From my recent travels, a common question across most agricultural sectors is “When are commodity prices going to bounce back?” Producers and lenders alike are eager for any sign of reversal in the economics of the industry. Well, it is true that some large weather event or another unusual circumstance, or “Black Swan” may provide temporary price relief. However, other forces such as the strong dollar, moderating economies in the emerging nations, and trade uncertainty indicate that today’s economic reset will continue onward. In fact, some experts say that where the 1980s reset was more abrupt and short, today’s economic cycle may impact U.S. agriculture for an extended period of time.
Data summaries from University of Minnesota demonstrate just how the economic reset is affecting key financial ratios and economic trends. In its analysis, University of Minnesota divides the participating farms into four groups for each economic indicator examined; the top 10 percent, the high 20 percent, average farms, and the low 20 percent. Of the indicators chosen to analyze, the term debt coverage ratio ranks at the top.
It is no secret that agricultural lenders use the term debt coverage ratio as a measure of repayment ability. Additionally, this metric strongly suggests the degree of financial distress. In 2016, the top 20 percent of farms with accrual adjusted data were at 190 percent; with 100 percent as the minimum. Although this percentage is strong, it is in sharp contrast to the range of 300 to 500 percent during the commodity supercycle. According to the data, the farms in the middle to lower percent ranges continue to feel the most severe economic stress.The average over the past four years, for the average farms group was slightly above, or right at 100 percent .This same group averaged 257 percent for the seven years prior to the downturn. Today, the average farms with prudent managers who reserved working capital are in a better position to weather an elongated downturn.
For the bottom 20 percent, the average 2016 term debt coverage ratio was negative 20 percent coming off negative 46 percent the year prior. Keep in mind that this ratio utilizes nonfarm income in the calculations as well. It is no surprise that refinancing of past-due operating loans and accounts payable to vendors are such popular options today. Strong equity positions, mainly in farmland, have allowed this option so far; however, for how much longer is another question.
It is the season for agricultural banking school across the country, and commodity prices will undoubtedly be a popular topic of discussion. Indicators such as the term debt coverage ratio tell us that the reset will continue; which means a sustained increase in commodity prices is unlikely. In banking classes, credit analysts as well as state and federal regulators continue to emphasize the importance of coverage ratios as indicators of loan status. Next time, we will examine more ratios to watch.