WEBVTT
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Cyrus McCormick invented the very first mechanical reaper and revolutionized American agriculture forever.
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But when we look around the agribusiness sector today, his most lasting impact wasn't made of iron.
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It was made of money and time.
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In other words, McCormick's most important contribution was commercializing the idea of buying farm equipment on credit.
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There were times when farmers weren't able to obtain their funds from a financial institution.
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And so the input suppliers, McCormick being one, did provide the financing for that farmer to make that purchase.
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That strategy of providing the financing as a sales tool, that's what the innovation was really.
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It was a marketing strategy.
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And so they became lenders.
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Agricultural lending might have started out as a way to get farmers into newfangled reapers in the 1800s, but since then, it's moved well beyond farm implements and become a core part of the agribusiness world.
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Today, American farms collectively borrow billions of dollars every year for farmland, operating expenses, and more.
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But as the world of ag lending expanded, it got riskier and more complex for farmers, bankers, and the organizations farmers do business with.
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And in our modern era of large-scale and consolidated operations, the role ag finance will play going forward is only becoming more critical.
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Financing the farm.
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Today on Agribusiness Blueprint.
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This is Agribusiness Blueprint, a limited series podcast about American agriculture's most impossible challenges and the agribusiness leaders who solve them.
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You're here with me, independent ag journalist Sarah Mock, and my co-host Trey Malone, Associate Professor of Agricultural Economics and the Bulgy Chair at Purdue University.
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And today is all about ag finance.
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The world of ag finance is impossible to cover in one episode, so we're going to focus on three key questions today.
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Why farm lending is fundamentally different than lending in other sectors, how farm businesses and their financial system have co-evolved over the last century, and what might be ahead as scale, consolidation, and risk continue to rise?
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Along the way, we'll learn more about how the idea of opportunity cost and the partial budget process that can help us evaluate it can support farmers, lenders, and agribusiness leaders across the sector in financial decision making.
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So today we're gonna start with our first question.
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What makes lending in agriculture so different from lending in other sectors?
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Over the course of the last six episodes, we've talked about a lot of differentiators between ag and the rest of the economy, from the culture of agriculture to the importance of policy, to the supremacy of personal relationships.
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Ag lending shares many of these same features.
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The geographic specificity of ag lending, I think, creates another layer.
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And then ultimately the cultural norms around ag lending, I think, look very different than traditional lending.
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This is a low margin business.
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Most of these farmers cannot afford to make a mistake because they have one harvest a year.
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And that one harvest a year is all that matters.
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They get in their adult lifetime, what, 50 harvests total?
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And realistically, they probably only get 20 of those harvests where they're the primary decision maker.
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So you better believe that they're going to try their best to make the most financially rational, protected decisions that they can make.
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That does not necessarily lend itself to high volume lending in a way that creates large returns.
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The cultural realities of agribusiness set agriculture in general apart from the rest of the economy and set ag lending specifically apart as well.
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But the differences here go deeper than culture.
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After all, the world of lending in finance hinges on risk, identifying, understanding, and managing it as much as possible.
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And yet, an unusually high degree of risk is one of the defining features of agriculture.
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There's more systemic risk in agriculture than there is in virtually every other business.
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This is why we have federally subsidized crop insurance.
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Right?
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So even the federal government has stepped in in a way that says we believe that the agricultural sector is so volatile, yet so important, that we have got to come up with a way to stabilize the industry through some type of federally subsidized system.
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The same can be said about agricultural lending.
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For a big chunk of American history, all of these risks and nuances were simply too much for most lenders to stomach.
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This often meant interest rates on loans to farms were extraordinarily high, or that banks just wouldn't lend to farmers at all.
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Here's Mike Bolgy, our guest from episode three, and the voice you heard in the intro, on what that looked like and still looks like in some places today.
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So lenders for farmers typically are much more conservative in terms of their lending willingness.
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Look at the typical underwriting standards that we use for farmers in terms of the amount of debt we use compared to the size of the business.
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How about say maybe 30%, 40% lenders are starting to get really nervous about whether in fact that's gonna be viable?
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And if you move up into the 60, 70 percent area, we don't go there.
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We just aren't gonna be able to allow farmers to borrow that much money.
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You go to some other industries and they'll love going to leverage ratios of 50, 60, 70.
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There are some that even will go as high as 80.
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That's one of the reasons why in agriculture we've typically had unique financial institutions like the farm credit system.
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So ag lending is different than lending in other sectors, in large part because farming is such a risky endeavor.
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And for farmers and lenders themselves, this risk is not a vague concept.
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It literally limits the amount of credit that lenders are willing to offer, and thus how much financing a farmer is ever able to secure.
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For generations, this put farmers in a real bind, because despite the fact that they are often very limited in how much credit they could acquire, the inputs to farming, from land to equipment to seed, are often expensive and have to be paid for well before a farmer makes any income.
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By 1933, this situation had become untenable for many American farmers.
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Seeing this market failure, Congress acted to provide farmers with a lending system that they could actually afford to use.
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In other words, they pushed the financial system to evolve a unique solution that would fit the needs of farmers.
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They created the farm credit system.
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In the farm credit system, we're pretty proud of our expertise.
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That's Mike Gunderson, Chief Credit Officer at Farm Credit Illinois, a farmer-owned lending cooperative.
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So our specialization in agriculture and production allows us to have a lot of opportunities to help that producer understand financials, understand how they can position themselves for success in the future, how to manage stress and risk in the short run.
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I think we just have so many things that we can bring to them.
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The farm credit system was purpose-built to do many of these things.
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And still today, farm credit institutions like Mike's are out there lending to farmers at more favorable rates and over longer periods of time than other lenders would.
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That's because where traditional financial institutions demand relatively stable and reliable returns because of their shorter-term duty to depositors or investors, farm credit institutions have the ability to support farmers over longer time horizons and through extreme exposure to risks, thanks to farm credit's unique access to government capital markets, which means that the capital they're lending is much more patient and secure.
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But access to this unique funding source doesn't mean that farm credit institutions are giving money away for free.
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A loan is still a loan that requires repayment.
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And like other lenders, farm credit institutions must decide which loans are worth taking a risk on.
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For farm credit lenders who see many loan requests daily from a wide range of potential borrowers, there's a framework for evaluating this risk.
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Five C's of credit.
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I think as you look across those five C's, the most important one is character.
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And then there are things that we do to try and measure it, credit scores, and all those things.
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But the same challenge exists as I think about capacity, capital, collateral, less so collateral, but capacity and capital is the cash flow and the profitability of a farm in one year indicative of how profitable that operation is over its lifetime.
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Almost certainly not.
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And so I've talked to the credit team here at Form Credit Illinois to say a person's true probability of default is probably some unknown parameter.
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The five C's represent a useful evaluation framework for lenders when determining whether or not to extend credit to a given farmer on a given project, even though it can feel like it doesn't necessarily capture a perfect picture of the operation, investment, or the farmer themselves.
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But it's not just lenders who have to evaluate whether a given investment is worth the risk.
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Farmers too have to determine whether it's worth financing equipment or farmland, expanding into new enterprises, or borrowing for some other investment.
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While lenders have the five C's of credit, farmers also have a framework they can use to determine which opportunities are the most worthwhile, especially if seizing them requires taking on debt.
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Though just being able to put some numbers to the costs and possible returns related to an investment can be clarifying.
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From Trey's perspective, a partial budget actually helps you understand much more than that.
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That's because this process gives a farmer insight into the opportunity cost of a given decision.
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Now, in all of decision making, there is always a cost associated with the choice you make, which is the opportunity that you forewent.
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So a partial budget saying, okay, I could make an investment and go this direction with my production process.
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Or I could do this.
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I can't do both.
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I've got to choose one.
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And whichever one I don't choose is the opportunity cost.
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So the opportunity cost is the next best alternative.
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What are the added revenues?
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What are the added costs?
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What are the differences between those two added revenues and costs for the two different outcomes?
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This is what we have to determine.
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Easy as the concept of a partial budget might be, I'm sure plenty of farmers listening can imagine more than a hundred complications just off the top of their heads.
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But trade challenges that just because a partial budget is not complete and doesn't necessarily capture every possible cost or risk doesn't mean it's not helpful in your decision making.
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A partial budget, again, it's called partial for a reason.
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You're not trying to do a total budget, right?
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What you're trying to do is you're trying to see two different outcomes.
