George Brinkman fears excessive debt. It’s a fear that has gripped him — some might say, obsessed him — for years.
Today is no different. Brinkman sees interest rates as a neutron-bomb, threatening to wipe out our over-leveraged farmers.
“This could be the greatest crisis Canadian agriculture has seen in recent times,” Brinkman tells me.
It’s a drum that Brinkman beats louder than any other ag economist in the country. They talk about economies of scale, about risk management, about diversification and farm structure. Brinkman gets into his pulpit and talks about farm debt.
Read Also
Riding the tariff rollercoaster
Farmers are accustomed to roller-coaster years. But the current geopolitical windstorm is something else entirely. On his cattle operation near…
But it’s quite a pulpit. Brinkman is, after all, professor emeritus of the University of Guelph. He’s past president of the ag economists association, he’s rated one of Canada’s top brains on the question of farm viability, and he’s often sought out by governments and farm groups for advice.
Here’s his case.
Record low interest rates have lulled us into a false security, says Brinkman. They’ve been an incentive to further leverage ourselves.
As the global, non-farm economy starts improving in next few years, interest rates are likely to increase. Farms then will be forced to absorb those escalating interest costs, says Brinkman. “Farmers should be prepared to pay up to six or even nine per cent interest.”
Flashback
If history repeats itself, and if Brinkman is right, we’re in trouble. Talk to any farmer over 50 years old about interest rates and you will hear their voices crack as the topic turns to the 1980s. They all knew a farmer down the road pushed out by 20-plus per cent interest rates.
Brinkman was teaching ag economics in the 80s and remembers it all too well. “In the 80s if you had less than 50 per cent equity, you couldn’t afford the interest rates,” he says.
After that, net farm income was slow to improve. In fact, it didn’t improve substantially until the new millennium. Yet the Canadian farm debt position has ballooned, especially compared to our major trading partners to the south.
In 1981, U.S. farm debt stood at US$177 billion. According to recent stats, now it’s $211 billion, a 20 per cent increase from the 1980s.
Yet Canadian farm debt has tripled. “We’re leveraged many times more than the U.S., and we are that much more sensitive to rising interest rates,” warns Brinkman. “A three per cent increase in rates could trigger some significant difficulties.”
Canada’s farms are three times more leveraged than in the 1980s, so Brinkman says if interest rates increase only a third as much, we’ll be in similar trouble.
Although our assets have also increased over this time, Brinkman is mainly concerned about cash flow and our capacity to carry that ever-growing debt. Our debt-to-income in the 1980s was about seven to one. In 2007 it was 40 to one.
“Our debt-to-income is four to six times higher than farmers in the U.S.,” says Brinkman.
Brinkman says it shows we’re not making much more money on our farms, we’re just servicing more debt. “Aggregate farm income since the mid-90s has been flat, and since the 80s there’s been only a modest percentage increase,” says Brinkman. We’re just eating up our income with interest payments.
Brinkman says the economic reality is that our debt positions should be based on cash-flow capacity, not on inflated assets. Based on that criterion, Canadian farmers are failing, especially compared to our major export market.
Land price bubble
The major assets farm businesses are accumulating are land and quota. Brinkman says land prices should be a good indicator of earning potential of that land. “We’re paying way too much for land relative to its earning capacity.”
Surging land prices have been fuelled by more than low interest rates. They’ve also been bid up on higher grain prices. Emotions are playing a role too. As well, Canadian land prices may seem a bargain compared to Europe, and we’ve seen unprecedented competition for land.
Now that grain prices are lower, we are once again vulnerable to increasing interest rates, says Brinkman.
Brinkman says farmers have been conditioned to think land is a good investment. Because we believe land will continue to increase in value, we need to buy the quarter section or 100 acres before the price goes up further.
But Brinkman warns that land prices can and will fall, especially if interest rates increase.
“Don’t forget there was a correction in land values across Canada in the 80s when interest rates shot up. In Saskatchewan, it lasted for a couple of decades,” Brinkman says. “If it doesn’t pay, then the market can be very brutal correcting.”
“At some point in time that bubble will burst and when it bursts it’s like a snowball rolling down a hill that keeps getting momentum,” says Brinkman. “It’ll just keep getting lower and lower.”
