When Virginia Tech Economist (Emeritus) Dave Kohl speaks to farm audiences these days, he paces the stage like a nervous coach shouting plays before the clock runs out. His advice to attendees of Texas A&M's elite TEPAP program this week in Austin was to get 2016 finances in order. Fast.
"We're in the first inning of a nine inning reset in agriculture," Kohl told the executive farm management course. He urged grain producers to prepare for a long ag recession that might not rebound before 2020, depending on uncontrollables like weather, the dollar value and how fast the global economy recovers.
While stressing "it's a reset, not a crash," Kohl emphasized farm borrowers will need to "step up their game" before they see their lenders for loan renewals in the next few weeks. Given the widespread losses incurred in 2015 and dismal projections for 2016, farm borrowers just can't go in asking for handouts without justification this season, he said.
For one thing, lenders will be under pressure from regulators who are increasingly nervous about the state of the farm economy and demanding more documentation, he warned. (In some cases, loan officers in the audience said regulators are already valuing farm equipment on year-end balance sheets using online machinery auction prices at 90% of wholesale levels. For recent model combines, that's possibly 30% below a year ago.)
It's true some top performers in agriculture still hold working capital levels of 40% of revenue or more, enough to weather the cycle. But many other farm operators have eroded working capital the past year or two as commodity prices slid across the board. Operators who showed losses in 2014 and 2015 have burnt through the fat.
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"Now they're into burning equity, and that's like burning muscle. Muscle hurts," Kohl said.
Kohl outlined a seven-point "Groundhog Day Game Plan" he thinks operators will need to develop by early February to secure their credit lines in time for planting. If they can build a case they meet six or seven of these criteria, they'll find lenders much more amenable to loan requests, he said. If they can only prove four, they may have difficulty:
1. Show a history of profits during the "up" cycle that beat interest costs. In other words, historic profit margins greater than 4%-6%.
2. Demonstrate balance sheet growth came from earned versus appreciated net worth in the past. Kohl recommended rates of 8% to 10%/year growth during "up" years, although that may slip to 3% to 4% during years when the farm economy resets.
3. Show you built and protected working capital during recent downturns. Financial standards rate 40% of gross revenue as a solid ratio, but amounts below 20% raise red flags.
4. Show ability to cut living expenses as profits wane. Some "alpha dogs and alpha pups" enjoyed such high lifestyles they were spending more than 70 cents/bu. of corn on family living and $2.28/bu. on soybeans, Kohl said.
5. Have already sold excess and unproductive assets.
6. Show a track record of planned and executed marketing and risk management programs. Lenders look for discipline.
7. Prove ability to cut costs by 10% to 30% over a multi-year period.
The 2016 year is a pivotal one, because costs are so out of whack with commodity prices, Kohl said. Cash rents haven't adjusted much yet, nor have inputs. "Next year (2017) will have to be the year of reckoning because people can't continue to lose money at this rate."
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