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One's the best thing, one's the second best thing.
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Now you're trying to figure out how much better is the best thing versus the second best thing.
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A partial budget can get complicated in a hurry.
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But the concept underneath it is pretty straightforward, right?
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But these are just approximations of future outcomes.
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And so you're really just trying to take a shot in the dark.
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That's a lot better than just what your gut reaction might be.
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What's the saying?
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In God we trust, everyone else brings data.
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This is how you put data to a decision.
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From Trey's perspective, being able to bring this kind of data to financial decisions is actually better for farmers and for farm lenders like Mike over at Farm Credit.
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Because when a farmer can demonstrate their awareness of opportunity cost and can show that they've put some numbers, even some imperfect numbers, behind a decision, it can completely change the lending conversation.
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So let's say you walk into your farm credit office and you're trying to finance some type of a decision.
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Maybe you're gonna buy a new combine and you got an old one.
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So you have two choices.
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Do I keep the old one and just pay the maintenance costs on that combine?
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Or do I upgrade and buy a new one?
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Well, I'm gonna sit down and I'm gonna hammer out a partial budget with the best data that I have for the best approximation of what I think the payoff rate might be for this new combine.
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Now I can walk right into my farm credit office and I can have a conversation with my loan officer based on my best approximation of what I think the future might look like.
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Now that that loan officer might push back and say, well, I don't think that that's exactly the right number here, or maybe you overshot your interest rate, or I don't know what it is.
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But this is a conversation that shifts from saying, are you a trustworthy person to do business with, to do I trust your numbers as we are doing business?
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Though these kinds of conversations and evaluations are common in ag lending today, that hasn't always been the case.
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A fact that has in the past gotten the farm credit system specifically into trouble.
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In fact, the 1980s farm financial crisis threw the farm credit system into crisis too.
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During that era, nearly 20% of all farms in the US experienced acute financial distress, and farm lenders were not immune from the distress either.
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Parts of the farm credit system, which was widely exposed, ended up having to be bailed out by the federal government.
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The funds were later paid back, but in the short term, the institutions were often forced to cut off farmers from lending right when those farmers needed support the most.
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There are people out there that will never do business with a farm credit system because of the experience of their grandparents or their parents in the 1980s.
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And like I respect that decision.
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I think living through 2007, that was really an echo of what had happened in the farm financial crisis in the 1980s.
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We were lending to people that didn't have income, we're lending on inflated market value.
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All the lessons we learned in the 1980s were recreated in the housing market in 2007.
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So I do think some of it was probably regulatory.
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Like we gotta have some capital in the association.
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You gotta assess their probability of default and think about cash flows for them.
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You can't do balance sheet lending.
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I think all of those things were things that we learned in the 1980s.
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And we as a system respect the importance of that implicit government backing, but we don't want to do anything to put that in jeopardy.
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And that's a system-wide commitment to serving farmers and serving them well in a way that's not necessarily conservative for the association, but conservative for the member or the borrower.
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We don't want to lend you into trouble.
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This final lesson learned of not wanting to lend farmers into trouble represents a key way that ag lenders have continued to evolve alongside farmers.
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And developing this lending discipline can be challenging, especially because farmers, for generations, relied heavily on a very personal relationship with their lender in order to secure what were increasingly becoming massive loans.
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In response, farm credit has actually adapted its structure in order to ensure that farmers themselves and the institution they depend on is protected.
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A strategy we've pursued, and this would probably have been in the 1990s, even, is a division of relationship management and credit management.
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So the credit team doesn't have to interact directly with the farmer.
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We've got a relationship manager that does it.
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A generation ago, the loan officer did both of those things.
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So we understood credit and had to manage the relationship.
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And when you divide those, you probably become more efficient because of the specialization and trade, but you also lose something.
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Somebody that only made loans in 2022, 23 when it was great, like they're learning some really important lessons right now and it's an environment that's a lot tougher.
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And maybe sometimes it's credit that understands the personal connection more than the relationship manager because we're willing to deliver a harder, tougher message that's better for them in the long run.
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Do you think it has anything to do with the cooperative structure of farm credit?
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100%.
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100%.
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So when I was at MetLife and MetLife has a long commitment to agriculture, actually longer than the farm credit system has existed.
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So I'm not knocking MetLife, but we were on a call with the team one time and somebody asked, who's more important, the farmer or the investor?
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And like they're both important, right?
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Because they're part of this financial transaction.
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At Farm Credit Illinois, the farmer is the investor.
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They own us.
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So there's there just doesn't even have to be tension.
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Like they are one and the same.
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Mike is right here.
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With farmer owners occupying the boards of the farm credit institutions, there tends to be much more of an appetite for lower returns, especially if it means that the organization can provide more support for farmers.
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But at the same time, these farmers are also especially sensitive to not lending farmers into trouble, both for the sake of the institution and for the sake of their peers.
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Though as the industry has continued to evolve in recent years, even the very idea that most farmers are peers has started to strain.
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An ingredient that made them really successful three or four generations ago was a lot of similarities in farmers.
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Like they're all owned a section and they had families and they were growing similar crops and were well diversified.
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And none of them had the existing wealth to go and build bins themselves.
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So pooling that capital to create that infrastructure made sense.
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And they were all the same.
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So they didn't have these different needs or wants.
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I think as we've experienced consolidation, as we've matured as an industry, that's not true anymore, or at least not as true as it once was.
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Farmers are of different size and different diversification and different strategy approach to the market.
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Today, both representing and serving this diverse range of farms is hard, especially because these farms don't just have different features.
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They're often pursuing fundamentally different strategies, which can have big impacts on what they need from a lender.
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And I think one of the biggest epiphanies I had at University of Illinois, Paul Ellinger teaching ag finance, said debt can be a good thing.
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I was like, no, no, debt's always bad.
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And I think used right, used prudently, you can use debt to grow your business.
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Same way with cash rent acres, right?
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I think where you used to think you got to own it all.
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But I think a lot of successful producers say, hey, I can grow this operation without tying up my capital and do the things that I love, make better use of my equipment, better use of my time.
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With the caveat, that guy who still has the goal of no debt and own it all can be successful.
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If that's their goal and that's what gets them going in the morning, like I think that's a model that can work for them and can work in the industry.
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I think another model is one that relies on very little land ownership and a healthy amount of debt to help them grow their business and be successful.
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So I do think there's probably more willingness to move in a direction away from all ownership, no debt.
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And I think the market discipline that comes with that probably sharpens folks.
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But room for everybody.
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Today, farmers and lenders are increasingly facing this brave new world where different models and strategies are working for different people if they have the wherewithal to stick with it.
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But when we look around at the conditions of the farm financial system today, as compared to the 1980s, it's worth asking whether this growing diversity of farm management strategy is working out, or just making all this farming and the credit that's fueling it even more risky.
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I'll look into the future of ag lending after the break.
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Agribusiness Blueprint is brought to you by Purdue University's Center for Food and Agricultural Business.
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This year marks the center's 40th anniversary, and its mission remains the same: connecting evidence-based insight with the decisions agribusiness leaders make every day.
00:21:17.839 --> 00:21:28.160
From strategy and marketing to sales, finance, and risk management, the center helps organizations and professionals navigate what makes agribusiness fundamentally different.
00:21:28.400 --> 00:21:33.680
Learn more about the center's programs and research at agribusiness.purdue.edu.
00:21:34.319 --> 00:21:36.240
Now, back to the show.
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So far, we've talked about the culture and risks that set ag lending apart from lending in other sectors and the way that the ag finance system has adapted to deal with that risk, especially through the creation of unique institutions like farm credit.
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As we turn to our last question about where the farm financial system goes from here, we have to first establish where exactly here is.
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That process starts with what Mike mentioned before the break.
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That given that enough time has passed since the 1980s, alternative farm business models and new debt management strategies have emerged and begun to thrive in agriculture.
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This might help explain why today something unusual is happening in the world of ag finance.
00:22:21.279 --> 00:22:27.599
We have some evidence in our portfolio we're experiencing a K-shaped recovery in the farm economy.
00:22:27.759 --> 00:22:35.440
We have had as many producers add to working capital last year as we had experienced a decline in working capital last year.
00:22:35.759 --> 00:22:42.640
So we have some folks making good decisions, they're locking in profit when they can, even if it's not as much as they wanted.
