 59.6 percent in 1999 (the latter two lowered because of the large Federal payments). Currently, the availability of funds is not the problem. In terms of the total supply of credit available to agriculture, farmers are not being turned away because of a lack of loanable funds. The current credit situation varies considerably by region, commodity, farm size, and farm type. Despite low commodity prices, lenders appear confident about the majority of their farm customers given the level of Federal assistance and the amount of off-farm earnings. Most farmers are not as heavily leveraged as they were over a decade ago. Veteran lenders cite significant differences from the 1980's, including lower interest rates, more owner equity, better credit analysis and monitoring methods, and the financial health of their producers. Lenders thus will work with most of their customers to restructure debt and provide credit for operating expenses. Interest rates on outstanding farm debt rose about 20 basis points (a basis point is 1/100 of 1 percent) from 1999 to 2000. Interest rates on new farm loans made in the fourth quarter of 2000 increased about 50 basis points from their 1999 fourth- quarter levels. The higher farm interest rates in 2000 reflected a tighter monetary policy by the Federal Reserve Board. The large cuts in interest rates by the Federal Reserve Board in January 2001 should result in lower interest rates in the farm sector in 2001. Total farm sector interest expenses are forecast to increase slightly in 2001 because of a lag in the lowering of interest rates on the existing portfolio and due to an increase in total farm debt. Agricultural banks remained very profitable through the middle of 2000. Their annualized rate of return on assets was 1.3 percent, even higher than their strong performance in recent years. At 13 percent, return on equity also increased from already strong levels. Nonperforming loans declined to 1.0 percent of total loans from 1.2 percent the prior June, and loan loss provisions were only 0.3 percent of total loans. These results indicate that problems in the farm sector have not seriously affected farm bank loan portfolios. Loan losses at agricultural banks may increase if farm sector problems persist over an extended period, but government assistance has helped farmers repay their loans, and the strong capital position of farm banks will allow most to survive. No agricultural bank failed in 2000, and only five failed during 1994-99. The average loan-to-deposit ratio for agricultural banks was nearly 76 percent on June 30, 2000, an increase of 4 percentage points from a year earlier and up from 57 percent at the end of 1992. In the current financial environment, commercial banks can easily access nondeposit sources of funds, and profitable, well- managed banks often have very high loan-to-deposit ratios. The Gramm-Leach-Bliley Act of 1999 provides most farm banks access to a stable source of long-term funds from the Federal Home Loan Bank System to supplement their traditional sources of loanable funds. The financial condition of the FCS remains solid as it enters 2001. Both loan volume and at-risk capital continue to grow. Income has rebounded from last year's decline, fueled by a reduction in tax liability, improved portfolio quality, and a higher loan volume. The reduction in tax liability relates to favorable court rulings on previously taxed income from long-term mortgage lending through Agricultural Credit Associations and from restructuring many of these associations to eliminate this tax liability in the future. Loan portfolio quality is strong and has improved, with the exception of loans to cooperatives. Volume growth has supported the System's level of earnings, while net interest margins have declined. Retained earnings for the first 9 months of 1999 remained sufficient to raise the ratio of at-risk capital to assets. The Farm Credit Administration is pursuing an initiative to provide national charters to FCS direct lending associations. Life insurance companies historically have been providers of mortgage credit to the farm sector. Among life insurance companies, total farm loans outstanding were up 2.8 percent in 2000. Approximately $1.6 billion in new farm mortgage loans was closed in 2000, compared with $2.5 billion in 1999. During 1981- 92, total industry farm mortgage holdings actually declined in 8 of the 11 years for an overall drop of 27.9 percent, so the 1992- 2000 increase totaling 34.7 percent over 8 consecutive years is significant. Life insurance companies report adequate funds for deals that meet their quality standards. Their farm lending is forecast to increase 2.4 percent in 2001. FSA's presence in farm credit markets continued to shrink in 2000. Of the $5.6 billion in FSA guaranteed and direct lending available for fiscal 2000, only $3.7 billion was obligated. Direct lending volume fell significantly during the year, while guaranteed lending rose to record levels. Stabilizing farm financial conditions and Federal farm support help explain why FSA loan demand did not rise in 2000. For fiscal 2001, FSA has $4 billion in lending authority, which should be sufficient to meet anticipated demand. The quality of direct and guaranteed loan portfolios improved significantly during fiscal 2000. Farmer Mac purchased or guaranteed $815 million in loans under its Farmer Mac I program during 2000, down from the $1.2 billion recorded in 1999. Purchases of Farmer Mac II loans were up significantly on higher U.S. Department of Agriculture (USDA) guaranteed loan volume. Delinquent loan volume and contributions to loan loss reserves rose during the year. The annual lender issue of the Agricultural Income and Finance Situation and Outlook report features two special articles. The first examines the characteristics of farm borrowers from the major lender types as reported in the USDAs 1999 Agricultural Resource Management Study and the second analyzes whether bank consolidation and nonbank office ownership hurt or help rural economies. Printed copies of the Agricultural Income and Finance Situation and Outlook report will be available in about 2 weeks. For more information, contact Jerome Stam (202) 694-5365 or e-mail him at jstam@ers.usda.gov. Full text of the report also will be available on the ERS website at www.ers.usda.gov. END_OF_FILE