Refinancing the Farm or Ranch

Situation

One of the concerns that has become obvious to many in agriculture is the rapid reduction in working capital the past few months. Operating loans for 2016 may not be paid off after harvest, especially with the rapid decline in grain prices since mid-June 2016. Refinancing or rolling forward the remainder of the operating loan is going to be an option for many farms and ranches. A lender may ask for more collateral to do the roll however or indicate there is enough to cover the additional debt. But rolling operating notes forward is a warning sign for farm and ranch operators. Why?

The incomplete payment of a current operating loan reflects a problem that farmers have experienced during the current growing season, a severe cost price squeeze. Simply rolling the debt to the next year and collateralizing it with machinery or land or cattle does not address the underlying cause. Not addressing the problem can lead to future outstanding operating loans and more debt to carry in the future. The remedy is to address the current cash flow problem.

Cash Flow Shortfall Solutions

There appears to be three cost areas that farmers and ranchers must address. Cash Rent rates are the first to deal with as these are being determined at this time. At least for the medium term, grain prices are not going to increase significantly above current numbers unless some dramatic occurrence takes place, e.g. a drought or a war. So cash rental rates need to match the income reality of the next few years.

Family living draw has increased in farm country since the ethanol boom began in 2006. In Nebraska, farm family living draw, not including taxes, doubled from 2004 to 2013 which was its peak. Since than in each of 2014 and 2015 family living draw declined by 4%. Some family living costs have increased since than which are hard to reduce such as health care and insurance and college costs. But family living will need to decline or added debt will be incurred without additional income.

Crop input costs must also be considered as well. This is the season when suppliers begin to offer pre-payment and booking incentives. How much have those prices declined since last year? Reports I have gathered indicate not much certainly compared to income from corn and soybeans. Farmers will need to indicate to suppliers their unwillingness to pay those prices before input prices are likely to drop. Don’t let emotion drive your input decision either. Products are available claiming better control or availability of an input. Farmers and ranchers should request unbiased research that shows a positive cost-benefit to the use of any input. With that research, they can analyze whether to use and how much of a product to use. Testimonials are not useful to make that cost-benefit analysis.

And then income can also be managed. Have a marketing plan and implement that plan. Of course farmers should not follow it blindly if some new information comes out which changes supply–demand of grains. At that point adjust the marketing plan. Robert Wisner, retired Iowa State University grains economist, related some of his research from more than a decade ago which showed that US corn farmers sold two-thirds of corn at a price less than the marketing year average price. Michael Swanson, Wells Fargo Chief Agricultural Economist, made the same point recently. Minnesota farmers sold the 2015 corn crop 6 cents per bushels less than the Minnesota average corn price. Most likely emotion drove farmers to wait for higher prices and eventually sell at below average prices. Following a marketing plan removes some of the emotion and can lead to more predictable income.

Summary

A proactive approach to managing the current cost-price squeeze dilemma is the way forward to improve sustainability. Farm and ranch managers have some control of the costs and income they can expect from their farm or ranch. Careful cost control, using marginal analysis, in all areas of production must be implemented first to improve cash flow. Marketing plans can have the effect of removing emotion from the selling decision and thus avoiding poor decision-making. Farms and ranches with high leverage are most at risk in the next few years and will need careful management to pull through. After those strategies are implemented, rolling current operating loans forward has a much better chance of being successful.

References:

Schnitkey, G. “The Danger of Refinancing.” farmdoc daily (6):164, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, August 30, 2016.

Swanson, M. “ True Farmers Never Sell a Rally.” https://wholesale.wf.com/food_for_thought/true-farmers-never-sell-a-rally/?contact-type=e&elqTrackId=dcac80eb4e684bc8977eb3b76e2bddad&elq=86e73390d8bc4e2d8c04ac217725a456&elqaid=9465&elqat=1&elqCampaignId=6120, Accessed 1 Sept 2016.

Wow What a WASDE!

The last few days have had the WASDE August 16 report released and a few days later I attended the Midwest-Great Plains Ag Outlook /conference in Des Moines IA. Many of us have heard the headlines from the WASDE report predicting the US largest corn and soybean crop on record. US corn yields are projected at 175.1 bushels (BU)/acre (A) for a 15.153 billion (b) bu crop. Both the size and yield were higher than the highest trade estimate. The same happened with the soybean estimates in WASDE, 4.060 bbu with 48.9 bu/A. Both are higher than trade estimates like the corn trade. Sounding like a broken record, milo followed the same pattern with WASDE beating trade estimates projecting 0.475 bbu total with 66.2 bu/A, both higher than analyst estimates.