00:22:42.799 --> 00:22:51.759
They are controlling their expenses, they're positioning themselves well, they're using that working capital cushion if they need to, but if they can protect it, they are.
00:22:51.920 --> 00:22:58.000
I think there's another set of folks that haven't made those same decisions to protect that working capital.
00:22:58.160 --> 00:23:01.200
They overspend on equipment or something of that nature.
00:23:01.440 --> 00:23:15.440
And so we I think we've seen in our portfolio that there are some folks that are licking their chops that land values might come down because they've got some working capital and some borrowing capacity to go and acquire that as those asset values potentially come down.
00:23:16.079 --> 00:23:18.960
There are a few explanations for what Mike is describing.
00:23:19.200 --> 00:23:29.200
If what's happening in the ag economy aligns with what's going on in the US economy more broadly, a combination of asset ownership and inflation probably explains much of what we're seeing.
00:23:29.440 --> 00:23:41.200
In other words, those who already own land and equipment and are on top of their debt are benefiting from things like rising real estate values, while those who aren't are getting squeezed more by rising input costs.
00:23:41.519 --> 00:23:44.480
This K-shaped recovery is where we are today.
00:23:44.720 --> 00:23:54.240
Those who are managing their farm businesses' debt and broadly their risk strategically are still seeing success, while many others are struggling.
00:23:54.480 --> 00:24:01.599
But from Mike's perspective, the activities and tools that separate those two groups are actually more marginal than you might expect.
00:24:02.240 --> 00:24:04.319
At this point, crop insurance is a no-brainer.
00:24:04.640 --> 00:24:09.039
The PLC opportunities eliminate a lot of risk.
00:24:10.160 --> 00:24:12.400
Futures markets eliminate a lot of risk.
00:24:12.559 --> 00:24:16.079
There are things that producers can do to really manage it.
00:24:16.240 --> 00:24:24.480
And I think really just starting this basic as a budget and understanding that and graduating that financial understanding.
00:24:24.640 --> 00:24:28.000
And I get it, I like doing some parts of my job better than others.
00:24:28.160 --> 00:24:33.519
And I think everybody can approach the farm management differently, but you can't ignore it.
00:24:34.000 --> 00:24:44.720
As long as you don't stick your head in the sand, you've got that and you've got expertise, whether it's your lender or a financial advisor, you've got an accountant, somebody to help you navigate that finance.
00:24:44.880 --> 00:24:50.559
The same way the guy that likes finance relies on the agronomist to help him grow that plant healthy.
00:24:50.720 --> 00:24:58.720
Like use your resources where you don't have an interest or you don't have an expertise to be able to be that CEO of your farming operation.
00:24:59.039 --> 00:25:17.039
As we look ahead to what seems likely to be an even riskier future, being able to use the tools Mike mentions here, from a partial budget to understand opportunity costs to market-based risk management tools, will be what sets successful farmers apart, both from a lender's perspective and in the market more broadly.
00:25:17.359 --> 00:25:22.400
Otherwise, what we know about the future of ag lending is really limited.
00:25:22.640 --> 00:25:29.920
As we've talked about in earlier episodes, uncertainty in agriculture is at all-time highs and it's still trending upwards.
00:25:30.079 --> 00:25:37.759
And the key ongoing challenge for both farmers and their lenders is trying to find the opportunities in all of that risk.
00:25:38.240 --> 00:25:42.000
The reality is that the world is changing around us in a hurry.
00:25:42.240 --> 00:25:45.759
And so you need to learn how to manage the change.
00:25:46.000 --> 00:25:49.279
Even if you don't want to change, it's too bad you're gonna have to change.
00:25:49.519 --> 00:26:02.799
And so when we think about a financial position, it's also a human position of understanding that it's all about the people that you hired and the directions that you've decided that your firm needs to take.
00:26:03.279 --> 00:26:09.519
Ultimately, it's very uncomfortable to have to know when to quit a location, a branch.
00:26:09.759 --> 00:26:12.079
It's hard to know when to let go an employee.
00:26:12.160 --> 00:26:18.000
It's hard to know when the crop that you've always been planting or you've always been supporting is not going to work anymore.
00:26:18.160 --> 00:26:19.599
That's not comfortable.
00:26:20.240 --> 00:26:30.720
But knowing when to quit and when to walk away is, I think, the fundamentally most important component of business financial strategy.
00:26:31.200 --> 00:26:35.279
Otherwise, you just get lost, and that's the quickest way to bankruptcy.
00:26:35.599 --> 00:26:37.759
Trey and Mike agree on this front.
00:26:38.000 --> 00:26:46.559
Good financial strategy at the farm level or the agribusiness level is not about being blind to the growing risk or willfully ignoring them.
00:26:47.440 --> 00:26:57.599
It's about understanding the risks you face as completely as possible, staying aware of the alternatives, and managing the gap between good and bad potential outcomes.
00:26:58.000 --> 00:27:22.079
So when we think about the gaps in farmer decision making, make sure that using your kind of ag finance tools of partial budgets or even just your lender relationship, pay attention, follow the indicators from the external environment, whether it be the cost of the land that you're acquiring or renting, what are rental rates doing, what is the sentiment of the farmers in your area.
00:27:22.400 --> 00:27:27.920
Honestly, spend some time on your co-op board, spend some time talking to the other farmers in your area.
00:27:28.079 --> 00:27:29.920
You're gonna get a lot more information that way.
00:27:30.079 --> 00:27:32.640
You're gonna at least hear how other people are thinking.
00:27:32.799 --> 00:27:37.039
Even though you probably shouldn't always follow the herd, you should at least be aware of what the herd is thinking.
00:27:37.200 --> 00:27:42.799
And you just push toward this, I think, more entrepreneurial strategy while covering your downside risk.
00:27:42.880 --> 00:27:44.079
That's the goal.
00:27:44.640 --> 00:27:59.759
Using a partial budget to evaluate opportunity costs and begin a conversation with a lender about possible investments is a really valuable first step that producers can take as they begin to navigate the higher degree of risk they face today and into the future.
00:28:00.079 --> 00:28:05.119
But the question remains, what might that farm financial future actually look like?
00:28:05.599 --> 00:28:12.000
One way to gain insight on what we might expect to encounter in the future, is to look a little more closely at the past.
00:28:12.240 --> 00:28:15.279
Which brings us all the way back to the story that kicked us off today.
00:28:15.440 --> 00:28:23.359
The story of one Cyrus McCormick, a farm implement manufacturer who revolutionized agribusiness by pioneering ag lending.
00:28:23.680 --> 00:28:36.400
The end of his story might not be the one you expected to hear, because his business, like so many other lenders who came after it, courted collapse because it failed to understand the true risks of aged lending.
00:28:36.559 --> 00:28:38.240
Here's Mike Bolgey again.
00:28:38.720 --> 00:28:46.720
I don't know all of the details of the failure of the International Harvester, but there were problems.
00:28:46.880 --> 00:28:52.720
Sometimes they didn't use very, very good underwriting tools and techniques.
00:28:52.960 --> 00:29:02.640
They didn't do credit analysis, they did sales analysis, and their sales analysis said we need to move product, right?
00:29:03.039 --> 00:29:13.680
And so what they did is basically they moved that product using this as a marketing technique, and sometimes that farmer was not able to pay on that.
00:29:14.160 --> 00:29:19.839
There's actually a current debate right now about whether this is actually happening in some other industries.
00:29:20.160 --> 00:29:22.960
The auto industry faced that for a period of time.
00:29:23.279 --> 00:29:33.680
And we actually have that type of thing happening where manufacturing companies in the energy industry for all these new energy plants that are going in.
00:29:33.920 --> 00:29:39.359
Some of the organizations that are financing those have ownership positions in them as well.
00:29:43.920 --> 00:29:50.720
And that, unless managed very, very carefully, can be a very, very, very risky proposition.
00:29:51.119 --> 00:30:03.759
While Cyrus McCormick's financial innovation helped thousands of farmers get their hands on a piece of farm equipment that they probably would never have been able to afford on their own, making this credit available was not a riskless bet.
00:30:04.079 --> 00:30:16.559
And as Mike points out, even more than half a century after McCormick's efforts, it seems that we still don't always have a good idea of how to identify sound investments, both within the ag sector and beyond it.
00:30:16.960 --> 00:30:26.720
When we think about the development of so many of these tools, it really is often about marketing first and then dealing with the outcome second.
