The Improved Financial Health of Ag Borrowers and Lenders

Summer 2022 Issue
Farm Economy
Market volatility, rising input prices, and rising interest rates have ag borrowers and lenders concerned. However, the strength of farm finances (and the strength of their capital providers) is much improved since the 1980s. Lower leverage, higher capitalization, and improved liquidity should buffer the sector if a downturn were to strike.
July 26, 2022

This year has brought unprecedented market volatility, economic and supply chain disruptions, and increased geopolitical tensions. As a result, commodity, input, and energy prices are reaching near-record highs. Meanwhile, in an attempt to combat inflation, the Federal Reserve has increased the Federal Funds Rate at the fastest pace in nearly 30 years, with further increases expected this year. These events are sending shock waves throughout agricultural sectors as producers look to navigate this historic environment.

This volatility has created questions regarding the state of the agriculture economy and ag borrowers, especially as increasing input, energy, and financing costs begin to eat into relatively healthy margins. Many of the issues we are facing today—slowing economic growth, rising inflation, increasing interest rates, etc.—echo the 1980s farm crisis. In assessing potential risks facing the ag and food sectors, we at Farmer Mac are also considering the health of the financial system that will need to support producers during such volatile times.

However, while the specter of the farm financial crisis understandably still looms large in some minds, the health of farm finances is much stronger in many respects today compared to the farm financial crisis, largely due to lower leverage. The total sector debt-to-asset ratio has averaged between 10-15% since the early 2000s, compared to 15-23% during the farm financial crisis. As Dr. Zhang noted in our last edition of The Feed, over 80% of Iowa farm ground is debt free, a trend that likely extends to other grain belt states. While the overall level of farmland debt has increased, the number of farms with debt has decreased during this period, partly due to continued farmland consolidation. This decline is also a function of changes in lending standards and practices.

From an agriculture lending perspective, the industry is dominated by the Farm Credit System and commercial banks, which combined represent nearly 70% of total agricultural real estate lending (and over 60% of operating lines). While structurally different (cooperative versus deposit-taking), both are in a much-improved position than in prior years. Partly, this reflects continued consolidation. Active agriculture banks have decreased by over 70% since the late 1970s to just over 1,200 today. The Farm Credit System continues to consolidate, with total banks and associations down 37% since 2000 and with another round of large mergers announced this year. Meanwhile, financing institutions are more diverse than ever, creating scale and risk mitigation across larger, diversified portfolios.

Another component of lending financial health reflects increasing capital and liquidity levels. Agriculture banks averaged equity capital ratios around 8% during the 1980s. Current levels on average are closer to 12%. The Farm Credit System overall is significantly more capitalized, currently averaging 15% equity capital ratios, which is more than double the equity capital ratios during the farm financial crisis. More importantly, these entities are holding significantly more liquidity to mitigate severe and prolonged capital market crises. The Farm Credit System banks’ liquidity position at the end of 2021 (cash and eligible investments) was $81 billion, or 23% of total debt, providing 175 days of liquidity to cover maturing debt and borrowings. This compares to a mere 20 days of liquidity in the 1986-1987 period.

Thus, while the near-term operating environment will likely remain volatile across most agricultural sectors, there is good reason to believe agricultural producers and financing institutions are on solid footing. Continued consolidation, improved liquidity and capital levels, and relatively healthy borrowers have resulted in a landscape that is much more suitable to handle volatility—and even more importantly, able to handle a potential prolonged downturn in the years to come.

Farm Sector Solvency Ratios Were Far Higher Than Today’s Levels Before the Farm Crisis