A Mid-Year Agricultural Market Review
by Phil Love, Pactola President/CEO
CAP Senior Member
7/10/2019

I am amazed that we are already in the second half of the year! Where has the time flown? Now is a good time for agricultural lenders to take stock of the current economic conditions and then apply that knowledge as you assess your producers in your loan portfolio. As I write today, soybean prices are off their May lows and have hit $9/bu. Some of this increase may be on the news that China is agreeing to purchase American beans. China also completed its first purchase of U.S. rice. Corn prices have finally topped $4/bu. Live cattle prices are down by 23% from their high earlier this year. In any event, it will probably be a long time before we see prices at the levels we were at half a decade ago. This is not primarily due to any trade issues; it is due to an oversupply of commodities in the world relative to demand. 

But even with some of the most recent rallies in prices, all markets are off their highs of 2012-2013. The challenge is that operating expenses continue to climb, thus squeezing margins. In many cases, you probably have farmers who have negative profits after factoring in living expenses. One area that has stayed in the farmer’s favor is oil. Now that the U.S. produces all its own oil and is now an exporter of oil, price swings from conflicts in the Persian Gulf are muted compared to what we would see decades ago. 

On May 10, the USDA released its report on World Agricultural Supply and Demand Estimates for this crop year. The report predicts corn to drop to $3.30/bu. Soybeans will continue to have downward pressure. Possible Chinese tariffs and a possible drop in Chinese demand due to the impact of swine flu on its hog population are cited. This current ag economic cycle will put pressure on the average and below average business managers. Farmers not being able to retire existing operating lines of credit are a leading indicator of additional ag risk to lenders.

Small agricultural based credit unions and banks are at risk, if economic trends do not change. The Federal Reserve of Kansas City published some recent trends showing small ag banks with assets under $500MM with at least 15% of their loan portfolio in ag production and real estate loans, have significantly increased ag originations since 2012. This group accounted for nearly 50% of the ag loan originations in 2017-2018. Another factor to consider is 22% of operating lines were done by non-regulated lenders last year. 

Consider that many of the lenders managing the larger complex credits are baby boomers in the twilight of their career. Large complex credits are showing financial stress as issues like fraud are beginning to pop up. Leading indicators of stress of heavy refinancing, increase in payables, declines in working capital, and partial liquidation are present. When one considers all these factors, a perfect storm may be on the horizon. 

One may cite low farm bankruptcies and good debt/asset ratio as indicators that there is no crisis. But these are lagging indicators of trouble. Plus, debt/asset ratio has not suffered as land prices, which make up 83% of farm assets, have stayed strong. Some of this is from demand from non-farm investors. Other positive factors have been favorable interest rates and availability of crop insurance. But, heavy land equity may lead to management complacency. I visited with a producer in the past month who has experienced serious losses in the past four years. Instead of setting out to make necessary structural changes, he is attempting to coast till he can sell his land, which is near a growing city.

What are some of the macro trends around the world to watch? On the international trade scene, watch the new USMCA agreement which is replacing NAFTA. This group has 450MM people, with a very young population in Mexico as 47% are under ager 25. The countries are heavy in energy production with the U.S. as #1, Canada as #4 and Mexico as #8 in oil production. As ag trading partners, Canada is our biggest customer and Mexico sits at #3. 

The other biggest international trade factor is China’s Belt and Road Initiative. China has invested $248billion of the $1 trillion it has committed to spend in countries in improving infrastructure and technology as they develop stronger trade partners. This investment has been in 68 countries around the world with much of this in the new 5G technology.  

As you look at the world economy, we are seeing the rising of Asia and the decline of Europe. In 1990, China, India, and Japan totaled 15% of the world’s economic output. By 2020, those three countries will make up 25%. This comes at a time when Western Europe drops from 31% to 22% of the world economy. By 2020. The CIJ countries at 25% will also outpace the 21% the U.S. produces of world economic output.

We are seeing a synchronized global economic slowdown. China is reporting the slowest growth in 28 years and has put substantial amount of central bank stimulus. Urban real estate in China is highly leveraged. It makes one wonder how long the trend can continue. In other countries, both Japan and Germany are at 0 or a slightly negative growth rate. Slower growth rates mean slower global demand for farm products. 

To sum it up, we are facing some significant challenges on the macro level for ag lenders. In future posts, I will try to address some thoughts about judging your operational financial acumen of your producer. 

 

Pactola is a CUAD CAP Senior Member and a subsidiary of Midwest Business Solutions. We are a Credit Union Service Organization that is dedicated to commercial and agricultural lending and serving multiple credit unions and banks throughout the United States with our services. We help our partners increase their earning assets and profitability. By doing so, we help them become a relevant financial force in their community increasing social good through helping businesses and farmers. Visit our website to learn more. You can contact Phil Love, Pactola CEO at phil.love@pactola.com or 605.223.5154.

 

 

 

 

 

 

 

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