by Brent Gloy
It seems that one can hardly pick up a farm magazine today without seeing a story laying out concerns about farm debt and the financial stability of the farm sector. It is true that some farms are facing a difficult economic situation and that there have been and will continue to be bankruptcies in farm country. However, we wanted to see what the data have to say about the level of debt in the U.S. farm sector and examine how that debt is distributed amongst different types of farms.
Total Farm Debt
According to the USDA-Economic Research Service, farm sector debt stands at an all-time high of $327 billion. Although growing steadily, the inflation adjusted total debt level still remains well below the 1980/81 peak (figure 1). Real debt increased steadily from 1960 to the peak and then fell rather sharply, bottoming in 1992. Since 2000 the amount of debt has risen, with only a few small declines in the last 15 years. One can also see that real estate debt has been slightly greater than non-real estate debt for most of the time period shown. In recent years, real estate debt has grown at a slightly faster rate than non-real estate debt.
Debt by Farm Sales
While farm debt has been growing it is also interesting to examine which farms are incurring debt. The Economic Research Service examines farm financial characteristics with its annual Agricultural Resource Management Survey (ARMS). In figure 2 the percentage of farms using debt is shown for farm businesses in various sales categories. In 2013 (the most recent data available) 36% of all farm businesses reported some debt. As farms become larger, the likelihood of debt use increases dramatically. Fifty percent of farms with over $100 thousand of sales, and almost 70% of farms with sales over $1 million report the use of debt. The obvious question becomes how much debt is used by these larger farms and how large is that debt relative to their repayment capacity.
Farm businesses with sales over $1 million account for 10 percent of farm businesses and utilize 50% of the total farm debt (figure 3). As one might expect farm businesses with sales of less than $100 thousand account for roughly the same number of farms, but only use about 10% of farm debt. The larger farms account for a much greater proportion of economic activity and one would think that they would rely on a larger volume of financing.
The ability to service debt or make payments is dependent upon the farms ability to generate cash flow and the size of the debt. Figure 4 shows the reported principal and interest payments for farms in the three largest size categories from 1996 to 2014. The amount of principal and interest payments has fluctuated over time. It appears that farms in the larger sales categories have significantly reduced their required debt service in recent years. On average, farms in the largest size categories faced principal and interest payments of $121,000 in 2013, down from $160,000 in 2011. This is a level last seen in 2003, which roughly coincided with the start of the farm boom. Farms in the smaller categories have seen debt service requirements slightly increase or remain similar to previous years.
Debt Repayment Capacity Utilization
When evaluating debt levels it is important to look at the ability of the farm to generate income to repay the debt. The Economic Research Service created a measure called debt repayment capacity utilization (DRCU) to help quantify whether debt levels were sustainable. This measure compares a farm’s current debt level to the theoretical maximum amount of debt that the farm could borrow. The maximum debt level is based upon the cash flow generation of a farm and some assumptions about interest rates and the amount of credit lenders would extend against this income. Those interested in the details of DRCU and the distribution of farm debt should read this thorough report on the subject.
The measure is reported as a percentage. So if DRCU is at 40%, the farm has borrowed 40% of the maximum amount that ERS estimates they could borrow. As DRCU increases, financial stress increases. For instance, DRCU was well over 100% in the 1980’s. Figure 5 shows DRCU for farms in the three largest sales classes from 1996-2013.
Although farms in the largest sales class have more debt, their debt repayment capacity utilization is the lowest on the chart. Today, farm businesses with sales over $1 million have borrowed 23 percent of the maximum amount that ERS estimates they could borrow. This is contrasted with farms in the $100 to $250 thousand sales category that are at 37% of their theoretical borrowing capacity. As one can see from the chart, all three sales classes are currently at levels that are toward the lower half of the range they have seen in the last 17 years.
Wrapping It Up
As the prospects of agricultural profitability have fallen from the farm boom, many have raised concerns about the record level of debt in the farm sector. While debt is at an all-time high, in real terms the amount of debt in the sector is well below the levels seen in the 1980s. Many (64%) farms do not have any debt at all.
Farm debt tends to be concentrated among larger farms. Farms with sales over $1 million represent about 10% of farm businesses and account for 50% of farm debt. This concentration of debt is certainly something to monitor carefully if economic conditions deteriorate. The good news is that for the most recent data available, on average these farms started to reduce their required principal and interest payments beginning in 2011. Additionally, their average borrowings as a percentage of the theoretical maximum borrowings are lower than farms in the next two largest sales categories. Relative to income levels, the 2013 borrowings would appear to fall into a range that should be quite comfortable by historical standards.
This points to a situation where “on-average” the farm sector is in fairly sound financial condition. Of course, the biggest challenge in evaluating the financial situation is that incomes can change very rapidly and it is very difficult to modify debt levels in the short-term. This can make it difficult to service a debt that once looked small next to lofty incomes. The other challenge is that, while we can break out debt by farm size, we do not have data on the distribution within farm size categories. There are undoubtedly farms that are over-leveraged in all of the categories and if incomes remain depressed, these farms will likely suffer financial distress.
As conditions evolve in light of lower net farm incomes, we will continue to monitor and observe these trends and metrics. Follow the Agricultural Economic Insights’ Blog to learn more by clicking here. Also, follow AEI on Twitter and Facebook.