A year ago, we expressed the opinion that AgriBank District** cropland values likely were headed to a soft landing despite the low forecasts and bearish long-term outlook for corn and soybean prices. We based this prediction primarily on three observations. All three still hold true.
Implied Cap Rate- Barometer of Farmland Values Shows Some Restraint in Decline
First, we noted that the AgriBank District “implied” cropland capitalization rate, which is calculated by dividing the USDA District average cropland cash rent rate by the average District cropland value, had stabilized in the 3.25 percent to 3.6 percent range since 2009 and had not followed the interest rate (measured by U.S. 10-year Treasury yield) to its record lows set in early 2013. This would indicate some restraint in setting the average District cropland value, as the market is building in a higher-risk premium compared to the projected growth rate in cash rents. The accompanying chart shows the plot of the implied cap rate versus the 10-year Treasury rate with the 2013 and 2014 observations added. The results show a slight decline over the past two years in the cap rate, but it still has held well above the 10-year Treasury rate, which started moving higher in 2014.
Implied Cap Rate Versus 10-Year U.S. Treasury Rate*Source: USDA 2014 Survey
*The 10-year treasury rate is the 12 month average from July of preceding year through June of current year. Cap rate is equal to the USDA cropland average rental rate ($ per acre) divided by the USDA cropland average price ($ per acre) from annual survey conducted in June of each year (see http://www.nass.usda.gov/Surveys/Guide_to_NASS_Surveys/June_Area/Index.asp).
Crop Price and Interest Rate Changes: Worst-Case Prediction Shows 25%-30% Drop in Cropland Values
Second, we observed, using linear regression and simulation analysis, that District cropland values tended to be more sensitive to changes in interest rates compared to crop prices (for District average cropland values, corn is the dominant price). With the major immediate factor looming over the market being the prospect of lower crop prices, our sensitivity analysis indicated a much smaller impact on cropland values, with a worst-case scenario of declines of 25 percent to 30 percent, compared to the 40 percent declines in the AgriBank 15-state District average farmland value (USDA) from 1981 to 1987. A re-estimation (adding the data from the last two years) and regeneration of forecasts (using current District average corn price and 10-year Treasury rates) from our District cropland value forecasting model confirms that the previous projection of a 25 percent to 30 percent pullback in cropland values still holds.
Borrowers & Lenders: Well-positioned for Land Value Correction
The third observation we made a year ago was that today’s environment is not comparable to the 1980s due to more prudent lending practices (such as loan to appraised value limits), the greater ability of producers to lock in long-term interest rates on farmland mortgages, and the very strong financial position of U.S. agriculture. As indicated earlier, the predicted aggregate debt-to-asset ratios for 2013 and 2014 are at their lowest levels since 1960 at around 10.8 percent. For comparison, in 1981, the ratio was almost 18 percent and climbed to over 22 percent in 1985.
In addition, ithe USDA aggregate farm sector balance sheet data shows current real (2009 dollars) total farm debt is almost $74 billion less (in 2009 dollars) than the peak value observed in 1980, just prior to the farm crisis years ($291 billion versus $365 billion). Since 2002, the real value of U.S. aggregate farm debt has increased at an annual rate of 2.4 percent, while the aggregate value of farm assets has increased at a 5.3 percent annual rate over the same time period.
Holding aggregate U.S. farm debt constant, a 40 percent decline in real asset values would result in the aggregate debt-to-asset ratio increasing to 18 percent—slightly above the pre-farm crisis values that were in the 15 percent to 18 percent range from 1973 through 1981. To get the debt-to-asset ratio up to the 1985 peak of 22.2 percent would require that aggregate U.S. farm asset values fall by over 51 percent, while holding debt constant.
Approximately 85 percent of the aggregate U.S. farm sector asset value is held in the form of real estate. Holding the non-real estate real asset value constant, it would require more than a 60 percent decline in farm real estate values to get the 51 percent decline in total asset values required to push the real debt-to-asset ratio up to the 1985 high.
The bottom line is that the U.S. farm sector is in the best financial shape in over a generation. Some farming operations may face unique challenges that lead to unique financial difficulties. Given current expectations for crop prices, interest rates and farm real estate values, we don’t foresee widespread conditions similar to the 1980s farm crisis.
**Information in this post was provided by AgriBank. AgriBank is FCS Financial’s funding source. It is one of the largest banks within the national Farm Credit System, with more than $80 billion in total assets. Under the Farm Credit System’s cooperative structure, AgriBank is owned by 17 affiliated Farm Credit Associations. The AgriBank District covers America’s Midwest, a 15-state area from Wyoming to Ohio and Minnesota to Arkansas. More than half of the nation’s cropland is located within the AgriBank District, providing the Bank and its Association owners with exceptional expertise in production agriculture. For more information, visit www.AgriBank.com.