Last year’s crops were not the largest on record leading to slightly lower corn ending stocks however soybean ending stocks did rise. Ending stocks for both corn and soybeans are projected to increase after the 2016 crop is harvested. Corn ending stocks are projected to be over 16% and soybean stocks 8% of use. That compares to last year’s ending stocks of 12% for corn and 6.5% for soybeans. The expected increase will over hang corn and soybean prices for some time, until some kind of news, lower yields or higher exports or problems with other country’s grain production, would change the supply/demand calculation. At this point however there are no big news items that could change our grains market to one that is bullish.

So what was the consensus, as if there really is such a thing, or my perception of it, at the Midwest-Great Plains Outlook conference? Except for a few areas of crop problems in Ohio and Michigan, crops are in very good shape and are likely to perform very close to the high yields that USDA and other crop yield modelers have calculated. No significant disease or insect problems were reported. The discussion led eventually to marketing, storage and transportation of the Fall 16 crop. We already know some portion of the winter wheat crop is stored on the ground which will likely lead to loss of quality and quantity. That wheat will probably end up in feed. The US wheat stocks are projected to be 47% of use by crop marketing end while world wheat stocks are projected to be only 35% of use. That is some good news for wheat but stocks of world wheat are up even though use is projected to be up. Use is projected up for the US wheat crop and still stocks are projected to increase. The same situation is going on in corn and soybeans. So then another question is about transportation. Railroad companies are telling university crop economists that they are ready for the anticipated large fall crop. Coal shipments are lower than in previous years freeing up rolling stock to move grain more expeditiously in the past. That is good news for farmers who can anticipate that Fall 16 basis may not be as low as would have been.

What are farmers to do when marketing such a big crop? Many will be convinced to store rather than sell at or near harvest. Big crops tend to have poor carry and thus storage may not gain enough to pay for itself. In planning post harvest crop marketing, farmers must consider the carry that is offered. If the carry is less than the cost of storage, the market is telling you to sell sooner rather than later which would mean less money for the crop in the future due to storage costs.

Managing Cow/Calf Hay Costs

One widely adopted hay making technology is the round bale. In 1892 the first stationary round baler was built and Allis Chalmers building the first moving round baler with a pickup in 1947. Two other types of baler followed in 1970 and 1972. The first was a ground rolled bale but the 1972 baler built by Vermeer had a bale chamber and a pickup in front. Many companies followed so that 15 or so were selling round balers by 1975. Round bales are convenient for hay making, feeding, transport and storage. But there are some limitations farmers and ranchers must be aware of. Round bales stored and fed outside can have as much as 50% loss. But if stored and fed inside that loss can be as low as 5-15%. Let’s take a look at the worst case example to illustrate just how costly high hay losses can be.

 

The University of Nebraska-Lincoln Beef website, beef.unl.edu, includes some representative budgets which include feed use with losses estimated at 15%. So actual intake of the amounts listed will be 85% of the hay amount listed. I will use the 2015 Central Nebraska budget as my example. With feed losses for hay set at 50%, ranchers would need. 0.31 tons more hay for cows and 0.47 tons more hay for 2 year olds. At $80 per ton for meadow hay, the additional hay needed with 50% loss adds $26.40 to feed cows and $37.40 to feed 2 year olds. A typical 300 cow herd, 84% mature cows and 16% 2-year olds, would spend $6652 for mature cows and $1795 more for 2-year olds, total $8847 more in hay due to high hay losses.

 

The next question then becomes where on this typical ranch the losses are occurring. Recommendations for storage loss reduction are in a Beef website article: http://beef.unl.edu/minimizing-storage-and-feeding-losses-round-bale-hay which shows where the losses occur and how to reduce them in storage. Another publication for the University of Missouri discusses ways to reduce feeding losses: http://extension.missouri.edu/p/G4570. These are good resources to utilize when looking for the hay losses on a ranch but when implementing those strategies calculate the cost of implementation. If the implementation costs are more than reduced feed costs, implementing those strategies would make the ranch worse off financially.

What Are Lenders Thinking About the US Ag Economy?

The US agricultural economy has had a tough ride in 2015. Recently the Kansas City Federal Reserve (KCFR) reported the 2015 Net Farm Income (NFI) Index at 55 (2004=100) and the operating loan index at 150 (2004=100). The NFI index is at its lowest and the operating index at its highest since 2004. Those data points reflect ongoing KCFR declining credit conditions. (Figure 1)

Figure 1

10 dist conditions

Source: Kauffman, KCFR

You will notice that the district agriculture loan repayment rate has been trending down since 2012 while loan renewals and extensions have been trending up. Farm loan demand is obviously up as well. KCFR found short term 1st Q 2016 short term lending 20% higher than historical expectations would lead one to believe. District ag lenders expect some deterioration of those credit conditions. The current credit conditions are related to profitability which the KCFR summarized in their findings. KCFR found that lenders believe:

  1. Due to strong US and world production and relatively high production costs and weaker world demand, NFI will continue to be weak.
  2. Tightening credit conditions will effect lending to farmers and ranchers.
  3. Downward pressure on cash rents and farmland values will continue due to weaker NFI.
  4. The broad US rural economy will weaken.
  5. For farmers and ranchers who have a strong financial position there will be opportunities to gain control over additional land and cattle.