00:30:26.960 --> 00:30:34.880
And I think that the McCormick model is a good example of somebody building an idea on the assumption that adoption will just take off.
00:30:35.119 --> 00:30:45.440
And so even if there are some losses, that the rate of adoption is so worth it that it's okay to accept that risk threshold.
00:30:45.680 --> 00:30:50.480
I think in the modern era, I think we're literally looking at the exact same gamble, right?
00:30:50.640 --> 00:31:05.039
So what we have to ask ourselves that I think McCormick would say if he was here is do you really think that AI is like a tractor but for every business decision in all of civilization?
00:31:05.279 --> 00:31:07.119
And I think that's the gamble that's being made.
00:31:07.200 --> 00:31:08.799
So we'll see how it pays off.
00:31:10.799 --> 00:31:17.599
The bet that's being made on AI today will certainly be one of the many factors that will impact the world of ag lending going forward.
00:31:17.839 --> 00:31:25.839
Whether artificial intelligence and other technologies will increase volatility or reduce it is really impossible to say right now.
00:31:26.079 --> 00:31:40.640
But even without that risk accounted for, there are plenty of other challenges that will ensure that ag finance remains a space where both farmers and lenders will need to stay focused, keep their pencil sharp, and always have an awareness of their opportunity cost.
00:31:41.119 --> 00:31:59.680
Partial budgets are a great tool for farmers, or really anyone, to suss out some of these costs, and they can be an invaluable complement to a fuller risk management strategy that includes federal insurance, hedging in the markets, and of course, having a deep, trusting relationship with a lender with agricultural expertise.
00:32:00.799 --> 00:32:20.240
When we look at the whole scope of ag lending history, it's been a long journey from simply helping farmers buy products when they're short on cash to building a billion-dollar system that actually works for farmers, lenders, and the rest of the industry too, helping to manage the risks inherent in growing and selling crops in a global market.
00:32:20.799 --> 00:32:33.920
And the reality is, as the successful models, strategies, and types of risk in agriculture continue to change, we're almost guaranteed to discover that today's ag lending system is not yet perfect.
00:32:34.160 --> 00:32:37.839
But we know from experience that we can't fix what we can't find.
00:32:38.000 --> 00:32:42.720
And so the best defense against those flaws is awareness and preparation.
00:32:42.960 --> 00:32:53.519
Because the more we investigate and understand risks in our financial system, the more likely we are to find weaknesses and address them before they lead to catastrophe.
00:32:57.759 --> 00:33:03.279
But before we put McCormick to bed today, let's consider one last possibility.
00:33:03.519 --> 00:33:11.200
What if the fatal flaw in his ag equipment business wasn't shoddy lending, but something more to do with the tool he created itself?
00:33:11.519 --> 00:33:18.480
What if he didn't fail to understand the business, but instead failed to understand something important about farmers?
00:33:18.799 --> 00:33:28.319
In the case of McCormick, it was a solid business for a long time, but International Harvester went the way of the dinosaur at one point for a reason, right?
00:33:28.400 --> 00:33:36.160
It's the game changes, and if you don't understand your adoption curve, it's likely that you might not be able to change with it.
00:33:36.559 --> 00:33:41.839
Agribusiness on the cutting edge or the bleeding edge of innovation and entrepreneurship.
00:33:42.079 --> 00:33:44.799
Next time on Agribusiness Blueprint.
00:33:47.119 --> 00:33:51.440
Agribusiness Blueprint is a production of Purdue University's Center for Food and Agribusin.
00:33:51.759 --> 00:33:55.119
I'm your host, Sarah Mock, alongside my co-host Trey Malone.
00:33:55.519 --> 00:34:00.720
This show is produced and mixed by me, Sarah Mock, with editing support from Trey Malone and Mike Bolgi.
00:34:01.039 --> 00:34:04.640
Additional support from the wider team at the Center for Food and Agribusiness.
00:34:04.880 --> 00:34:17.039
To learn more about programs, classes, and continuing education opportunities through the Center for Food and Agribusin, visit our website at agribusiness.purdue.edu and follow us on LinkedIn for the latest news and updates.
00:34:17.360 --> 00:34:23.440
For specific questions about the show, contact Trey Malone and the Department of Agricultural Economics at Purdue University.
00:34:24.079 --> 00:34:39.039
Agribusiness Blueprint is sponsored in part by the Agriculture and Food Research Initiative competitive program of the USDA National Institute of Food and Agriculture, NIFA, award number two zero two two six eight zero zero six three six four three three.
00:00:00.320 --> 00:00:07.360
Cyrus McCormick invented the very first mechanical reaper and revolutionized American agriculture forever.
00:00:07.599 --> 00:00:13.839
But when we look around the agribusiness sector today, his most lasting impact wasn't made of iron.
00:00:14.000 --> 00:00:16.079
It was made of money and time.
00:00:16.879 --> 00:00:25.120
In other words, McCormick's most important contribution was commercializing the idea of buying farm equipment on credit.
00:00:25.679 --> 00:00:32.079
There were times when farmers weren't able to obtain their funds from a financial institution.
00:00:32.240 --> 00:00:39.759
And so the input suppliers, McCormick being one, did provide the financing for that farmer to make that purchase.
00:00:39.920 --> 00:00:45.759
That strategy of providing the financing as a sales tool, that's what the innovation was really.
00:00:46.000 --> 00:00:47.520
It was a marketing strategy.
00:00:47.679 --> 00:00:49.439
And so they became lenders.
00:00:49.759 --> 00:01:02.159
Agricultural lending might have started out as a way to get farmers into newfangled reapers in the 1800s, but since then, it's moved well beyond farm implements and become a core part of the agribusiness world.
00:01:02.479 --> 00:01:10.159
Today, American farms collectively borrow billions of dollars every year for farmland, operating expenses, and more.
00:01:10.480 --> 00:01:20.079
But as the world of ag lending expanded, it got riskier and more complex for farmers, bankers, and the organizations farmers do business with.
00:01:20.239 --> 00:01:29.519
And in our modern era of large-scale and consolidated operations, the role ag finance will play going forward is only becoming more critical.
00:01:29.920 --> 00:01:31.280
Financing the farm.
00:01:31.519 --> 00:01:34.159
Today on Agribusiness Blueprint.
00:01:36.480 --> 00:01:45.200
This is Agribusiness Blueprint, a limited series podcast about American agriculture's most impossible challenges and the agribusiness leaders who solve them.
00:01:45.439 --> 00:01:55.040
You're here with me, independent ag journalist Sarah Mock, and my co-host Trey Malone, Associate Professor of Agricultural Economics and the Bulgy Chair at Purdue University.
00:01:55.359 --> 00:01:57.760
And today is all about ag finance.
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The world of ag finance is impossible to cover in one episode, so we're going to focus on three key questions today.
00:02:05.680 --> 00:02:20.719
Why farm lending is fundamentally different than lending in other sectors, how farm businesses and their financial system have co-evolved over the last century, and what might be ahead as scale, consolidation, and risk continue to rise?
00:02:20.960 --> 00:02:35.039
Along the way, we'll learn more about how the idea of opportunity cost and the partial budget process that can help us evaluate it can support farmers, lenders, and agribusiness leaders across the sector in financial decision making.
00:02:36.800 --> 00:02:39.360
So today we're gonna start with our first question.
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What makes lending in agriculture so different from lending in other sectors?
00:02:43.840 --> 00:02:56.319
Over the course of the last six episodes, we've talked about a lot of differentiators between ag and the rest of the economy, from the culture of agriculture to the importance of policy, to the supremacy of personal relationships.
00:02:56.639 --> 00:02:59.599
Ag lending shares many of these same features.
00:03:10.879 --> 00:03:15.360
The geographic specificity of ag lending, I think, creates another layer.
00:03:15.599 --> 00:03:21.599
And then ultimately the cultural norms around ag lending, I think, look very different than traditional lending.
00:03:21.680 --> 00:03:23.360
This is a low margin business.
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Most of these farmers cannot afford to make a mistake because they have one harvest a year.
00:03:28.400 --> 00:03:30.960
And that one harvest a year is all that matters.
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They get in their adult lifetime, what, 50 harvests total?
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And realistically, they probably only get 20 of those harvests where they're the primary decision maker.
00:03:42.000 --> 00:03:50.719
So you better believe that they're going to try their best to make the most financially rational, protected decisions that they can make.