Assets to income
Our asset values are too high relative to their earning capacity, says Brinkman. Farms in the U.S. from 2004 to 2007 had equity to income ratio of 26 to one. Across the border in Ontario it was 293 to one. “We’ve got nearly 12 times more money invested per dollar earned,” says Brinkman. “We’re paying 12 times too much for our assets compared to the U.S., per dollar earned.”
Take stock
When Brinkman compares the financial performance of Canadian farms to shares in publicly traded companies, he becomes a grim forecaster. “If you look at the stock market, the sustainable level of price-to-earnings ratios is about 16 to one,” he says. “In early 2000, when we had the tech bubble and earnings ratio of 200 to one… until it crashed.”
Brinkman says the price-to-earnings ratio on land in Ontario over the last four years is over 1,000 to one, auguring a huge potential for readjustment. “We’re
very vulnerable,” says Brinkman. “We’re simply paying too much for land.”
Brinkman isn’t utterly without hope. “We may be able to walk on the edge of the table without falling off, but if we do fall off, it’s a long ways down,” Brinkman says.
In fact, if it hadn’t been for the runup in crop prices in 2007, that was the year when Brinkman was expecting the “correction” in Canadian agriculture would have started.
Expand later
Larger farms have higher earning capacity and most have lower margins. Even so, large farms that are very leveraged are at risk, no matter how efficient they are, says Brinkman.
Debt and equity have increased for all farms, but the faster rise of debt on large farms leaves them more exposed than smaller farms.
Large farms have sizeable levels of debt and high debt-to-equity ratios, but they also had more efficient sales-to-asset ratios and a higher return on equity. In 2005, the average margin for mid-size farms (gross revenues from $250,000 to $499,999) was 6.5 per cent, down 10 per cent from 1999. In contrast, the average margin for large farms ($1.0 million to $2.5 million) was 12.1 per cent, compared with 14.0 per cent in 1999.
Brinkman says the balance between size and debt is a moot point if you buy assets at above a value that can’t cover interest payments. With incredibly tight (and sometimes negative) margins in agriculture, it doesn’t take much change to tip a heavily-leverage farm into insolvency — even a big farm.
Brinkman’s bottom line: Don’t expand just to get bigger, and don’t buy a farm because it comes up for sale. It has to pay for itself at higher interest rates.
Risk crunch
Canadian farmers should calculate their current debt-to-income ratio, and then re-calculate it with interest rates that move three to four points higher over the next five years, says Brinkman. That’s your red flag. If it doesn’t fly at the higher rates, the time to start making adjustments is now.
You may also want to consider restructuring your loan. Open, variable-rate loans have worked great for the last decade, but setting a strategy on how and when to book longer-term loans will take the guess-and-miss out of it later.
When you’re looking at your loan structure, consider the risk of higher interest rates. Brinkman isn’t a fan of interest-only or no-money-down loans. “It’s just encouraging farmers to over extend themselves,” he says.
“Bank competition in the market can be good,” says Brinkman. “But we need discipline.”
Making purchases on interest-only payment loans, with no capacity to pay for inflated assets, parallels the factors that led to the U.S. housing market crash, says Brinkman. “Cross your fingers and toes.”
“The financial institutions that are continuing to lend are contributing to the further capitalization of land and quota,” says Brinkman.
If you want long-term viability, he says, you must pay off assets and generate more income. If not, you’ve created a potential nightmare. “These are the farmers that’ll be needing assistance to stay on the farm and asking government to respond,” says Brinkman.
Time the market
Brinkman predicts land purchases will continue in the short term, despite inflated prices. We’re not likely to stop buying until higher interest rates slam the breaks on. According to Brinkman, once this happens, land prices will drop closer to productive value.
“When I look into my crystal ball, I see this dilemma, and it’s really a question of market timing,” says Brinkman. If you agree with him and are concerned that interest rates are going to go up from their record low, then you need to position yourself for a market correction for land values.
In that scenerio, you don’t want to own too many assets, indebted or not. Rent doesn’t change significantly with interest rates and then you’re not vulnerable to land prices weakening.
If you think it’ll be two or three years, you should be preparing yourself now. Know what your sell points are, Brinkman says, and consider renegotiating your loans and locking in low interest rates. CG
