DESPITE falling incomes, the price farmers are willing to pay for farmland continues to increase, according to data from the Federal Reserve Bank of Kansas City (KC-Fed).
With commodity prices moderating considerably in 2013, the question of "if" a perceived agricultural bubble might burst has morphed into "when?"
Speaking at the KC-Fed's annual agriculture symposium in July, Purdue University economist Michael Boejlje said unequivocally that the agricultural economy is exhibiting signs of a bubble, particularly in the land market.
"Is this a bubble?" he asked the audience of lenders and finance professionals. "Yes. The question is: What's the bust?"
While observers generally point to low levels of leverage among producers as proof that the bust will not be a repeat of the infamous 1980s farm crisis, Boehlje said the reality isn't nearly so simple.
"Plenty of people in agriculture are highly leveraged," he explained. "Average leverage does not matter, because the tails of the distribution drive these events."
Condemning what he called "new paint disease," Boehlje said farmers' distaste for paying taxes have led them to spend working capital on improvements and machinery purchases at precisely the time average net farm income is likely to start coming down — perhaps precipitously.
In its latest survey of agricultural credit conditions, the KC-Fed reported that farm income fell in the second quarter of 2013, and bankers surveyed expect a further drop in the third quarter. Continued challenges in the livestock sector and the likelihood of sharply lower grain prices come harvest time have lenders bracing for the specter of an extended period of contracting profitability.
Farmland prices, however, appear bulletproof in the face of coming adversity. KC-Fed economists Nathan Kauffman and Maria Akers reported that farmland values in the 10th federal reserve district surged during the last quarter, with irrigated cropland prices up 25% from a year ago and non-irrigated land up 18%.
"Bankers indicated that expected farm income was not the main factor contributing to the value of farmland," Kauffman and Akers wrote in their quarterly summary. "Instead, bankers cited the overall wealth level of the farm sector, supported by several years of strong income, as the primary driver of farmland values."
Low interest rates and a lack of more appealing investment options both ranked ahead of farm income as significant drivers reported by lenders in the survey. Perhaps not surprisingly, the survey also found that lower incomes drove stronger demand for operating loans last quarter, with demand reaching its highest level in more than two years.
Another side effect of the recent bullishness in agriculture is that agricultural lending has shifted more toward larger lenders and away from smaller, localized financial institutions.
In a July report, Kauffman and Akers revealed that the share of non-real estate loans originated by large banks relative to their smaller counterparts reached its highest level in nearly 20 years.
"Rising production costs prompted some agricultural producers to take on more debt, and lenders continued to compete for market share," the economists explained. "The shift to borrowing from larger lenders could be due, in part, to attractive and flexible loan terms."
Typically, larger banks offered more floating interest rate products, lending at lower rates than small and midsized lenders. As operating loans took on larger and larger proportions, smaller banks might also have struggled to keep large producers in their portfolio.
According to a national survey of commercial banks conducted in early May, three-quarters of new non-real estate farm loans generated during the survey period originated with large lenders. New loan volumes at large lenders were near record highs, while volumes at smaller lenders were near record lows (Figures 1 and 2).
"Almost 90% of non-real estate loans at large lenders were made with floating interest rates — double the percentage at small and midsized banks," Kauffman and Akers wrote.
That figure could portend a rude awakening for leveraged producers when interest rates invariably begin climbing.
The Federal Open Markets Committee has spent much of the past two months discussing the wisdom of tapering off its quantitative easing program, with KC-Fed president Esther George sitting as one of the leading hawks on the issue. George told symposium attendees in July that the government's current fiscal policy is weighing on economic growth.
"I'm skeptical of the real economic benefits of quantitative easing," she said. "Markets are now starting to reflect this reality. ... I have expressed concern for some time about market distortions that might be created by current interest rates."
As Boehlje concluded at the symposium's close, the government's "free money policy" has accelerated many of the farmland and farm lending trends sparked by record net farm incomes and record agricultural commodity prices. When prices fall and interest rates rise, the industry will be looking at a very different landscape, indeed.