Ag Quarterly NewsletterWinter 2018

Agricultural Finance

Agricultural EconomyThe agricultural economy improved modestly in 2017. In November, the USDA released its updated estimate for net farm income. If realized, net farm income in 2017 will be $63.2 billion, marking the first year-over-year increase since 2013. The upward revision to the USDA’s estimate was primarily driven by stronger than expected fundamentals in the livestock sector. However, annual crop farmers continue to struggle with low agricultural commodity prices due to oversupply.

We expect 2018 to be similar to 2017 as the U.S. farm sector enters a modest recovery following a four year slump. However, the potential for a U.S. withdrawal from the North American Free Trade Agreement (NAFTA) represents a downside risk to the outlook, as the farm sector relies heavily on trade. Reduced access to key agricultural markets in Canada and Mexico could cause inventories of U.S. farm products to continue rising, further prolonging the downturn.

2 | Ag Quarterly

Land values showed signs of stabilization in 2017 despite continued low commodity prices and rising interest rates. USDA data show that, adjusted for inflation,1 national cropland values in 2017 were below recent peaks, with the largest declines occurring in Kansas, Nebraska, South Dakota, Iowa, and North Dakota, respectively (see Figure 1). We expect farmland values to continue declining into 2018, but as Figures 2-3 indicate, multiple surveys and agricultural land value indices point to a slowdown in the pace of the declines.

Changes in the yield curve may provide some insight into the stabilization observed in the farmland market in 2017. Although the Federal Reserve raised the federal funds rate two times in 2017, longer-term interest rates did not follow suit. As Figure 4 shows, the rise in short-term interest rates was not accompanied by a rise in longer-term interest rates and as a result, the yield curve “flattened”.

Farmland Indicators

Figure 1 | In�ation-Adjusted Declines from Recent Peaks in Cropland Values by State

Figure 2 | Creighton Farmland Price Index

-0.2 -0.15 -0.1 -0.05 0ArizonaVirginia

OhioMinnesota

MichiganWyoming

West VirginiaIllinois

IndianaNorth Carolina

North DakotaIowa

South DakotaNebraska

Kansas

-4%-4%

-4%-5%

Source: USDA, MIM

-5%-6%

-6%-8%

-8%-9%

-10%-11%

-14%-15%

-16%

0102030405060708090

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2006

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2014

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2014

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2015

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Source: Rural Mainstreet Index, MIM

The Creighton Farmland Price Index tracks farmland value momentum relative to a base value of 50 (growth neutral).

Figure 3 | Kansas City Federal Reserve Figure 4 | Treasury Yield Curve

4-Quarter Rolling Year-Over-Year Change

-10%-5%0%5%

10%15%

20%25%30%35%

Q1-

2007

Q3-

2007

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2008

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2008

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2009

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2009

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2010

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2010

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2011

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2012

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2012

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2013

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2014

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2014

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2015

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2016

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2017

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2017

Source: K.C. Federal Reserve AgFinance Databook, MIM

Irrigated Farmland Ranchland

Source: Haver Analytics, MIM

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

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1-M

onth

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onth

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onth

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ear

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ear

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ear

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ear

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ear

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ear

2012-Average 2014-Average

2017-January 2017-December

3

Since yields on government notes and bonds are a proxy for the cost of capital in the economy, the flattening of the yield curve suggests that the cost of increasing the term of an obligation has declined. This has benefitted the farm sector, as the cost (the increase in interest rates associated with a longer loan term) for farmers to extend the maturity of their liabilities to reduce debt payments and, in some cases, supplement working capital, is low from a historical standpoint.

For illustration purposes, Table 1 shows a hypothetical purchase of a 160 acre farm in 2012 for $10,000 per acre. Assuming the purchasers used 60% debt financing, a 15 year loan term, and a 4.44% interest rate,2 the monthly payment would be $7,312. The principal outstanding on this loan in 2017 would be approximately $708,000, representing 49% of the total farmland value if farmland values are 10% below 2012 levels.

As the columns shaded in green show, this hypothetical farmer could refinance the loan and increase the principal amount back to 60% of the property value, increasing working capital by over $156,000 and lowering the monthly payment between 10% and 32% depending on the loan maturity selected. While this example is admittedly oversimplified, it highlights how the flattening yield curve has provided farmers with options to offset the negative impact of low commodity prices, and has likely helped keep farmland off the market.

Table 1

Original Loan Refinanced Loan

2012 2017 2017 2017 2017

Years Remaining 15 10 15 20 30

Acres 160 160 160 160 160

Land Value/Acre $10,000 $9,000 $9,000 $9,000 $9,000

Farmland Value $1,600,000 $1,440,000 $1,440,000 $1,440,000 $1,440,000

Loan Amount $960,000 $707,685 $864,000 $864,000 $864,000

LTV 60% 49% 60% 60% 60%

Interest Rate 4.44% 4.44% 4.50% 4.60% 4.77%

Monthly Payment $7,312 $7,312 $6,610 $5,513 $4,517

Working Capital Supplement

$156,315 $156,315 $156,315

Annualized Savings from Reduced Payment

$8,434 $21,595 $33,539

4 | Ag Quarterly

Annual CropsFollowing four years of rising inventories and declining prices, U.S. annual crops continue to be in a state of oversupply, with a reduction in acreage and/or crop yields remaining elusive. The USDA currently expects the U.S. corn and soybean stocks-to-use ratio, which measures ending inventories as a percentage of expected use, to increase to 17% and 11%,3 respectively, in the 2017/2018 marketing year. Although not unprecedented, stockpiles of these magnitudes dampen hopes for a significant price recovery absent a notable weather event.

