By Steve Cocheo, executive editor. This roundtable was held during ABA’s late 2009 National Agricultural Bankers Conference. See www.aba.com/Solutions/AgriculturalBanking.htm for activities of the ABA Center for Agricultural and Rural Banking

Potential for a continued downturn in farmland values carries implications good and bad

Land, and its values, are funny things. In some parts of the country, commercial real estate lenders, facing withering re-appraisals of collateral, hope not to see raw land marked back down to farmland values. But in markets served by farm lenders, the bankers’ concern often seems to be raised most when farmland values rise too high, or too quickly, or for too long.

In many markets, these two cases are actually two facets of the same matter. During the long housing boom, with its cheap credit for builder and prospective borrower alike, what had been farmland was transformed into suburbia. Some of those new subdivisions are homes, some will be ghost towns, and some, never actually having gone beyond land clearance, have been going back to nature.

Falling values, nationally and locally
Last year the U.S. Department of Agriculture reported a 3.2% decline in national farmland values, the first drop since 1987. The average was $2,100 per acre, as reported in Land Values and Cash Rents 2009 Summary. Regional changes varied widely, from no change in the Northeast to a fall of 11% in the Mountain states. These numbers reflect decreases in all land and buildings on farms. Similar declines were seen in 2009 for cropland and pasture land. The annual report, published in August 2009, was based on January 2009 numbers.

National numbers only bear out what some bankers see locally.

“We have had many outside influences in our markets that are not ag related, but so far our area has not lost its values as I thought it would, because of those outside influences,” said Gene Copenhaver, vice-president and ag credit regional supervisor for First Bank and Trust Co., Abingdon, Va. Among these factors are 1031 land exchanges—a tax-deferred land sales technique used for investment property.

“They’re gone now,” said Copenhaver of the investors, explaining the risk of a downturn, “but that was the source of the big inflation in prices in our ag markets. They’d sell them near urban markets, and the sellers would put the money into other ag properties.”

USDA research indicates that most 1031s involving farmland resulted in exchanges for other farmland, and non-farmer investors accounted for three times as many 1031s involving farmland-for-farmland exchanges as did farmers themselves. The same 2009 USDA research paper theorized that 1031s inflated farmland prices through an abundance of investors chasing limited farmland.

Copenhaver’s $1.1 billion-assets bank serves markets in Maryland, Tennessee, Virginia, and the Carolinas. The influence of factors such as the 1031 exchanges has been seen elsewhere, according to a roundtable discussion with selected members or alumni of the ABA Agricultural and Rural Bankers Committee.

Leo Nelson said land values in the Texas and Louisiana markets where he lends have been “relatively stable.”

“Now, the sales are becoming pretty few and far between,” said Nelson, senior ag specialist at Capital One Bank, based in Bastrop, La. “But the ones we have seen recently have surprised me, because they have been close to what might be perceived as the peak.”

The 1031 program and similar factors haven’t been a boon to the farmers Nelson works with.

“For the most part, the actual agricultural producers didn’t participate in those higher values,” said Nelson, “or, if they did, they did it with land that might not have been leveraged. But production agriculture is having a really, really hard time paying the price for land, even in today’s markets.”

“You can’t justify the prices of land for the potential income a farmer can make off it, not in our area,” agreed Kreg Denton, senior vice-president, First Community Bank of Western Kentucky, Clinton. He also cited “outside influences” as the reason.

There’s been more going on in farm country than just suburbanization and tax-deferred investing, of course. In some areas the demand for land for ethanol plants, for instance, has played a role in recent years. And alternative agricultural uses for land, such as feedlots, are yet another factor.

“Something I found when real estate began to exceed the ability of the land’s production to meet its cost was about the attitudes of the aging population of my farm communities,” observed Nelson. Many of his bank’s customers lived through the ag crisis of the 1980s.

“They became extremely careful when they started correlating things between what they had gone through then and what they were seeing in the late 1990s and early 2000s,” said Nelson. The banker said he started in the business in 1983 and remembered watching the same tracts of land turning over again and again. Nelson said there were plenty of lenders who would have helped the farmers jump into the land grab all over again.

“But those older farmers decided not to participate this time. They had been in the water before, and it was hot,” he continues. “As a result, they have kept their balance sheets in really good shape.”

Not all farmers necessarily have the same savvy, or, perhaps, scar tissue, which is often the same thing.

“It’s the younger generation, in their 40s, who don’t have the institutional memory,” said Dennis Everson. “They were able to buy when rates were disintegrating. They’re the ones I worry about.”

Everson is president of the agri-business division of First Dakota National Bank, Yankton, S.D. The $737 million-assets bank with a heavy concentration in ag, commercial, and commercial real estate lending. (Everson’s organization also includes Dakota Mac, which originates long-term farm real estate loans for the secondary market in 15 states.)

In the Pacific Northwest, lender Cori Price of $612.3 million-assets South Valley Bank & Trust, Klamath Falls, Ore., has seen something of a two-tier trend in land values. Overall, values increased over the last few years, with land suitable for row crops like alfalfa averaging $2,000 an acre. But the area also plays host to some specialty crops—one is the production of root-stocks for strawberries, the root stocks being shipped to California for actual berry production. Land that’s suitable for specialties averages more like $3,500 an acre.