00:03:50.960 --> 00:03:57.840
That does not necessarily lend itself to high volume lending in a way that creates large returns.
00:03:58.159 --> 00:04:07.360
The cultural realities of agribusiness set agriculture in general apart from the rest of the economy and set ag lending specifically apart as well.
00:04:07.599 --> 00:04:10.400
But the differences here go deeper than culture.
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After all, the world of lending in finance hinges on risk, identifying, understanding, and managing it as much as possible.
00:04:18.560 --> 00:04:24.480
And yet, an unusually high degree of risk is one of the defining features of agriculture.
00:04:24.879 --> 00:04:30.639
There's more systemic risk in agriculture than there is in virtually every other business.
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This is why we have federally subsidized crop insurance.
00:04:33.759 --> 00:04:34.000
Right?
00:04:34.160 --> 00:04:49.839
So even the federal government has stepped in in a way that says we believe that the agricultural sector is so volatile, yet so important, that we have got to come up with a way to stabilize the industry through some type of federally subsidized system.
00:04:50.160 --> 00:04:54.000
The same can be said about agricultural lending.
00:04:54.399 --> 00:05:01.600
For a big chunk of American history, all of these risks and nuances were simply too much for most lenders to stomach.
00:05:01.839 --> 00:05:08.720
This often meant interest rates on loans to farms were extraordinarily high, or that banks just wouldn't lend to farmers at all.
00:05:08.959 --> 00:05:17.439
Here's Mike Bolgy, our guest from episode three, and the voice you heard in the intro, on what that looked like and still looks like in some places today.
00:05:17.839 --> 00:05:25.839
So lenders for farmers typically are much more conservative in terms of their lending willingness.
00:05:26.240 --> 00:05:37.279
Look at the typical underwriting standards that we use for farmers in terms of the amount of debt we use compared to the size of the business.
00:05:37.600 --> 00:05:46.000
How about say maybe 30%, 40% lenders are starting to get really nervous about whether in fact that's gonna be viable?
00:05:46.480 --> 00:05:52.319
And if you move up into the 60, 70 percent area, we don't go there.
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We just aren't gonna be able to allow farmers to borrow that much money.
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You go to some other industries and they'll love going to leverage ratios of 50, 60, 70.
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There are some that even will go as high as 80.
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That's one of the reasons why in agriculture we've typically had unique financial institutions like the farm credit system.
00:06:16.720 --> 00:06:23.519
So ag lending is different than lending in other sectors, in large part because farming is such a risky endeavor.
00:06:23.759 --> 00:06:28.720
And for farmers and lenders themselves, this risk is not a vague concept.
00:06:28.959 --> 00:06:36.720
It literally limits the amount of credit that lenders are willing to offer, and thus how much financing a farmer is ever able to secure.
00:06:37.040 --> 00:06:55.040
For generations, this put farmers in a real bind, because despite the fact that they are often very limited in how much credit they could acquire, the inputs to farming, from land to equipment to seed, are often expensive and have to be paid for well before a farmer makes any income.
00:06:55.439 --> 00:07:00.879
By 1933, this situation had become untenable for many American farmers.
00:07:01.120 --> 00:07:08.160
Seeing this market failure, Congress acted to provide farmers with a lending system that they could actually afford to use.
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In other words, they pushed the financial system to evolve a unique solution that would fit the needs of farmers.
00:07:15.120 --> 00:07:16.879
They created the farm credit system.
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In the farm credit system, we're pretty proud of our expertise.
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That's Mike Gunderson, Chief Credit Officer at Farm Credit Illinois, a farmer-owned lending cooperative.
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So our specialization in agriculture and production allows us to have a lot of opportunities to help that producer understand financials, understand how they can position themselves for success in the future, how to manage stress and risk in the short run.
00:07:44.959 --> 00:07:48.160
I think we just have so many things that we can bring to them.
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The farm credit system was purpose-built to do many of these things.
00:07:52.160 --> 00:08:01.519
And still today, farm credit institutions like Mike's are out there lending to farmers at more favorable rates and over longer periods of time than other lenders would.
00:08:01.759 --> 00:08:27.600
That's because where traditional financial institutions demand relatively stable and reliable returns because of their shorter-term duty to depositors or investors, farm credit institutions have the ability to support farmers over longer time horizons and through extreme exposure to risks, thanks to farm credit's unique access to government capital markets, which means that the capital they're lending is much more patient and secure.
00:08:28.160 --> 00:08:34.240
But access to this unique funding source doesn't mean that farm credit institutions are giving money away for free.
00:08:34.480 --> 00:08:37.039
A loan is still a loan that requires repayment.
00:08:37.120 --> 00:08:42.960
And like other lenders, farm credit institutions must decide which loans are worth taking a risk on.
00:08:43.120 --> 00:08:51.679
For farm credit lenders who see many loan requests daily from a wide range of potential borrowers, there's a framework for evaluating this risk.
00:08:52.080 --> 00:08:53.120
Five C's of credit.
00:08:53.279 --> 00:08:58.159
I think as you look across those five C's, the most important one is character.
00:08:58.240 --> 00:09:01.679
And then there are things that we do to try and measure it, credit scores, and all those things.
00:09:01.840 --> 00:09:20.240
But the same challenge exists as I think about capacity, capital, collateral, less so collateral, but capacity and capital is the cash flow and the profitability of a farm in one year indicative of how profitable that operation is over its lifetime.
00:09:20.559 --> 00:09:21.679
Almost certainly not.
00:09:21.919 --> 00:09:31.200
And so I've talked to the credit team here at Form Credit Illinois to say a person's true probability of default is probably some unknown parameter.
00:09:31.600 --> 00:09:46.559
The five C's represent a useful evaluation framework for lenders when determining whether or not to extend credit to a given farmer on a given project, even though it can feel like it doesn't necessarily capture a perfect picture of the operation, investment, or the farmer themselves.
00:09:46.799 --> 00:09:51.360
But it's not just lenders who have to evaluate whether a given investment is worth the risk.
00:09:51.679 --> 00:10:00.559
Farmers too have to determine whether it's worth financing equipment or farmland, expanding into new enterprises, or borrowing for some other investment.
00:10:00.879 --> 00:10:11.679
While lenders have the five C's of credit, farmers also have a framework they can use to determine which opportunities are the most worthwhile, especially if seizing them requires taking on debt.
00:10:40.720 --> 00:10:46.720
Though just being able to put some numbers to the costs and possible returns related to an investment can be clarifying.
00:10:46.879 --> 00:10:51.519
From Trey's perspective, a partial budget actually helps you understand much more than that.
00:10:51.759 --> 00:10:57.600
That's because this process gives a farmer insight into the opportunity cost of a given decision.
00:10:58.000 --> 00:11:04.879
Now, in all of decision making, there is always a cost associated with the choice you make, which is the opportunity that you forewent.
00:11:05.120 --> 00:11:12.960
So a partial budget saying, okay, I could make an investment and go this direction with my production process.
00:11:13.279 --> 00:11:14.960
Or I could do this.
00:11:15.120 --> 00:11:15.919
I can't do both.
00:11:16.080 --> 00:11:17.279
I've got to choose one.
00:11:17.519 --> 00:11:20.399
And whichever one I don't choose is the opportunity cost.
00:11:20.799 --> 00:11:23.039
So the opportunity cost is the next best alternative.
00:11:23.279 --> 00:11:24.399
What are the added revenues?
00:11:24.559 --> 00:11:25.679
What are the added costs?
00:11:25.840 --> 00:11:30.080
What are the differences between those two added revenues and costs for the two different outcomes?
00:11:30.320 --> 00:11:31.679
This is what we have to determine.
00:11:32.080 --> 00:11:40.799
Easy as the concept of a partial budget might be, I'm sure plenty of farmers listening can imagine more than a hundred complications just off the top of their heads.
00:11:41.120 --> 00:11:51.840
But trade challenges that just because a partial budget is not complete and doesn't necessarily capture every possible cost or risk doesn't mean it's not helpful in your decision making.
00:11:52.480 --> 00:11:55.840
A partial budget, again, it's called partial for a reason.
00:11:56.080 --> 00:11:58.559
You're not trying to do a total budget, right?
00:11:58.720 --> 00:12:02.080
What you're trying to do is you're trying to see two different outcomes.
00:12:02.159 --> 00:12:04.399
One's the best thing, one's the second best thing.