One ag economist, Greg Ibendahl Kansas State University, suggests that loan delinquency rates are a trailing indicator for financial strength because it takes a couple of years for them to develop. A better indicator then would be working capital and NFI. Farmers will often use their working capital to pay down debt early on but if NFI drops too, working capital won’t get rebuilt. After working capital drops off farmers will sell off assets like extra machinery to generate cash for debt repayment or reduction. Eventually if NFI can’t be increased and or expenses reduced, the debt delinquency rates will increase.

Rabobank serves the US agriculture industry as well as various EU and Asian clients. Thus their analyses often include a world perspective also. Periodically they review the ag complex. Their most recent analysis covered the corn and protein complexes. In early April fed cattle prices were thought by Rabobank to have trouble reaching $140 per cwt. and that has turned out to be correct with nearby CME fed cattle near $120 falling from $130 in mid-March. Feeder calf prices have weakened since their April analysis was published. Rabobank mentions that very heavy carcasses continue in the beef industry and are a drag on prices since they increase beef supply with the same cattle numbers. Sterling Marketing’s Beef Profit Tracker” continues to show beef feeders losing money as of 29 April, -$74.64, and their analysis going back 1 year shows losses as well. Under that scenario feeder calf prices will decline further, but feeder calf supplies are lower than usual due to the recent drought in cattle producing areas.

 

What Does USDA’s Prospective Plantings Report Tell Us?

What Does USDA’s Prospective Plantings Report Tell Us?

 

Last week, March 31, USDA released it 2016 Prospective Plantings and the Quarterly Stocks reports and the market reacted quickly to the numbers. Especially in the corn market. USDA reported farmer intentions to plant 93.601 million acres of corn, 3.629 million acres more than the trade expected and 4.802 million acres more than 2015’s Prospective Plantings. The 5-year average corn planting intentions is 92.638 million acres. Thus the 2016 corn planting intentions is only a little less than 1 million acres than the 2010-2015 average. 2016 soybean planting expectations are for 82.236 million acres compared to the 2015 intended soybean acres of 82.650 million acres. Both numbers are well above the 5-year average of 79 million acres.

 

These numbers would tell us that corn and soybean stocks are likely to remain nearly constant for soybeans and could increase for corn assuming trend-line yields. But we all know that plans will change due to on farm factors like weather. The changes raise the question whether the Prospective Plantings report is an accurate predictor of final planted acre numbers. I’ll cover a couple of reviews of the Prospective Plantings report to help answer that question.

 

Figure 1 below shows the distribution of error of the Prospective Planting report compared to final planting acres. The Prospective Plantings report is within ± 3% of the corn planted acres, 2 million acres, 95% of the time. The error is less than 1 million acres, 1.48 % of the acres, 45% of the time for corn. In soybeans 80% of the time the Prospective Plantings report is within 3% of the final planted acres, less than 2 million acres. The Prospective Planting report was an accurate estimate of corn planted acres except in periods of acreage contraction when the Prospective Plantings report over-estimated planted acres. The average error in corn was 1.48% and 2.1% for soybeans during 1996-2015. But these errors are not statistically significant.

 

USDA has also reported error in the Prospective Plantings compared to actual planted acres. For the same time period as Isengildina-Massa used. Their average error was 1.9% for corn and 2.1% for soybeans. The error for milo was 9.3% and 1.7% for winter wheat. Seven times the final planted corn acres were below and 13 times above the Prospective Plantings report. Soybean final plantings were above 9 times and 11 times below the final planted acres

 

Taking these two reports together, the Prospective Plantings report is a very good predictor of at least the corn, soybean and winter wheat acres. Of course yields will have a big impact on corn and soybean stocks.

Capture2

Source: Isengildina-Massa, O. “What Do Prospective Plantings Tell Us About Planted Acreage?farmdoc daily (6):59, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, March 25, 2016.

