Most of us knew there would be a hangover from $6 corn, but who would have thought that subprime lending might cause it?
Our interconnected world has some growers wondering where Wall Street ends and Main Street begins. “It's one long street, and always has been,” says Michael Swanson, agricultural economist, Wells Fargo Bank. “The farm economy has never been an island, but it used to take longer for the waves to reach distant shores.
“As margins compress, farmers will have to compete with other segments of the economy for operating capital. Capital is like water; it flows to the best return,” he says.
The good news is that crop farmers' credit risks are “pretty good, and the Farm Credit System has its own source of funds,” says Gary Schnitkey, University of Illinois farm management specialist. He doesn't think that Wall Street's credit crunch will alter farm businesses much. “Farm Credit has agency status, so it can float its own bonds, and they might look like an attractive alternative.
“Investors are fleeing traditional investments, making farmland look even more attractive. I don't anticipate that farmers will have much problem with the credit side of things; most crop farmers are in pretty good financial shape,” Schnitkey says.
“Where I see the risk in agriculture is that operating costs have doubled, increasing operating loans. If we have high loan costs and a drop in crop prices, growers are stuck with $4 average corn breakeven costs, in Illinois for example. Corn prices below $4.50 will become a problem for many growers,” he says.
A global recession could dampen oil prices, which could drag other commodity prices with them. And lower oil prices also reduce ethanol prices, which weaken demand for corn. The upside is that lower oil prices could also lower fertilizer prices.
“The real driver of the ag economy is energy prices,” Swanson says. “The big question is what kind of floor energy prices will put under crop prices. Every $10/barrel drop in crude price reduces corn's value by 90¢/bu. (Each $10/barrel drop in crude oil drops gasoline by about 30¢/gal. Since we get 2.8 gal. ethanol from 1 bu. of corn, this 30¢ price swing in gasoline price creates a 90¢ drop in the market value of corn.) These are general rules of thumb,” Swanson says.
The whole credit crunch on Wall Street “is really undercutting expectations about demand,” explains Darrel Good, University of Illinois ag economist. “If it negatively affects global economic growth, then this robust increase we've seen in meat consumption will slow, weakening demand for grains. It could lower crude oil prices, which reverberates through the biofuels market. The oil and ethanol link is very strong. Reduced demand across the board is an overall negative for the crop market.”
Ethanol prices drive corn prices these days more than export demand, Swanson says. “The U.S. is only exporting 16% of its corn crop because we've made policy decisions to channel more corn into ethanol. “Not long ago, we exported in the high-20% range of our corn crop — a drop from 2.4 billion bushels in the 2007-2008 marketing year to 2 billion bushels this year (2009-2009),” he says. “And we've gone from using 1 billion bushels of corn for ethanol to 4.1 billion bushels this year.”
The Renewable Fuels Standard calls for 10.5 billion gallons of biofuels for 2009, which will consume 3.6 billion bushels of the 2008 crop and 4.1 billion bushels from the 2009 crop to meet the demand for 12 billion gallons of biofuels in 2010.
Local elevators are the focus of Iowa State University Economist Mike Duffy's concern: “They had their books and balance sheets set up to carry $2.30-2.50/bu. corn, not $7 corn; and their working capital got sucked up. Now we're back in the $5 range and they have adjusted, but it will be a while until we see how this finishes out. I know of one elevator that wrestled with a $25-million margin call.
“Elevators may not have it as tough as some other small businesses, but I have noticed that my local elevator has not yet listed 2009 contracts,” Duffy says.
“The Federal Reserve Seventh District reported in spring of 2008 there were more funds available at 32% of its banks. Where has that money gone? It is not totally clear to me. I do think ag is somewhat insulated from this subprime debacle, and it will take some time before things settle out. Here in Iowa, our land ownership survey reports that 75% of farmland is owned without debt,” Duffy says.
What has changed, Swanson explains, is that many banks held stock in Fannie Mae and Freddie Mac (the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation), and when they went into receivership, that money disappeared. “So those banks will require larger spreads (on the cost of funds) even if the Federal Reserve doesn't raise its benchmark lending rate.”
But “community banks in the Midwest did not have as much involvement in this as the larger banks did,” explains Paul Ellinger, ag finance professor, University of Illinois. “At this stage, the Wall Street credit crunch still doesn't affect the traditional corn and soybean farmer like it does corporate America because community banks are more deposit-based. The portfolios of agricultural banks in general have been very strong due to two years of high crop incomes.
“Of more concern to community banks is farmers' breakeven level,” he says.
THERE ARE TWO SIDES to how the Wall Street credit crunch will impact corn and soybean growers, as Michael Boehlje sees it. He is distinguished professor, ag economics, Purdue University. “We already have financial stress from price volatility, and we have just exacerbated that problem with this credit crunch,” he says.
“It may slightly raise the cost of funds for farmers and make lenders more conservative. Rural banks and the Farm Credit System have hardly participated in the subprime housing markets, so funds will be available, but at higher cost. But that would not impact growers as much as price volatility,” he says.
Farm balance sheets are very strong, according to USDA figures. “On average, farmers have 91% equity in their farms and only 9% debt; many have no debt at all,” Boehlje says. “And those averages include livestock producers who are having a very rough time.
“Farmers and their lenders learned from the 1980s, so they have already been more conservative. They have not tried to finance appreciating values like we saw in the housing market,” he says. “That's a very important difference, which means agriculture is much better positioned to weather this storm.
“Longer term,” Boehlje says, “if we do have a global economic slowdown, that could slow the global dietary transition from vegetable to animal proteins. But I don't think that would reverse or permanently reduce animal protein consumption.
“I don't want to conclude that we are facing a global recession or that a slowdown would be permanent. We might have a rougher patch for a time,” he says.
MOST GROWERS HAVE always been wise to keep an eye on their debt-to-equity ratios. “But an even more important principle today is discipline around land,” Swanson says. “It costs just as much to farm marginal ground as it does to farm excellent ground. Yet good soils will outperform marginal ones substantially.
“So the rents and prices of marginal land have to be heavily discounted so that lower yields don't penalize you. Yet we are in a time where everyone wants to farm every acre and pay top dollar for every acre no matter how marginal the soil. We have done this to ourselves. We have not been able to walk away from 200 acres of breakeven or money-losing acres,” he says.
“You should review every acre you farm and ask ‘is this paying the bills or taking money out of my pocket?’,” Swanson says. “If you are renting marginal ground, let it go to someone else. Why pay $200 for the chance to lose money? This discipline is so difficult because we've been motivated to farm bigger acres with more paint.”
A VIEW FROM THE CAB
Credit availability does not appear to be a threat for Jim Klever. He farms 3,800 acres in northern Illinois near Lena. “Our local Farm Credit affiliate says that credit availability will not be an issue for them, and I think we're OK as far as I can see,” he says.
In early October, Klever was more concerned with how far out he would be able to lock in grain prices, given what he's prepaid for inputs.
“My assessment is that the biggest fallout is probably going to be that some of the hedge funds will dry up, which I hope will reduce the volatility. I'm not sure that's a bad thing — getting rid of some of the volatility. During the run-up in grain prices, you couldn't contract too far into 2008, and couldn't get anything done in 2009 last spring,” he says.
“My concern is that I'll need 190-bu. corn just to break even, with anhydrous here at $1,250-1,300/ton and potash at $1,000. If corn stays at $5 and rents wanting to climb, how's that going to work? I think our credit supply will be OK,” he says.