00:12:04.480 --> 00:12:08.159
Now you're trying to figure out how much better is the best thing versus the second best thing.
00:12:08.559 --> 00:12:10.879
A partial budget can get complicated in a hurry.
00:12:11.120 --> 00:12:15.120
But the concept underneath it is pretty straightforward, right?
00:12:15.679 --> 00:12:19.519
But these are just approximations of future outcomes.
00:12:19.759 --> 00:12:22.159
And so you're really just trying to take a shot in the dark.
00:12:22.240 --> 00:12:24.960
That's a lot better than just what your gut reaction might be.
00:12:25.519 --> 00:12:26.480
What's the saying?
00:12:26.639 --> 00:12:29.440
In God we trust, everyone else brings data.
00:12:30.000 --> 00:12:32.320
This is how you put data to a decision.
00:12:33.440 --> 00:12:43.120
From Trey's perspective, being able to bring this kind of data to financial decisions is actually better for farmers and for farm lenders like Mike over at Farm Credit.
00:12:43.360 --> 00:12:54.720
Because when a farmer can demonstrate their awareness of opportunity cost and can show that they've put some numbers, even some imperfect numbers, behind a decision, it can completely change the lending conversation.
00:12:55.200 --> 00:13:00.320
So let's say you walk into your farm credit office and you're trying to finance some type of a decision.
00:13:00.559 --> 00:13:03.519
Maybe you're gonna buy a new combine and you got an old one.
00:13:03.759 --> 00:13:05.039
So you have two choices.
00:13:05.279 --> 00:13:08.639
Do I keep the old one and just pay the maintenance costs on that combine?
00:13:08.720 --> 00:13:10.720
Or do I upgrade and buy a new one?
00:13:11.039 --> 00:13:20.639
Well, I'm gonna sit down and I'm gonna hammer out a partial budget with the best data that I have for the best approximation of what I think the payoff rate might be for this new combine.
00:13:20.799 --> 00:13:30.399
Now I can walk right into my farm credit office and I can have a conversation with my loan officer based on my best approximation of what I think the future might look like.
00:13:30.559 --> 00:13:39.679
Now that that loan officer might push back and say, well, I don't think that that's exactly the right number here, or maybe you overshot your interest rate, or I don't know what it is.
00:13:39.840 --> 00:13:49.360
But this is a conversation that shifts from saying, are you a trustworthy person to do business with, to do I trust your numbers as we are doing business?
00:13:49.919 --> 00:13:56.000
Though these kinds of conversations and evaluations are common in ag lending today, that hasn't always been the case.
00:13:56.240 --> 00:14:01.759
A fact that has in the past gotten the farm credit system specifically into trouble.
00:14:02.559 --> 00:14:08.159
In fact, the 1980s farm financial crisis threw the farm credit system into crisis too.
00:14:08.559 --> 00:14:18.639
During that era, nearly 20% of all farms in the US experienced acute financial distress, and farm lenders were not immune from the distress either.
00:14:19.200 --> 00:14:25.360
Parts of the farm credit system, which was widely exposed, ended up having to be bailed out by the federal government.
00:14:25.840 --> 00:14:35.759
The funds were later paid back, but in the short term, the institutions were often forced to cut off farmers from lending right when those farmers needed support the most.
00:14:36.159 --> 00:14:43.759
There are people out there that will never do business with a farm credit system because of the experience of their grandparents or their parents in the 1980s.
00:14:43.840 --> 00:14:45.919
And like I respect that decision.
00:14:46.159 --> 00:14:54.000
I think living through 2007, that was really an echo of what had happened in the farm financial crisis in the 1980s.
00:14:54.240 --> 00:14:58.799
We were lending to people that didn't have income, we're lending on inflated market value.
00:14:59.039 --> 00:15:04.799
All the lessons we learned in the 1980s were recreated in the housing market in 2007.
00:15:05.039 --> 00:15:08.320
So I do think some of it was probably regulatory.
00:15:08.399 --> 00:15:11.519
Like we gotta have some capital in the association.
00:15:11.600 --> 00:15:16.399
You gotta assess their probability of default and think about cash flows for them.
00:15:16.559 --> 00:15:18.159
You can't do balance sheet lending.
00:15:18.240 --> 00:15:22.080
I think all of those things were things that we learned in the 1980s.
00:15:22.240 --> 00:15:31.200
And we as a system respect the importance of that implicit government backing, but we don't want to do anything to put that in jeopardy.
00:15:31.279 --> 00:15:41.600
And that's a system-wide commitment to serving farmers and serving them well in a way that's not necessarily conservative for the association, but conservative for the member or the borrower.
00:15:41.759 --> 00:15:44.000
We don't want to lend you into trouble.
00:15:44.399 --> 00:15:53.919
This final lesson learned of not wanting to lend farmers into trouble represents a key way that ag lenders have continued to evolve alongside farmers.
00:15:54.159 --> 00:16:07.679
And developing this lending discipline can be challenging, especially because farmers, for generations, relied heavily on a very personal relationship with their lender in order to secure what were increasingly becoming massive loans.
00:16:08.080 --> 00:16:17.360
In response, farm credit has actually adapted its structure in order to ensure that farmers themselves and the institution they depend on is protected.
00:16:17.919 --> 00:16:27.360
A strategy we've pursued, and this would probably have been in the 1990s, even, is a division of relationship management and credit management.
00:16:27.600 --> 00:16:31.200
So the credit team doesn't have to interact directly with the farmer.
00:16:31.360 --> 00:16:33.759
We've got a relationship manager that does it.
00:16:34.080 --> 00:16:37.039
A generation ago, the loan officer did both of those things.
00:16:37.200 --> 00:16:40.480
So we understood credit and had to manage the relationship.
00:16:40.559 --> 00:16:48.159
And when you divide those, you probably become more efficient because of the specialization and trade, but you also lose something.
00:16:48.399 --> 00:16:58.879
Somebody that only made loans in 2022, 23 when it was great, like they're learning some really important lessons right now and it's an environment that's a lot tougher.
00:16:59.039 --> 00:17:10.799
And maybe sometimes it's credit that understands the personal connection more than the relationship manager because we're willing to deliver a harder, tougher message that's better for them in the long run.
00:17:11.039 --> 00:17:13.839
Do you think it has anything to do with the cooperative structure of farm credit?
00:17:14.079 --> 00:17:14.400
100%.
00:17:14.799 --> 00:17:15.119
100%.
00:17:15.519 --> 00:17:23.119
So when I was at MetLife and MetLife has a long commitment to agriculture, actually longer than the farm credit system has existed.
00:17:23.279 --> 00:17:31.519
So I'm not knocking MetLife, but we were on a call with the team one time and somebody asked, who's more important, the farmer or the investor?
00:17:32.319 --> 00:17:34.400
And like they're both important, right?
00:17:34.480 --> 00:17:37.359
Because they're part of this financial transaction.
00:17:37.599 --> 00:17:40.559
At Farm Credit Illinois, the farmer is the investor.
00:17:40.640 --> 00:17:41.200
They own us.
00:17:41.359 --> 00:17:43.359
So there's there just doesn't even have to be tension.
00:17:43.440 --> 00:17:44.640
Like they are one and the same.
00:17:45.039 --> 00:17:46.319
Mike is right here.
00:17:46.480 --> 00:17:58.160
With farmer owners occupying the boards of the farm credit institutions, there tends to be much more of an appetite for lower returns, especially if it means that the organization can provide more support for farmers.
00:17:58.559 --> 00:18:07.920
But at the same time, these farmers are also especially sensitive to not lending farmers into trouble, both for the sake of the institution and for the sake of their peers.
00:18:08.559 --> 00:18:16.640
Though as the industry has continued to evolve in recent years, even the very idea that most farmers are peers has started to strain.
00:18:17.440 --> 00:18:24.880
An ingredient that made them really successful three or four generations ago was a lot of similarities in farmers.
00:18:25.039 --> 00:18:32.400
Like they're all owned a section and they had families and they were growing similar crops and were well diversified.
00:18:32.480 --> 00:18:36.799
And none of them had the existing wealth to go and build bins themselves.
00:18:36.880 --> 00:18:41.599
So pooling that capital to create that infrastructure made sense.
00:18:41.680 --> 00:18:42.400
And they were all the same.
00:18:42.559 --> 00:18:45.599
So they didn't have these different needs or wants.
