January 10, 2022
*This is the fourth article in our 2022 Southwest Economic Outlook series. Hear from Oklahoma State University and Texas A&M AgriLife Extension economists about the 2022 outlook.
Following a half-decade of low and stagnant commodity prices, culminating with the scare of economic shutdown and pandemic uncertainty, the farm economy looked bleak in 2020. Prices recovered reasonably well before most of the 2020 harvest and have since improved as economies gradually emerged from lockdown and continue to adjust to new ways of doing business. Net farm incomes in 2020 and 2021 were much improved with support from government relief programs and bolstered commodity prices. With improved farm profits, credit conditions have also seen much improvement over the last two years. Outstanding farm debt has generally decreased since the spring of 2020 and delinquency rates have fallen. In spite of slightly less activity and loan demand, ag lenders have also seen improved net incomes resulting from improved loan performance, fewer charge-offs, and lower interest expenses.
In general, recent loan demand has been rather slow, especially for operating loans. At least for a time, one would expect healthy competition among lenders for business in the face of weak demand and improved commodity prices. However, that environment may turn quickly as production costs climb and farm margins taper. As is often the case, sooner rather than later is the best time to start conversations with your lender about operating credit needs for 2022. Increases in short-term operating loans may be necessary to pay for significantly higher input costs, and those increases may be justified if the borrower also manages revenue risk appropriately with current high commodity prices. Loan demand for farmland real estate has been more stable and land values continue to rise. Both are supported by a combination of strong farm equity coupled with a mostly flat yield curve that has kept long-term fixed interest rates at very attractive levels. Until those two factors change, expect that trend to continue.
So, there lies the significant questions. How long will farm profits hold and what happens with interest rates and inflation? As a warning sign, it’s interesting to overlay the history of commodity prices, farm input prices, and loan delinquency rates. Look back at 2008-09, for example. In rapid succession, corn prices spiked, then fertilizer prices spiked, and soon after loan delinquency rates spiked. Obviously, there were countless other factors at play, but those events are easily pieced together and were not coincidental. Are we on a similar path?
What about inflation? Inflation and/or higher interest rates in response to potential inflation are both high on the list of concerns. In either case, it may be tempting to take on additional term debt by leveraging today’s increased land values and improved equity positions. Adding to the temptation is the thought of locking in cheap money (low fixed interest rates) on an extended term to pay it off later with inflated dollars. Don’t fall into that trap, it only comes close to working if your income source and asset base perfectly mirror any general inflation. Commodity price levels might offer something of an inflation hedge, but farm margins and profits clearly do not. Borrowers and lenders alike need to be wary of lending on the basis of asset values. Repayment capacity and cash flow lending should continue to be the standard. And in the face of an uncertain and potentially fragile economic outlook, effective risk assessment and management are essential to evaluating credit questions.
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