Ag Finance Insights: Looking Back, and Looking Ahead

In recent weeks, loan renewal season has been wrapping up, as ag banks and lenders have worked with producers to review the previous year’s profitability and set up the coming year’s operating lines of credit.

In speaking with ag lenders in several states and regions, it sounds like 2023 was a mixed bag in terms of profitability. I recently spent a week in Wyoming and Montana visiting ag bankers and their customers. It’s breathtaking and scenic country, and everyone I met was honest, genuine and authentic. Livestock is big in many of these areas – particularly cow/calf producers. Between experiencing excellent prices for cattle and some decent moisture to get their pastures off to a good start, the mood was pretty optimistic and upbeat – a little different from what we’re starting to see in corn, soybean and wheat country.

Data from the University of Minnesota’s Center for Farm Financial Management largely validates what lenders are saying. Good producers and managers are generally doing fine, while many producers on the lower end are struggling for the first time in four years.

This chart shows an aggregate of about 2,500 producers in different ag sectors (such as livestock, grains, dairy and hogs). So, while it isn’t reflective of all producers, the information and trends still tell the story.

As I’ve noted before, 2020 through 2022 was an extremely profitable period for many producers – especially in the case of grain. 2023 looks to be a return to a more normal distribution of profitability, and I suspect 2024 breakeven prices for many corn and soybean producers will be close to $5 and $12, respectively.

Even with grain markets showing some strength in the past few weeks, further margin compression can be expected in 2024, with profitability swings and variances likely even larger. Having said that, the ag sector and most individual operations are in good financial shape and have an extended financial runway. However, it’s important to not let yourself be complacent. It will still take strong management and attention to detail to maintain financial strength. Many poor management decisions are made at the top of economic cycles.

Farmland Remains a Strong Asset

One key to the success of businesses such as farming, ranching, manufacturing or even banking is having adequate liquidity or working capital to absorb increased downside risk. As bankers, it’s something we watch closely – both the amount of liquidity and the sources of liquidity.

Don’t sleep on or ignore leverage, either. Leverage has a tendency to creep up on producers. Up until the last year or so, capital has been relatively cheap because interest rates were very low. That has changed considerably. The cost of leverage (interest rates), whether for new purchases or having to refinance longer-term debt to cover operating losses and build back liquidity, is something to be aware of.

Land values remain strong, if a producer needs to leverage farmland assets to secure new debt in order to replenish an operation’s liquidity. On average, the tops may be in for land values – at least in the short term. It’s always interesting to note the historical returns on owning farmland. One way to look at it is that over the last 25 years, land values have approximately quadrupled, returning on average about a 6% annual return while inflation during the same period averaged only about 2.6%. In short, these are key reasons why a lot of folks want to own farmland. It’s been a good inflation hedge.

Other Thoughts

Historically, there seems to be a relationship between commodities and inflation, with commodities also seen as a hedge against inflation. Precious metals are examples (gold and copper are currently very high). Is this relationship still relevant in today’s economic environment, and can agricultural commodities possibly be far behind?

Looking at the overall economy, it can be difficult to take a positive long-term outlook, with a $35 trillion deficit and daily interest costs approaching $3 billion. Is the economy doing well? For one thing, consumer spending continues to be robust. Despite much of the excess government stimulus cash being gone, many consumers don’t have a problem putting their continued spending on credit cards.

Moreover, it’s worth noting that the government is the strongest sector of the economy, with a large amount of economic growth coming as a result of government deficit spending. Historically, government spending has ranged from 18% to 20% of GDP. Currently, it’s 23% to 25%. That’s a significant difference.

Looking ahead, there are a couple of things in agriculture that bear watching. First, there are possible bio-security concerns over the spreading of bird flu to other species. It’s been found in a few humans as well as in dairy cattle (thankfully, cows recover pretty quickly), but not yet in meat or pasteurized milk. This is on the radar of many, and overreactions in these situations often come into play.

Something else worth keeping an eye on is how U.S. regulators are looking at Sustainable Aviation Fuel (SAF), and how it needs to meet certain carbon guidelines. As I’ve discussed before, based on current regulations, it appears that it’s difficult, if not impossible, for U.S. farmers to meet SAF requirements. Ironically, it seems Brazil is already meeting these requirements, and we’re reportedly importing used cooking oil from China and Brazil that meets the requirements as well. Go figure.

Artificial intelligence has the potential to be a real game changer as well. In agriculture, AI likely won’t replace farmers or producers, but at least hypothetically, producers who use AI may replace those who do not.

I’ll touch a bit more on these topics and more at AgViews Live.

Spring Planting Update

Earlier this spring, concerns persisted over a lack of moisture and a growing chance of a significant drought in much of the Upper Midwest. A virtually snowless winter and above-average temperatures combined to make many worried about what spring would bring.

Well, Mother Nature reminded us she’s still in charge, with significant and frequent rainfall throughout May. As mid-June, many producers are probably thinking they’ve seen enough rain and would instead like to get some heat and sunshine for a change.

We’ve seen some wild swings, to be sure. You can get too much moisture in a matter of hours, while it usually takes weeks to end up in a drought. Finding the right balance is in the hands of Mother Nature. At least for now, drought concerns have faded for most areas.