00:18:46.000 --> 00:18:54.720
I think as we've experienced consolidation, as we've matured as an industry, that's not true anymore, or at least not as true as it once was.
00:18:55.440 --> 00:19:00.720
Farmers are of different size and different diversification and different strategy approach to the market.
00:19:02.000 --> 00:19:11.039
Today, both representing and serving this diverse range of farms is hard, especially because these farms don't just have different features.
00:19:11.200 --> 00:19:17.440
They're often pursuing fundamentally different strategies, which can have big impacts on what they need from a lender.
00:19:23.440 --> 00:19:31.440
And I think one of the biggest epiphanies I had at University of Illinois, Paul Ellinger teaching ag finance, said debt can be a good thing.
00:19:31.599 --> 00:19:33.599
I was like, no, no, debt's always bad.
00:19:33.759 --> 00:19:38.640
And I think used right, used prudently, you can use debt to grow your business.
00:19:38.799 --> 00:19:41.039
Same way with cash rent acres, right?
00:19:41.119 --> 00:19:43.279
I think where you used to think you got to own it all.
00:19:43.519 --> 00:19:54.079
But I think a lot of successful producers say, hey, I can grow this operation without tying up my capital and do the things that I love, make better use of my equipment, better use of my time.
00:19:54.240 --> 00:20:00.319
With the caveat, that guy who still has the goal of no debt and own it all can be successful.
00:20:00.559 --> 00:20:07.119
If that's their goal and that's what gets them going in the morning, like I think that's a model that can work for them and can work in the industry.
00:20:07.279 --> 00:20:15.359
I think another model is one that relies on very little land ownership and a healthy amount of debt to help them grow their business and be successful.
00:20:15.440 --> 00:20:21.920
So I do think there's probably more willingness to move in a direction away from all ownership, no debt.
00:20:22.160 --> 00:20:27.680
And I think the market discipline that comes with that probably sharpens folks.
00:20:27.759 --> 00:20:29.519
But room for everybody.
00:20:29.839 --> 00:20:40.079
Today, farmers and lenders are increasingly facing this brave new world where different models and strategies are working for different people if they have the wherewithal to stick with it.
00:20:41.119 --> 00:20:57.039
But when we look around at the conditions of the farm financial system today, as compared to the 1980s, it's worth asking whether this growing diversity of farm management strategy is working out, or just making all this farming and the credit that's fueling it even more risky.
00:20:57.359 --> 00:21:00.880
I'll look into the future of ag lending after the break.
00:21:02.720 --> 00:21:07.680
Agribusiness Blueprint is brought to you by Purdue University's Center for Food and Agricultural Business.
00:21:07.920 --> 00:21:17.599
This year marks the center's 40th anniversary, and its mission remains the same: connecting evidence-based insight with the decisions agribusiness leaders make every day.
00:21:17.839 --> 00:21:28.160
From strategy and marketing to sales, finance, and risk management, the center helps organizations and professionals navigate what makes agribusiness fundamentally different.
00:21:28.400 --> 00:21:33.680
Learn more about the center's programs and research at agribusiness.purdue.edu.
00:21:34.319 --> 00:21:36.240
Now, back to the show.
00:21:37.920 --> 00:21:51.920
So far, we've talked about the culture and risks that set ag lending apart from lending in other sectors and the way that the ag finance system has adapted to deal with that risk, especially through the creation of unique institutions like farm credit.
00:21:52.079 --> 00:21:59.680
As we turn to our last question about where the farm financial system goes from here, we have to first establish where exactly here is.
00:22:00.880 --> 00:22:04.319
That process starts with what Mike mentioned before the break.
00:22:04.480 --> 00:22:14.960
That given that enough time has passed since the 1980s, alternative farm business models and new debt management strategies have emerged and begun to thrive in agriculture.
00:22:15.200 --> 00:22:20.799
This might help explain why today something unusual is happening in the world of ag finance.
00:22:21.279 --> 00:22:27.599
We have some evidence in our portfolio we're experiencing a K-shaped recovery in the farm economy.
00:22:27.759 --> 00:22:35.440
We have had as many producers add to working capital last year as we had experienced a decline in working capital last year.
00:22:35.759 --> 00:22:42.640
So we have some folks making good decisions, they're locking in profit when they can, even if it's not as much as they wanted.
00:22:42.799 --> 00:22:51.759
They are controlling their expenses, they're positioning themselves well, they're using that working capital cushion if they need to, but if they can protect it, they are.
00:22:51.920 --> 00:22:58.000
I think there's another set of folks that haven't made those same decisions to protect that working capital.
00:22:58.160 --> 00:23:01.200
They overspend on equipment or something of that nature.
00:23:01.440 --> 00:23:15.440
And so we I think we've seen in our portfolio that there are some folks that are licking their chops that land values might come down because they've got some working capital and some borrowing capacity to go and acquire that as those asset values potentially come down.
00:23:16.079 --> 00:23:18.960
There are a few explanations for what Mike is describing.
00:23:19.200 --> 00:23:29.200
If what's happening in the ag economy aligns with what's going on in the US economy more broadly, a combination of asset ownership and inflation probably explains much of what we're seeing.
00:23:29.440 --> 00:23:41.200
In other words, those who already own land and equipment and are on top of their debt are benefiting from things like rising real estate values, while those who aren't are getting squeezed more by rising input costs.
00:23:41.519 --> 00:23:44.480
This K-shaped recovery is where we are today.
00:23:44.720 --> 00:23:54.240
Those who are managing their farm businesses' debt and broadly their risk strategically are still seeing success, while many others are struggling.
00:23:54.480 --> 00:24:01.599
But from Mike's perspective, the activities and tools that separate those two groups are actually more marginal than you might expect.
00:24:02.240 --> 00:24:04.319
At this point, crop insurance is a no-brainer.
00:24:04.640 --> 00:24:09.039
The PLC opportunities eliminate a lot of risk.
00:24:10.160 --> 00:24:12.400
Futures markets eliminate a lot of risk.
00:24:12.559 --> 00:24:16.079
There are things that producers can do to really manage it.
00:24:16.240 --> 00:24:24.480
And I think really just starting this basic as a budget and understanding that and graduating that financial understanding.
00:24:24.640 --> 00:24:28.000
And I get it, I like doing some parts of my job better than others.
00:24:28.160 --> 00:24:33.519
And I think everybody can approach the farm management differently, but you can't ignore it.
00:24:34.000 --> 00:24:44.720
As long as you don't stick your head in the sand, you've got that and you've got expertise, whether it's your lender or a financial advisor, you've got an accountant, somebody to help you navigate that finance.
00:24:44.880 --> 00:24:50.559
The same way the guy that likes finance relies on the agronomist to help him grow that plant healthy.
00:24:50.720 --> 00:24:58.720
Like use your resources where you don't have an interest or you don't have an expertise to be able to be that CEO of your farming operation.
00:24:59.039 --> 00:25:17.039
As we look ahead to what seems likely to be an even riskier future, being able to use the tools Mike mentions here, from a partial budget to understand opportunity costs to market-based risk management tools, will be what sets successful farmers apart, both from a lender's perspective and in the market more broadly.
00:25:17.359 --> 00:25:22.400
Otherwise, what we know about the future of ag lending is really limited.
00:25:22.640 --> 00:25:29.920
As we've talked about in earlier episodes, uncertainty in agriculture is at all-time highs and it's still trending upwards.
00:25:30.079 --> 00:25:37.759
And the key ongoing challenge for both farmers and their lenders is trying to find the opportunities in all of that risk.
00:25:38.240 --> 00:25:42.000
The reality is that the world is changing around us in a hurry.
00:25:42.240 --> 00:25:45.759
And so you need to learn how to manage the change.
00:25:46.000 --> 00:25:49.279
Even if you don't want to change, it's too bad you're gonna have to change.
00:25:49.519 --> 00:26:02.799
And so when we think about a financial position, it's also a human position of understanding that it's all about the people that you hired and the directions that you've decided that your firm needs to take.
00:26:03.279 --> 00:26:09.519
Ultimately, it's very uncomfortable to have to know when to quit a location, a branch.
00:26:09.759 --> 00:26:12.079
It's hard to know when to let go an employee.
00:26:12.160 --> 00:26:18.000
It's hard to know when the crop that you've always been planting or you've always been supporting is not going to work anymore.
00:26:18.160 --> 00:26:19.599
That's not comfortable.
