Farmland – they aren’t making any more of it
The good times for corn and soybean farmers are here. That means their business planning should mimic hard times.
So said Jim Knuth, a senior vice president with Farm Credit Service of America. He is a guy who can look in the face of good numbers – corn trading at $6.55 a bushel on Tuesday morning, soybeans at $13.97 a bushel – and respond with a “let’s not get carried away here.”
“I know the questions have to be asked sooner or later: ‘How high will land prices go, how high will grain prices go in 2011, how low will interest rates go?’ The answer to all three questions is: I don’t know; nobody knows,” Knuth said during the Peoples Company land expo Jan. 21 in West Des Moines.
It isn’t that Knuth is a guy without a brighter side. As a key agriculture lender, Farm Credit plays its approach to risk pretty close to the vest.
Knuth, who oversees an area made up of Iowa, Nebraska, South Dakota and Wyoming, does allow that “the stars are aligned for grain farmers.”
He is proud of the farmers who tap his office for a loan. In fact, he gave all of the farmers attending the land expo a verbal pat on the back, saying they have developed an enviable degree of financial savvy and business acumen over the years.
They’ve had to. Knuth had simply to remind them of the farm crisis of the 1980s, when lending was based on inflated land prices that eventually went bust, sort of like the crisis in residential lending that fueled a financial crisis that fueled the Great Recession.
Knuth draws the line at that kind of nonsense – Farm Credit isn’t about to advance a 100 percent loan to someone whose financial statement shouts “credit risk.”
Still, with prices for farm- land jumping 20 percent in late 2010 and grain prices steadily climbing – although, it should be noted that Tuesday prices for corn and soybeans represented modest declines from the previous day – it’s difficult to resist asking “will it ever end?”
Of course it will, is Knuth’s response.
“Our credit philosophy says we want to be conservative in good times. What you do in good times has a significant impact on your viability and options in tough times,” he said. “Most mistakes made by borrowers and lenders are made in good times. Everybody says, ‘let’s go make money.’”
Market highs and lows typically are seen “in the rear view mirror,” Knuth said.
Knuth noted that Iowa farmland is being purchased from a position of financial strength. In Iowa, the buyers tend to be other farmers with the ability to pay for the land, as opposed to out-of-state investors.
Delinquencies on loans from Farm Credit ran at 0.17 percent in 2010. On average, buyers provided nearly half of the loan value. Their debt-to-asset ratio was 34 percent. The average loan was for $272,613, with a loan term of 17 years.
The surge in land prices has been in Iowa and other grain-producing states. There are a variety of reasons, but a key is the desire of people in developing nations, such as China and India, to add protein to their diets in the form of beef, pork and poultry, all fed by grains produced in farm country.
“We need to recognize higher commodity prices without becoming over-exuberant or overreacting,” Knuth said.
In making loans, Knuth said he considers the borrower’s financial position, the cost per acre of the land, the correlation between price and quality, and whether the borrower can withstand changes in interest rates.
A 2 percentage point increase in interest rates can add $60 to $70 an acre to the cost of land, he said.
The ability of Iowa farm ground to produce larger crops means that its quality and cost are on the increase.
“We all want to know when 300 bushel an acre corn will become the standard. The answer probably is sooner rather than later,” Knuth said.
All buyers of farmland should consider the annual cost per acre of the loan. They should try to keep that cost below average rental rates, he said.
Knuth cautioned that rising asset values do not repay loans, a truth that was proven prior to the collapse of real estate markets in 2008, when the value of residential property escalated and was purchased by home owners and developers who lacked the financial resources to continue paying for the properties.
“The question when you get in an environment of rapidly rising asset values is whether the valuation is correcting or overheating. The answer is that the asset is only worth the income it can generate,” he said.
Knuth said it is doubtful that high grain prices are permanent.
“Higher prices are not permanent; they tend to last for short periods of time and then normalize over time. That’s true of every business entity, not just agriculture,” he said.
Farmland remains an attractive investment because it produces income, it can’t be corrupted, it can’t go bankrupt, and it has an “infinite useful life,” Knuth said.