by David A. Widmar
A few weeks ago we took a look at farm-level interest rates and how a rate increase might impact producers. While interest rates are important, it is also critical to keep in mind total debt and farm income, or earnings, when looking at farm financial conditions. In this post, we take a look at farm interest expense and the recent trend of higher interest expense even with historically low interest rates.
Real Farm Interest Expense
Inflation-adjusted (or real) farm interest expense across the U.S. is shown in figure 1. In 1982, real interest expense peaked at $42.3 billion (2009 dollars). This was during the height of the farm financial crisis. Interest rates on non-real estate loans were approaching a staggering 20%. Interest rates changed rapidly during this period. As real interest expense quickly rose, doubling from 1975 to 1982 (7 years), it similarly dropped in half from 1982 to 1990 (8 years). After that period of dramatic change, things have been much more stable. Since 1990, real farm interest expense has hovered around $15 billion annually.
Relative to Earnings
Interest expense is perhaps best viewed relative to earnings. This is commonly done by measuring interest expense relative to earnings before interest and provides a measure of the proportion of earnings consumed by interest expense. In figure 2, interest expense as a share of earnings before interest is shown. Again, the stand-out period is during the farm financial crisis when interest as a share of earnings before interest peaked at 60% in 1983. In other words, the interest bill alone consumed 60% of farm income, a recipe for extreme financial stress.
If one looks to periods that were more “normal” throughout history, before the farm financial crisis interest expenses tended to be quite low, rarely consuming more than 20% of farm income. For instance, interest expense was greater than 20% of earnings before interest in only three years from 1929 to 1975.
The period after the crisis has seen interest expenses regularly consume a slightly higher portion of earnings than the pre-crisis period. Since 1990, farm interest expense has accounted for about 20% of earnings before interest. However, only during four years, or 15% of the time, was the share more than 23%.
The most current forecast for 2015 has interest expense at 24.9% of earnings before interest. While this is not a large departure from the range of observations since 1990, current conditions stand out for a couple reasons. First, while current conditions are similar to those in 2002 (24.7%) and 1995 (24.1%), interest expense as a share of earnings is forecast to be the highest since 1988.
Second, interest expense as a share of earnings has surged in the last two years. In 2013, interest expense accounted for 10.7% of earnings, compared to nearly 25% forecast in 2015; more than doubling its share in just two years. From 2014 to 2015 alone, the share increased by more than 10 percentage points, the third largest single-year increase observed.
Figure 2. Farm Interest Expense as a Share of Earning Before Interest Expense. 1929-2015F. Data Source: USDA ERS.
Wrapping it Up
The trend toward interest expense accounting for a larger portion of farm earnings is driven by two key factors, declining earnings and increased use of debt (also see the KC Fed’s latest report on operating loans). At this point, the biggest driver is undoubtedly earnings which have dropped very rapidly. Such rapid drops can make debt loads that felt very manageable in previous periods start to become burdensome. Because it is difficult for borrowers to quickly adjust debt loads lower, the volatility in agriculture earnings makes it critical to carefully manage debt loads.
Moving forward, farm interest expense will be a metric we will continue to monitor. If net farm income trends lower and farm debt levels trends higher into 2016, interest expense may account for an even larger share of total earnings. These are trends that will likely make the financial situation in agriculture less comfortable than it has been for some time.
Photo by Johnny Klemme