00:26:20.240 --> 00:26:30.720
But knowing when to quit and when to walk away is, I think, the fundamentally most important component of business financial strategy.
00:26:31.200 --> 00:26:35.279
Otherwise, you just get lost, and that's the quickest way to bankruptcy.
00:26:35.599 --> 00:26:37.759
Trey and Mike agree on this front.
00:26:38.000 --> 00:26:46.559
Good financial strategy at the farm level or the agribusiness level is not about being blind to the growing risk or willfully ignoring them.
00:26:47.440 --> 00:26:57.599
It's about understanding the risks you face as completely as possible, staying aware of the alternatives, and managing the gap between good and bad potential outcomes.
00:26:58.000 --> 00:27:22.079
So when we think about the gaps in farmer decision making, make sure that using your kind of ag finance tools of partial budgets or even just your lender relationship, pay attention, follow the indicators from the external environment, whether it be the cost of the land that you're acquiring or renting, what are rental rates doing, what is the sentiment of the farmers in your area.
00:27:22.400 --> 00:27:27.920
Honestly, spend some time on your co-op board, spend some time talking to the other farmers in your area.
00:27:28.079 --> 00:27:29.920
You're gonna get a lot more information that way.
00:27:30.079 --> 00:27:32.640
You're gonna at least hear how other people are thinking.
00:27:32.799 --> 00:27:37.039
Even though you probably shouldn't always follow the herd, you should at least be aware of what the herd is thinking.
00:27:37.200 --> 00:27:42.799
And you just push toward this, I think, more entrepreneurial strategy while covering your downside risk.
00:27:42.880 --> 00:27:44.079
That's the goal.
00:27:44.640 --> 00:27:59.759
Using a partial budget to evaluate opportunity costs and begin a conversation with a lender about possible investments is a really valuable first step that producers can take as they begin to navigate the higher degree of risk they face today and into the future.
00:28:00.079 --> 00:28:05.119
But the question remains, what might that farm financial future actually look like?
00:28:05.599 --> 00:28:12.000
One way to gain insight on what we might expect to encounter in the future, is to look a little more closely at the past.
00:28:12.240 --> 00:28:15.279
Which brings us all the way back to the story that kicked us off today.
00:28:15.440 --> 00:28:23.359
The story of one Cyrus McCormick, a farm implement manufacturer who revolutionized agribusiness by pioneering ag lending.
00:28:23.680 --> 00:28:36.400
The end of his story might not be the one you expected to hear, because his business, like so many other lenders who came after it, courted collapse because it failed to understand the true risks of aged lending.
00:28:36.559 --> 00:28:38.240
Here's Mike Bolgey again.
00:28:38.720 --> 00:28:46.720
I don't know all of the details of the failure of the International Harvester, but there were problems.
00:28:46.880 --> 00:28:52.720
Sometimes they didn't use very, very good underwriting tools and techniques.
00:28:52.960 --> 00:29:02.640
They didn't do credit analysis, they did sales analysis, and their sales analysis said we need to move product, right?
00:29:03.039 --> 00:29:13.680
And so what they did is basically they moved that product using this as a marketing technique, and sometimes that farmer was not able to pay on that.
00:29:14.160 --> 00:29:19.839
There's actually a current debate right now about whether this is actually happening in some other industries.
00:29:20.160 --> 00:29:22.960
The auto industry faced that for a period of time.
00:29:23.279 --> 00:29:33.680
And we actually have that type of thing happening where manufacturing companies in the energy industry for all these new energy plants that are going in.
00:29:33.920 --> 00:29:39.359
Some of the organizations that are financing those have ownership positions in them as well.
00:29:43.920 --> 00:29:50.720
And that, unless managed very, very carefully, can be a very, very, very risky proposition.
00:29:51.119 --> 00:30:03.759
While Cyrus McCormick's financial innovation helped thousands of farmers get their hands on a piece of farm equipment that they probably would never have been able to afford on their own, making this credit available was not a riskless bet.
00:30:04.079 --> 00:30:16.559
And as Mike points out, even more than half a century after McCormick's efforts, it seems that we still don't always have a good idea of how to identify sound investments, both within the ag sector and beyond it.
00:30:16.960 --> 00:30:26.720
When we think about the development of so many of these tools, it really is often about marketing first and then dealing with the outcome second.
00:30:26.960 --> 00:30:34.880
And I think that the McCormick model is a good example of somebody building an idea on the assumption that adoption will just take off.
00:30:35.119 --> 00:30:45.440
And so even if there are some losses, that the rate of adoption is so worth it that it's okay to accept that risk threshold.
00:30:45.680 --> 00:30:50.480
I think in the modern era, I think we're literally looking at the exact same gamble, right?
00:30:50.640 --> 00:31:05.039
So what we have to ask ourselves that I think McCormick would say if he was here is do you really think that AI is like a tractor but for every business decision in all of civilization?
00:31:05.279 --> 00:31:07.119
And I think that's the gamble that's being made.
00:31:07.200 --> 00:31:08.799
So we'll see how it pays off.
00:31:10.799 --> 00:31:17.599
The bet that's being made on AI today will certainly be one of the many factors that will impact the world of ag lending going forward.
00:31:17.839 --> 00:31:25.839
Whether artificial intelligence and other technologies will increase volatility or reduce it is really impossible to say right now.
00:31:26.079 --> 00:31:40.640
But even without that risk accounted for, there are plenty of other challenges that will ensure that ag finance remains a space where both farmers and lenders will need to stay focused, keep their pencil sharp, and always have an awareness of their opportunity cost.
00:31:41.119 --> 00:31:59.680
Partial budgets are a great tool for farmers, or really anyone, to suss out some of these costs, and they can be an invaluable complement to a fuller risk management strategy that includes federal insurance, hedging in the markets, and of course, having a deep, trusting relationship with a lender with agricultural expertise.
00:32:00.799 --> 00:32:20.240
When we look at the whole scope of ag lending history, it's been a long journey from simply helping farmers buy products when they're short on cash to building a billion-dollar system that actually works for farmers, lenders, and the rest of the industry too, helping to manage the risks inherent in growing and selling crops in a global market.
00:32:20.799 --> 00:32:33.920
And the reality is, as the successful models, strategies, and types of risk in agriculture continue to change, we're almost guaranteed to discover that today's ag lending system is not yet perfect.
00:32:34.160 --> 00:32:37.839
But we know from experience that we can't fix what we can't find.
00:32:38.000 --> 00:32:42.720
And so the best defense against those flaws is awareness and preparation.
00:32:42.960 --> 00:32:53.519
Because the more we investigate and understand risks in our financial system, the more likely we are to find weaknesses and address them before they lead to catastrophe.
00:32:57.759 --> 00:33:03.279
But before we put McCormick to bed today, let's consider one last possibility.
00:33:03.519 --> 00:33:11.200
What if the fatal flaw in his ag equipment business wasn't shoddy lending, but something more to do with the tool he created itself?
00:33:11.519 --> 00:33:18.480
What if he didn't fail to understand the business, but instead failed to understand something important about farmers?
00:33:18.799 --> 00:33:28.319
In the case of McCormick, it was a solid business for a long time, but International Harvester went the way of the dinosaur at one point for a reason, right?
00:33:28.400 --> 00:33:36.160
It's the game changes, and if you don't understand your adoption curve, it's likely that you might not be able to change with it.
00:33:36.559 --> 00:33:41.839
Agribusiness on the cutting edge or the bleeding edge of innovation and entrepreneurship.
00:33:42.079 --> 00:33:44.799
Next time on Agribusiness Blueprint.
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Agribusiness Blueprint is a production of Purdue University's Center for Food and Agribusin.
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I'm your host, Sarah Mock, alongside my co-host Trey Malone.
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This show is produced and mixed by me, Sarah Mock, with editing support from Trey Malone and Mike Bolgi.
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Additional support from the wider team at the Center for Food and Agribusiness.
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To learn more about programs, classes, and continuing education opportunities through the Center for Food and Agribusin, visit our website at agribusiness.purdue.edu and follow us on LinkedIn for the latest news and updates.
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For specific questions about the show, contact Trey Malone and the Department of Agricultural Economics at Purdue University.
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Agribusiness Blueprint is sponsored in part by the Agriculture and Food Research Initiative competitive program of the USDA National Institute of Food and Agriculture, NIFA, award number two zero two two six eight zero zero six three six four three three.
