Thursday, January 20, 2011

What Would Happen if Today's Farm Debt Levels were Stressed?

Graph #1: Total Real Farm Debt.



According to a new report out from the Kansas City Federal Reserve Bank which studied the relationship between debt, farm income and farm financial stress, farmers have been increasing their debt levels at a rate of five percent per year since 2004, the fastest level since the 1980s farm crisis.
"The primary determinants of financial stress are the level of debt, its cost or interest rate, and the amount of farm income available to service the debt."

The study concluded that over the past year, historically low interest rates and rising incomes have allowed farmers to service elevated debt levels that are concentrated among a few farm types. A financial shock—an increase in farm interest rates, a decline in farm income, or both—could increase financial stress quickly, especially among livestock producers and young operators. A surge in financial stress among livestock producers, who hold half of all farm debt, would be of particular concern to agricultural lenders.

These next two graphs use the DRCU* unit measure and are the results of the Briggeman study which calculated which farms would be stressed if farm incomes fell 30 percent or if interest rates went up to 18%.

*[Farm financial stress can be measured using a debt repayment capacity utilization (DRCU) ratio, which takes into account all three determinants of stress: debt, income, and interest rates. Specifically, the DRCU is defined as outstanding farm debt divided by how much debt the farmer can afford to repay with net farm income at current interest rates. Thus, a DRCU of 1 indicates net farm income is sufficient to service outstanding debt. A DRCU of less than 1 reflects that income is more than sufficient to handle debt—and thus financial stress is low. For example, producers with a DRCU of 0.5 could afford to service twice as much farm debt. As the DRCU moves higher, financial stress rises. Farmers with DRCUs above 1 would be unable to service all debt using net farm income alone. Farmers with DRCUs above 2 would be under extreme financial stress because their debt would be double the amount they could afford.]

Graph #2: Scenario of 30% drop in farm incomes.


It is not unusual for annual net farm income to plunge 30 percent as it did in 2002, 2006, and 2009. Applying a one-year, 30 percent drop in income across today’s producers indicates livestock producers and young farmers would be more likely to move into the highest stressed category.

Graph #3: Scenario where farm income drops 30% and interest rates go up to 18%.



A combination of sharply higher interest rates and a steep income decline would lead to greater impacts on farm financial stress. The last such period occurred in the 1980s, when farm interest rates doubled from 1976 to 1981, reaching a peak of 18 percent in 1981, and farm incomes declined by 30 percent. Under this scenario, the number of financially stressed farms would jump significantly.

The percentage of large farming operations facing DRCUs greater than 1 would more than double, rising from 10 to 24 percent. Yet, the greatest stresses would emerge for livestock producers and young operators —farming operations with the weakest net farm incomes.

Under record-high interest rates and sharply falling incomes, the number of livestock producers with DRCUs above 1 would soar from 49 to 67 percent, and the number of young operators with DRCUs above 1 would rise from 50 to 65 percent.

Moreover, this acute financial shock would lead to a steep rise in the percentage of farms under severe stress. The number of severely stressed large farmers—those with DRCUs greater than 2—would nearly triple, rising from 4 to 11 percent.

Livestock producers and young farmers would again experience the most severe financial stress because their weak net farm incomes would not be enough to absorb the shock. The percentage of producers with DRCUs above 2 would rise from 32 to 51 percent for livestock producers and from 35 to 51 percent for young operators.

source: PDF

1 comment:

  1. The KC Fed does excellent work in rural economics. I always enjoy reading their Main Street Economist articles. Just a couple of comments about this report:
    (1) The macro-economy is quite different today than it was before the 1980s farm crisis. Inflation rates, interest rates, and global demand/supply conditions were quite different then. So it’s very hard to make direct comparisons to that time period that are meaningful today, except perhaps as a cautionary tale.
    (2) It seems obvious that young and new producers with higher debt loads are more vulnerable to economic shocks. But how are we going avoid this and yet transition the older generation of farmers to the younger generation? This transition needs to take place, as the average age of US farmers continues to climb. Obviously this new “crop” of farmers may need some kind of safety-net more than the older established farmers would.

    -DB

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