“But I wonder how long can those prices hold when producers no longer have income that supports them?” asks Price.

Implications of the price drop
As indicated, 2009 marked the first national drop in years. Some of the bankers believe a price correction is going to be seen in more markets.

Everson noted that in his market, prices are stable, and some recent sales have reached new records. “But I think we’re in for a 20%-25% correction in land values,” said Everson, “and I’ll go on the record as saying that I think that wouldn’t be a bad thing.”

“It would be a good thing for agriculture, said Capitol One’s Nelson. “You would actually eliminate some people who weren’t really participating in the ag economy.”

Indeed, Cori Price suggested that falling values would benefit young beginning farmers, especially.

“There might be more opportunities for them to actually be able to buy their land,” she said, “and they can use their profits to pay for it. Right now, there has been no opportunity to do that.”

But there’s another side to the “youth opportunity” argument.

“You’ve got those young farmers who didn’t go through the bad times, and there’s a lot of lending institutions out there—and we all know who they are—that are volume driven,” said Kreg Denton. The Kentuckian said that he’s seen farms sell for $450,000-$500,000 in his markets, “and they’re just not worth that.”

“They’re not even worth half that,” Denton continues. “But those lenders are willing to make those loans. And that’s the scary part. We all know that farmers don’t always make the best decisions when it comes to buying stuff. They need some guidance. If you don’t have a person willing to say ‘no,’ well, easy credit isn’t always good credit.”

Perils of youth—on both sides
Ed O’Leary, retired banker and www.ababj.com “Talking Credit” blogger, sitting in on the roundtable, is a survivor of several banking crises. He asked his fellow participants whether the industry had really learned from that painful history. This led to a discussion of youth on both sides of the loan desk.

Everson, elder statesman of the working bankers in the group, tackled the question first. He spoke of his concern about young customers “who have never known anything but a low-interest-rate market.” And he urged people like himself to pass on more of what they’d learned to younger lenders, even about chores unpleasant in the short-term, but merciful in the long-run.

To elaborate: An ag lender has two jobs, Everson believes. First is to protect his bank’s own net worth. But second is to protect the net worth of the customer.

“I was one of those lenders, unfortunately, who put a lot of people on the highway in 1981-1985,” said Everson. “They wanted to bet the last piece of equity they had. And I was stupid enough to let them do it.”

He fears for a repetition of those days. He worries that the industry is already sliding towards real estate problems, where commercial real estate hasn’t already become one.

“I caution every ag lender out there, especially the younger officers, to make sure that they understand the service they can do some customers,” he said. “It’s a tough thing, but sometimes you have to look the customer in the eye and say, ‘Enough is enough’.”

Kreg Denton agreed. “Sometimes it’s better to let your customer walk away with something,” said Denton. His bank had had just such a discussion with a dairy borrower.

“Luckily, he had real estate, and with values as they were, he was able to walk away with money in his pocket,” said Denton. “Hopefully he lived happily ever after.”

The alternative?

“Watching that balance sheet three years in a row,” said Denton, “losing equity every year.”

Oregonian Cori Price was the youngest lender in the room.

“I’m one of the ones who don’t know how the 1980s were,” said Price. “I graduated from high school in 1988, and college in the 1990s. There are many people like me in banking now, people under 40 managing ag portfolios, and we owe it to our banks, our customers, and ourselves to really listen and rely on those who were around in the 1980s.”

With the benefit of hindsight, Everson said that he’s learned the value of being proactive, rather than reactive. He had told the group of a meeting he and fellow South Dakota bankers had with regulators. A senior agency district official gave the audience a warning: Don’t think being in the upper Midwest will protect you.

“She said something like this,” recalled Everson. “ ‘Go back to your banks, and reach out to your account officers, and tell them that they are in denial’.”

Blunt as that was, Everson saw some value to it. Over time, Everson concluded, “I’ve learned that being proactive limits a bank’s losses, helps customers work through their problems, and sometimes give customers a bit more time to make the big decision to stay in business, or leave while they have assets.”

Credit culture in ag country
Ed O’Leary has blogged extensively on www.ababj.com about credit culture. (His blog series “Credit Culture Reboot” remains available online.) He asked the bankers how their banks maintained a credit culture. He defined that as: “A set of shared expectations and values that create expectations of certain results.”

“Our credit culture starts with our CEO,” said Gene Copenhaver of Virginia. “He was there when the bank started 30 years ago, and he is the top credit guy at the bank. Everybody participates in Loan Committee who wants to, and they see that culture start with what he says there every week.”

Copenhaver says this works. “It’s consistent all the way down the line, and you had better be with the program whether you are a 25-year-old loan officer or a 60-year-old loan officer. If not, you’ll be left behind.”

Kentucky’s Kreg Denton told of a “perfect storm” his institution went through in 2001. The bank suffered losses. “We had gotten into some things where we didn’t know what we were doing, and then we had some poor crops in our markets,” said Denton.

The bank went on a major campaign to revamp credit policies, procedures, audits, and more. And recently all this was tweaked a bit more.

Pretty much the same team has been aboard all the way through, and the shared learning process is a big part of the culture.

“We know what we can do, and what we can’t do,” said Denton. “We stick to what we can do, and that’s helped.” BJ

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