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Corn+Soybean Digest

Leverage Pros and Cons

Having just read several commentaries that predict $5 corn and $15 soybeans, it sends chills down my spine reliving some of the past.

Times have definitely changed and we may be experiencing some inflated price levels, but cycles are still a fact of life. Why? Fear and greed are two basic human emotions. And as long as they're present, we'll have cycles. If prices get that high it will choke off demand. I just spoke with a client who is replacing a significant portion of his bean meal with lysine. Market rationing has already started.

Looking back, it appears that net farm income for 2007 will be around $87.5 billion.

Below are figures from the USDA Farm Income statement for the entire industry.

Initial forecasts will not be released for 2008 until Feb. 12 and 2007 is still an estimate. However, you can see a trend emerging.

First, although net farm income is at a record level in today's dollars, in 1982 dollars it's only slightly above the adjusted average for the last 92 years (1915-2007).

In the October issue, I outlined net farm income for the past 90 years, and historically good times do not last more than several years. Based on inflation-adjusted figures, we're not even in the good times yet.

Another significant thing from the chart I notice is the expense trend. It is up every year. Income has not been.

That equates to volatility. The best way to manage in these times is to take a profit when it meets your goals. And if prices go up, sell some crop for the next year.

Reviewing some concepts involved in leverage might serve us well in these times.

First, if managed properly, financial leverage can increase your return on equity (ROE), which is partly attributed to our client average ROE, which was 16.9 % in 2006. The industry overall was less than half that. However, leverage is like fire: useful if controlled, devastating if not.

Following is an example of a 50% leverage position with a 10% return on assets (ROA).

After paying the interest, you make $6,500 — a 13% ROE. That's better than the 10% if you used all your own money.

However, if you if have a 10% loss on those assets, the return is -26%. Not a good deal, but a livable situation.

Using a similar example, but at 80% leverage, one makes even more (22%) on original equity with a 10% ROA.

However, if you have a -10% ROA, the results are devastating — you are essentially broke.

This example clearly points out the importance of bullet-proofing your balance sheet during volatile times.

If you are highly leveraged, which many of our younger clients are, here are three recommendations for being “Riskwise”:

  1. Have a high percentage of your debt at fixed rates.

  2. Use risk management to lock in costs and returns.

  3. Manage your margins to keep the top side open where possible.

Moe Russell is president of Russell Consulting Group, Panora, IA. Russell provides risk management advice to clients in 34 states and Canada. For more risk management tips, check his Web site ( or call toll-free 877-333-6135.

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