Is it time to rethink your farm debt?

Over the past decade, the consensus among Canada’s ag economists has been clear. Yes, farmers have accumulated more debt than ever. But the debt load is manageable. There’s no looming crisis.

Now, however, with the prospect of a series of modest interest rate hikes, can we still be so complacent?

First, let’s look at the big picture. Statistics Canada data shows that total farm debt has increased from $79 billion in 2013 to $102 billion in 2017, and is mostly owed to financial institutions.

At the same time, farm cash receipts, which include market receipts from crop and livestock sales as well as program payments, rose for the seventh consecutive year in 2017, up 1.8 per cent to $61.6 billion. This was led by Manitoba (up 9.0 per cent) and Alberta (up 4.5 per cent).

Total net income (the return to owner’s equity, unpaid farm labour, management and risk) was essentially unchanged in 2017 at $9.8 billion. This follows a $1.8 billion increase in 2016. Total net income was up in six provinces, led by Manitoba.

At the same time, Statistics Canada reports that total farm operating expenses (after rebates) also rose every year over the same period, and sat at $46.2 billion in 2017. Machinery fuel expenses increased 11.5 per cent, and higher prices and larger interprovincial movements of cattle and calves pushed livestock and poultry purchases up 12.3 per cent. Interest expenses rose 7.1 per cent, primarily the result of higher debt levels. Balancing these increases somewhat was a 3.8 per cent decline in the price of fertilizer.

Ag sector’s financial health

As we look at the manageability of Canada’s farm sector debt, it’s important to examine debt-to-asset ratios. They are an important marker of financial health, and Craig Klemmer, senior agriculture economist at Farm Credit Canada, is quick to point out that the farm debt-to-asset ratio in Canada is lower than the current 15-year average.

“The current ratio remains strong and the net worth of Canadian farms has grown steadily over the past decade,” he observes. “The strong current ratio means that Canadian farmers have sufficient cash or current ratios to meet short-term liabilities and be able to take advantage of market opportunities.”

In terms of total net worth of Canadian farms, Klemmer says it has increased over the last 10 years at an average of $2 billion per year. He notes that Canadian farms have used debt mostly to achieve this higher net worth — by making strategic investments in improving productivity and fueling growth in their businesses.

As to whether the proportion of farmers with high and/or risky debt is worrying, Klemmer first cautions that there are many aspects to financial stability. For example, the life stage of the farm matters a great deal.

To illustrate, Klemmer says to consider a new farmer or a farm that’s expanding because multiple children want to be involved in the operation. Farms in this situation are likely going to have significantly more debt than an operation that is mature. “The level of debt of the operation is less important than the ability of the farm to service the debt that it is carrying,” Klemmer says. “To this point, Canadian agriculture is well positioned to meet cash-flow obligations and the debt levels remain supportive of total assets.”

Klemmer adds that “specific to FCC, we have a healthy loan portfolio of more than $33 billion and have seen 25 consecutive years of portfolio growth. If we look at FCC’s portfolio as an indicator, we are showing a healthy loan portfolio with a stable allowance for credit loss, reflecting a strong and vibrant industry. For example, our impaired loans (amounts 90 days or more past due) improved from 0.6 per cent in 2017 to 0.4 per cent of loans receivable in 2018, a $46 million decrease.”

An assessment from Agriculture and Agri-Food Canada (AAFC) supports Klemmer. Most farms continue to be in a very good financial position with assets increasing more than debt, notes AAFC senior media relations officer Patrick Girard. “Strong sales, low interest rates and high asset values have allowed farmers to use farm debt for strategic investments in equipment and farm expansions.”

AAFC points to 2016, where total farm debt of the Canadian agricultural sector had increased by $43 billion since 2006, but that during the same period, farm assets and farm equity also increased by $311 billion and $268 billion, respectively. “The value of total farm assets continued to rise, mainly as a result of continued gains in the value of farmland, which represents two-thirds of total farm assets,” Girard notes. “The agricultural sector is well positioned to manage its debt commitments, as the vast majority of farms have the equity and cash flow to support their debt levels.”

AAFC reports that the majority of Canadian farms (62 per cent) had low debt-to-asset ratios in 2015, and only 13 per cent of them could be classified as having high debt-to-asset ratios or risky solvency in 2015. It was 15 per cent in 2005.

Larger farms usually have higher debt-to-asset ratios, notes Girard, as they are often actively adopting new technologies and expanding operations. Potato, dairy and hog farms had the highest average debt-to-asset ratio in 2015 and grains and oilseed and beef cattle farms had lower debt-to-asset ratios due to a greater proportion of smaller farms.

Tom Eisenhauer notes that Canadian farm debt-to-asset ratios have improved significantly in the past 20 years despite falling interest rates, which typically encourage increased borrowing. “Moreover, more than a third of Canadian debt is in the supply-managed dairy and poultry sectors and another 20 per cent is in the livestock sector,” says the president and CEO at Bonnefield, a business that creates long-term financial partnerships with Canadian farmers to help them grow, reduce debt and finance retirement and succession.

“Because the livestock sector is concentrated in the West and the supply-managed sector is concentrated in Quebec, these two areas might be at a slightly higher risk,” Eisenhauer says. “But overall risk levels remain low even in the livestock and supply-managed sectors.”

Where you fit

According to Klemmer, there are two ways to discover if you have manageable debt or risky debt — and to judge your farm’s overall financial fitness.

One is to check your debt service ratio. “That’s the cash available to cover expenses like interest, principal and lease payments,” he explains. “The debt service ratio is calculated by dividing your net operating income by your annual debt service payments.”

“For example, if you have a net operating income of $78,000 and your average annual debt service payment is $50,000, you have a debt service ratio of 1.56 — not bad,” he explains. “If your farm’s ratio falls below 1.25, debt repayment becomes a bit more challenging.”

Klemmer says a ratio of less than one means you’re not generating enough income to cover your debt payments and you’ll need to make changes to improve your financial footing.

A second step that Klemmer recommends is to go over your situation with a financial manager. “It is important to consider where you are in the lifecycle of the operation,” he reminds us. “(Account for) future plans both personally and for the farm, and the cash flow.”

Looking ahead

In terms of the outlook for farm debt over the next five, 10 or 20 years, Klemmer says it’s difficult to predict. “The need for debt largely depends on a variety of economic conditions and individual business situations,” he notes. “Instead, we encourage Canadian farmers to focus on improving productivity and efficiency, while carefully managing their debt.”

Eisenhauer adds “there’s no reason to expect that farmers will suddenly abandon the borrowing discipline they displayed in the past 20 years, especially if interest rates creep back up as widely expected.”

Klemmer does not believe that increasing productivity levels on the farm will necessarily mean Canadian farmers need to expand their operations and thereby increase debt. “While this is one option, it is also about maximizing the assets of the farm and having a solid marketing plan,” he says. “It’s also about efficiency and the need to find ways of reducing costs, whether that means increasing the yield per acre or getting more butterfat from a litre of milk.”

Strategic investments in innovation and technology, he notes, will go a long way in ensuring Canadian agriculture remains productive, competitive and sustainable.

“That is good debt,” Klemmer concludes. “At the same time, producers need to be cautious and pay attention to changes — such as an increase in interest rates or a decline in commodity prices — that could throw off their business plans. That’s why FCC emphasizes sound risk management practices to ensure customers are in a strong working capital position to weather any abrupt changes in economic conditions.”