In 2017, the agricultural loan environment was characterized by lenders replacing diminished liquidity on farmers’ balance sheets with extensive loan restructuring. Lenders will be faced with a much more difficult task in 2018. Collateral valuation and appraisals will be significant in this decision process. During the past 40 years, I have held many roles in agricultural lending, risk management, auditing and appraising for all types of agricultural assets. Here are observations and trends in agricultural asset values and their impact on lending decisions.
Since the decline in grain prices, we have seen an increase in the instances where farmers converted grain and other commodities that were the lender’s collateral. Lenders have been lax with due diligence. Bins are not sealed, farm inspections and verifications have been reduced, and local and regional buyers have not been notified of the lender’s security interest in the property. It is now a necessity to protect the lender’s interest. Many commodities are now selling below the cost of production, and this affects a farmer’s ability to repay operating loans. It is AgVisory’s opinion that this has been the main driver of the increase in unlawful conversions. Lenders need to be mindful, and the appropriate controls need to be reinstituted, monitored and enforced. Borrowers may push back against such practices; however, it is a sign of the times. Local basis and local cash markets set the collateral value, so stay tuned to what is happening.
Many dairy farms, in particular, are operating at breakeven. The outlook is not optimistic for milk price increases in 2018. Cattle prices are also under pressure. Lenders need to ensure their collateral values are current and reflective of local cattle sales and auctions. The increasing financial stress in the dairy sector will further lower cattle values. Stay alert to decreasing cow numbers in stressed operations; conversion or cash sales may be occurring. Dairy feed is also problematic as hay and silage are experiencing downward economic pressure. Feed inventories can be easily overvalued and heavily discounted if the dairy is depopulated and cows are sold or moved from where the feed is stored. Lenders need to confirm milk assignments are properly filed and enforced.
Low feed costs have kept beef cattle values relatively stable. Cattle prices received by producers are largely controlled by vertical integrators. Interest is increasing for local and grass-fed.
When agricultural land sales become infrequent, sales prices increase in variability, and the market is flooded with listings; the signs are very clear that land values are changing. This is occurring in many areas around the country. The lack of recent non-arm’s-length transactions make real estate appraisals less reliable. In many areas of the country, the market for agricultural land is tied to commodity prices and interest rates. The lower commodity prices are decreasing land rents and weakening profitability. The loan restructuring that has occurred will most likely not improve overall profitability.
Net losses in 2018 will force more farmers, lenders and creditors to monetize their land holdings. This wave is rapidly approaching and will increase downward pressure on land values. Referencing sales from 2015 to 2017 will be unreliable to establish the new land value paradigm. The agriculture industry has seen this previously. It is a time of great uncertainty for lenders and appraisers. We know something is happening with land values; however, we have little supporting evidence. Distressed sales will set a lower benchmark as they increase in frequency. Lenders can respond to lower prices by using more aggressive net recovery value (NRV) calculations or discounts to appraised values. This prevents lenders from relying on outdated, unreliable appraisals and gives them a quick way to assess the collateral position. It is noted that this is purely an accounting function and is not a Financial Institutions Reform, Recovery and Enforcement Act-driven issue. The larger the land base, or land holdings, a borrower has, the fewer qualified buyers there are. A more aggressive NRV will provide a better estimate of the current market.
Permanent plantings are becoming dramatically less permanent. Rapid changes in varieties, technology, plant breeding and consumer preferences are shortening the profitable life of these plantings including apples, citrus and blueberries. It is imperative to understand the industry, market, cost of installation and cost of production to manage this portion of a portfolio.
The agriculture industry has seen a significant increase in private equity and real estate investment trust funds. Yield is their mantra; therefore, the downward pressure on land rents and profitability will be interesting to watch. Will private equity stay competitive in the row-crop game? We have come to rely on these investors as an outside source of capital. As equity yields change, will these investors still be there, or will their models have to change?
Swine, poultry, egg and other livestock production buildings tend to retain their values through bleak times. They can also provide business-saving positive cash flow to farm operations during extended economic downturns. Modern packing and refrigerated storage facilities typically retain their values as they are related to the value-added side of farms. This is true as long as farms maintain their profitability.
Values have softened for ancillary farm buildings including on-farm grain storage, high-end shops and machinery storage. These facilities were constructed during profitable times, but they do not provide an economic return to the business. Many appraisers use the cost approach and physical depreciation only to establish values for these improvements, and it is important to keep this in mind. Depreciation does not occur in a neat, linear fashion. Depreciation, in all forms, occurs in big ugly chunks as economic forces, obsolescence and technology change. For example, relatively new on-farm grain bins that cost $4 per bu. have sold for less than $1 per bu. in distressed situations. The grain bins built in the past seven years will experience the largest negative impact.
As a tenured appraiser, I have always said when analyzing a farm sale, you will run out of dollars before allocating value to land and buildings. Does every structure contribute value? The short answer is no.
Specialized Agricultural & Processing Facilities
AgVisory works nationwide to value all types of specialized agricultural facilities. The level of consolidation that is occurring in agriculture and the food processing industries, domestically and globally, is unprecedented. Multiple agribusiness and co-op mergers have occurred. On the food processing side, most of the acquisitions are businesses that process or produce healthy, sustainable foods. These acquisitions typically sell based on multiples of revenue or earnings, and many transactions have been at above- average multiples. Concurrently, there have been sales of specialized assets at severely discounted or salvage values due to economic or functional obsolescence. Lenders need to understand the dynamic forces that are occurring and underwrite these facilities accordingly. Utilizing experienced and knowledgeable professionals to assist them is imperative to the survival of this changing world of agricultural finance.
About the author. Richard (Dick) Gilmore is the senior vice president of AgVisory. He has been a member of the American Society of Farm Managers and Rural Appraisers since 1989 and received his accredited rural appraiser designation in 1995. He was employed by CoBank and the Farm Credit Bank of Springfield as a credit reviewer and appraiser for 30 years. He co-founded AgVisory with Jodi Pries in 2012.