By Bert ElyIs history about to repeat itself? In rural America it just might as the Federal Reserve moves aggressively to push up interest rates to deflate the inflation that has erupted in recent months. Older farmers and ranchers, as well as bankers, who have studied financial history (or lived through it) remember the agricultural crisis of the 1980s when the Fed boosted interest rates to record levels to reduce the rate of inflation. Given how much farmland prices have risen in recent years, due in part to very low interest rates, sharply higher rates could pop a farmland bubble.
The Fed’s very low rates of recent years coupled with “quantitative easing,” which has pushed down rates across the entire yield curve, have helped to inflate farmland prices as various reports have documented. For example, the Federal Reserve Bank of Chicago’s May 2022 AgLetter reported that its district saw a year-over-year gain of 23% in its farmland values in the first quarter of 2022.
A chart published by the Federal Reserve Bank of Kansas showed that after a slight decline in farmland prices in the middle of the last decade that bottomed about 2017, farmland prices began to experience significant annual increases. On an inflation-adjusted basis, farmland prices in the Kansas Fed’s district have hit a peak last reached in 2013 and are nearly double where they were in 2009.
The Financial Times reported on April 7 that “land values in the Midwest grain belt have gained 25-30% in the past year while auctions draw intense bidding for available ground.”
In the years leading up to the 1980s farm crisis, farmland prices, which had nearly doubled on inflation-adjusted basis since 1971, collapsed, leading to thousands of farm bankruptcies and economic distress throughout rural America.
Various factors helped to inflate that bubble, including liberalized collateral practices at the Farm Credit System authorized by the 1971 Farm Act. Far worse, FCS institutions set their loan interest rates based on their average cost of funds, which meant that in the rising interest rate environment of the late 1970s and early 1980s, the FCS consistently underpriced its loans, which further inflated the farmland bubble.
In recent weeks, the Fed has begun pushing up interest rates—the question now is how fast and how far. These rate increases are coming, though, at an especially difficult time for American agriculture as inflation drives up the cost of a broad range of farm inputs, a situation worsened by the supply chain challenges of recent months.
Quite worrisome for many areas, from California to the Mountain West and portions of the Midwest, is a severe drought, “about as bad as we’ve ever seen,” according to one Kansas banker. How bad the drought will be, how widespread, and for how long is the great unknown.
Two other uncertainties affecting farm income, and therefore farmland values, are the outlook for federal government payments and the effect of the Ukraine war. U.S. Department of Agriculture’s Economic Research Service has projected a continuing decline in direct payments to farmers from the federal government with payments in 2022 forecast to be only slightly more than half what they were in 2019; that outlook is hardly positive for farmland values. While the war has caused a global spike in wheat prices, that effect on farm incomes may be quite transitory.
History, hopefully, will not repeat itself, with rising interest driving down farmland values and trigging increased farm bankruptcies, but given the near certainty of significantly higher interest rates over the next few years, now is the time for ag lenders, including the FCS, to be especially cautious in forecasting farmland values very far into the future.
Consolidation continuing within the FCS
Two recent announcements evidence the continuing consolidation within the FCS that is leading to bigger FCS associations that are more distant than ever from their member-borrowers. Currently, there are 65 FCS associations, ranging in size from $37.8 billion (FCS of America) down to Delta ACA of Dermott, Arkansas, with $33 million of assets. Here is a link to a listing of the loan and asset totals for the 65 associations as of March 31.
Two mid-Atlantic associations—AgChoice of Mechanicsville, Pennsylvania, and MidAtlantic Farm Credit of Westminster, Maryland—will merge to form a new association that will have approximately $5.85 billion in assets, making it the 11th-largest association. At the other end of the scale, Delta ACA is so small that it could not find a merger partner. Consequently, it is in the process of being liquidated and its loans transferred to another association.
Given all the consolidation that has occurred within the FCS, as of March 31 of this year, the six largest, multistate FCS associations held slightly over half of the total assets of all 65 associations. The median-size association had $1.44 billion in assets and the bottom half of the associations, in terms of asset size, held less than 10% of total association assets as of March 31.
Consolidation undoubtedly will continue within the FCS, particularly in those regions of the country, such as in Texas, the lower Plains states, and the Southeast, where the smaller associations tend to be concentrated. One troubling consequence of all of this consolidation has been the emergence of some very large associations—10 now have more than $10 billion in assets—that will be difficult for the Farm Credit Administration and the Farm Credit System Insurance Corporation to resolve should a large association experience financial difficulty. As the previous article outlined, rural America is not impervious to another round of financial distress.
While it is easy to see on the map of the FCS associations, the scope of the consolidation that has occurred, the FCA does not publish data on FCS branch office numbers and locations, but as the associations themselves have reported occasionally, they have been consolidating and closing branch offices. Not only do office closures distance FCS lenders from the farmers and ranchers they are lending to, but those lenders are likely to be less in touch with local agricultural conditions, which could increase the riskiness of FCS lending, especially on ag real estate.
Editor’s note: If you have questions for Bert, feel free to email him at Bert@ely-co.com.