2016 Crop Marketing Considerations

As we all know there are 2 components of US corn and soybean production, total planted, and then harvested acreage, as well as yields of each. During the last week of February, USDA held its annual Outlook Forum and presented the Grains and Oilseeds Outlook. USDA is projecting a 2.2% reduction in planted acres (5.5 million) for eight major crops. USDA projects 2.3 million more acres of corn will be planted in the US. Annually, USDA conducts a planting intentions survey, Prospective Plantings, which is released March 31. The other component of total corn production will be the average yield. Current yield projections are usually based on trend line yields. Some yield projection also include a weather model; USDA includes a weather model. USDA projected a 168 bu/acre US corn yield at its recent Outlook Forum.

U of IL ag economists Good and Irwin have taken US average corn yields from 1960-2015 to develop a yield trend line as well. Their 2016 corn trend yield estimate is 164.2 bushels/acre. However they indicate that a weather bias, think 1983, 1988 and 2012, slightly underestimates the trend line. This underestimation is 2 bu/acre leading to a trend line yield of 166.2 bu/acre. The difference between the USDA and the U of Illinois models is that they each use a different time series to calculate the trend line. However there is only 1.8 bushels/acre difference.

We also know that corn yields vary following a major El Nino event, +11 bushels to -28.6 bu/acre compared to the trend line. The US corn yield in a year after El Nino was equal to or above the trend line 58% of the time. The U of IL analysis indicates that when El Nino was as strong as that during 2015, the realized yield averaged -4.8 bushels/acre from the trend line. That average is misleading since only 3 years are included in the calculation and 1 was 23 bushels/acre below the trend line. Irwin and Good estimate that there is a 2/3 chance that US corn yields will follow trend line yield.

USDA also forecast soybean planted acreage at the Outlook Forum down 0.2 million acres, -0.2%, from 2015. USDA also projected 2016 soybean yields at 46.7 bushels/acre down from the 48 bushels per acre in 2015 of 48 bushels. Irwin and Good also reviews soybean yield data for 1960-2015 to develop a trend line yield. Their trend line yield for 2016 is 45 bushels but a few years of weather variation, 6 years, cause a downward bias to the trend line, but it is small., 0.2 bushels/acre. Adjusting for the bias gives a 2016 soybean yield projection of 45.2 bushels of soybeans, just 1.5 bushels less than the USDA’s estimate.

As with corn, Irwin and Good looked a the effect of El Nino on soybean yields. They found 3 years similar to the El Nino we have just experienced. Their data suggest that we would expect yields on average 1.2 bushels below trend line but the range of the outcomes is +1.3 to -5.3bushels from trend line. And of course there are only 3 years to make a comparison. The whole The whole data set had a range of yields of +2.4 to -6.6 bushels from trend line. Irwin and Good calculate that soybeans yields 2/3 of the time follow the trend line following a strong El Nino.

Farm Income Likely to Drop in 2016

USDA recently projected 2016 Net Farm Income (NFI) would be near $54.8 billion or 2.8% less than 2015. This would be the third consecutive year of income decline. this follows 2013’s record income following a year of widespread US drought. High livestock prices and hog and poultry disease problems have helped hold up NFI since 2013 but the production problems are easing. 2016 Farm Bill Price Loss Contract (PLC) payments are projected to increase 31% to $13.9 billion compared to 2015. That means just over 25% of the 2016 NFI will come from government payments. 2015 Farm Bill program payments accounted for 18.8% of NFI.

Agricultural economists at Texas A&M and the University of Missouri-Columbia have pointed to a couple of financial ratios that indicate very strong balance sheets for farms and ranches. There has been an uptick in the financial stress of farm and ranches but are still at very low rates. Factors pointing to prolonged risk though are commodity over-supplies in nearly every sector. Ethanol growth has ended unless a new blend mandate is approved and Chinese economic growth to just 4% or so, but that is nearly 3X the current US growth however. This lack of growth reduces prospects for increased consumption of agricultural commodities along with higher prices. So over the next few years, absent weather or world political problems, supplies of these commodities will likely decline to more nearly align with demand. Poultry and dairy are likely to make supply adjustments quickly. But grains, oilseeds and beef production are burdened by increased supplies during the next couple of years.

USDA did point out that expenses have declined and are likely to decline for the second consecutive year since 1986-7. “A drop in overall production expenses is forecast for 2016, cushioning the decline in cash receipts. Notably, expenses for inputs that typically are produced by the farm sector itself, including feed, as well as livestock/poultry purchases, are expected down. Also, expenses for fuels and oils are forecast down by 14.5 percent in 2016.  If realized, the expenses across each of these three categories will have fallen for 3 straight years. In contrast, hired labor costs and interest expenses are forecast to increase by $1.5 billion (5 percent) and $1.3 billion (6.8 percent), respectively, over 2015.” Source: USDA