As the saying goes, "Those who cannot remember the past, are condemned to repeat it." By examining mistakes of the recent past, agricultural lenders can make rational business decisions that will protect their financial institutions.
Many economic factors affect agriculture: commodity supply and demand; foreign, trade, and monetary policies; population growth; and consumer income levels. During the late 1970s and early 1980s, exports expanded, net farm income increased, and land values rose. The increase in exports resulted, in part, from purchasing decisions of foreign centralized economies and greater purchasing capacity resulting from loans to developing oil producing nations. Much of this demand eroded in the early eighties and the dollar strengthened in response to domestic monetary policy. In the severe economic downturn that resulted, net farm income was significantly lower. Farm operators' repayment capacity was reduced, and land values were substantially depressed. Lenders were forced to write off hundreds of millions of dollars in their agricultural loan portfolios.
Over the past year, the agricultural economy has been influenced by some of the same factors that existed in the late seventies and early eighties:
* Foreign demand increased in both livestock and crop sectors.
* Grain stocks declined to record low levels, both domestically and globally.
* Prices of many field crops reached record high levels.
* Land prices increased significantly in many areas.
* Population rose in developing countries.
Rising population may be the most significant factor affecting the agricultural outlook. World population is expected to increase from 5.6 billion to 8 billion by 2020. In addition, rapid economic growth in China, India, and the Pacific Rim - leading to rising income levels and the creation of a middle class - is significantly affecting agricultural demand. Meeting this increased demand will be limited by the restraints of infrastructure - harbors, transportation, and marketing and distribution facility capacity.
Higher demand certainly will create a supply response from global producers. Most agricultural economists believe there is opportunity in this emerging environment, but they also are concerned that the agricultural and lending communities may repeat mistakes made in the late seventies and early eighties.
Are lenders destined to repeat the same errors, or will they make rational business decisions to protect their financial institutions? A comparison of 1980s mistakes to current developments may hold the answer.
Inadequate understanding of loan purpose. During the 1980s, a frequent loan purpose was to refinance operating losses rather than to acquire earning assets. While recapitalizing a farming business is necessary from time to time, such refinance activity needs to be carefully analyzed and understood. Recapitalization should be granted only if the operation has the repayment capacity necessary to service the loan. Rising land values and resulting increases in net worth do not provide the basis for lending.
Inappropriate loan terms and conditions. After recovering from the financial adversities of the 1980s and experiencing a series of profitable years, lending institutions generally have good liquidity and capitalization. A resulting competitive and aggressive agricultural lending environment - based not only on price but also on terms and conditions - is similar to the competitiveness for corporate loans reported by many commercial banks. Required levels of liquidity and solvency are weaker. The lowering of collateral requirements is raising the loan-to-value ratio on loans being added to portfolios. This situation is indeed reminiscent of the 1970s environment and the costly mistakes realized in the 1980s.
Failure to assess the economic value of land. Lenders in the seventies and eighties often financed land purchases at values that exceeded the properties' economic value (ability to repay indebtedness) based on cash flow. …