As is generally the case early in the year, market participants are beginning to shift their focus to U.S. farmer planting intentions for the 2018/19 marketing year. In late November 2017, the USDA released its long-term agricultural baseline projections which offered an early glimpse into expectations for next year. Despite the aforementioned large inventories, the USDA projects greater profitability for corn and soybeans compared to wheat and cotton, resulting in a corresponding shift in acres (see Figure 5).

Interestingly, over the long-term, the USDA projects farmers will favor soybeans over corn. For the first time since 1983, soybean acres are expected to match corn acres in 2018 and then surpass them thereafter. This projection—the dethroning of “King Corn”—reflects a stronger demand outlook for soybeans compared to corn, despite the large current inventories of both. The USDA projects the soybean-to-corn price ratio, which represents a relative measure of profitability between the two crops, will average 2.80 over the next decade. This is well above the five-year average (2.61) and the long-term average (2.48) and reflects the growing global appetite for soybeans.4 In 2017 alone, global consumption of soybeans increased 5%, led by an 8% increase in China.5

Permanent CropsIn 2017, new orange varieties and the recent tax bill have provided hopes of some relief to Florida citrus farmers who have been impacted by natural disasters and citrus greening. Meanwhile, tree nuts continued to benefit from strong global demand.

Florida orange production declined for the 10th consecutive season in 2017 due to a combination of Hurricane Irma’s landfall in September and disease pressure. However, a provision in the recently passed tax bill may provide relief in 2018 and beyond. The Emergency Citrus Disease Response Act of 2017 incentivizes the replacement of damaged or destroyed trees due to casualty by allowing the full expensing of replanting costs for farmers who have an equity interest of no less than 50% in the replanted citrus. Previously, farmers had to bear the full cost of replacement to qualify for the expensing benefit. The Act also gives the purchasers of land with infected trees this same benefit.6 This resolution provides relief to a sector still

1.20

-1.00

0.30

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0.80

1.00

-1.50 -1.00 -0.50 0.00 0.50 1.00 1.50

Upland Cotton

Wheat

Oats

Rice

Barley

Corn

Soybeans

Sorghum

Source: USDA Long-term Agricultural Projections

Figure 5 | USDA Projected Acreage Shift in 2018 (millions)

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struggling with the effects of Citrus Greening—a bacterial disease behind the 81% decline in Florida orange production between 2003 and 2017.7 Recently developed orange varieties that have shown tolerance to Citrus Greening will further incentivize producers to replant orchards.8 While researchers believe a disease-resistant tree will be developed in the near future, the Emergency Citrus Disease Relief Act will help Florida farmers adopt tolerant varieties.

Initial reports show large harvests of most tree nut varieties in 2017, including the projected second largest walnut and pistachio harvests on record at 1,300 and 575 million pounds, respectively.9 Additionally, 2017’s almond harvest is forecast to hit a record 2.25 billion pounds, an increase of 5% compared to last year’s record crop.10 Despite these large harvests, strong export demand from the Eurozone and Asia has provided support for tree nut prices. Export prices for pistachios, pecans, and walnuts were 8%, 10%, and 27% higher in 2017 than 2016, respectively.11 Although large inventories will likely limit further tree nut price appreciation in the near-term, we expect a strong global economy to help drive exports and prevent further growth in inventory levels.

Livestock Low feed costs and favorable red meat and poultry prices supported profit margins for livestock producers in 2017, and incentivized expansion in the sector. Supplies of red meat and poultry increased 2.5% compared to 2016, with the domestic market and exports absorbing 67% and 28% of the increase, respectively, and the balance of the increase (5%) going to cold storage.12

Red meat and poultry export volumes increased 5% in 2017, driven mainly by demand from Asia.13 Compared to 2016, beef exports to China and Japan increased 20% through Q3 2017,14 aided by a drought that reduced Australia’s beef herd to its smallest size in twenty years.15 Additionally, U.S. pork producers continue to benefit from the Korea-U.S. Free Trade Agreement (KORUS) as pork exports to South Korea grew 27% year-over-year through Q3 2017.16

Prices received by farmers for most livestock products have risen in 2017 despite increases in production, suggesting a favorable shift in demand. On a year-over-year basis, the USDA’s aggregate Livestock Prices Received by Farmers Index rose 7% in Q3 2017 (see Figure 6). Indices for the pork and poultry/egg sectors experienced the biggest year-over-year increases at 11% and 16%, respectively. A major tailwind for the livestock sector in 2017 was the low cost of feed, which was driven by the aforementioned large annual crop inventories.

In 2018, we expect exports to grow an additional 5% as low feed costs encourage expansion in the livestock sector.17 However, uncertainty surrounding trade policy represents a downside risk to this outlook as the U.S. is currently renegotiating NAFTA. A proposed complete withdrawal from NAFTA could reduce exports and lead to lower livestock prices, potentially halting the expansion.

-50%-40%-30%-20%-10%

0%10%20%30%

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2013

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Source: USDA and Haver Analytics

Livestock & Products Feed Grains

Figure 6 | Prices Received by Farmers (Year-Over-Year Change)

6 | Ag Quarterly

Agribusiness The agribusiness sector, which includes a large and diverse group of businesses focused on the processing and marketing of raw agricultural commodities, has benefitted from a period of low input costs. However, recent increases in farm-level commodity prices could cause profits for the sector to normalize in 2018.

The Census Bureau’s Quarterly Financial Reports provide information on the financial results of U.S. food manufacturers, serving as a proxy for overarching conditions in the agribusiness sector. Food manufacturers have enjoyed above average profit margins18 since Q1 2015. High profitability levels over this period have occurred despite declining food prices, as farm-level prices (input costs) have declined at a faster rate than the prices food manufacturers receive for their finished goods.

Figure 7, which displays food manufacturer profit margins and the Producer Price Indices for processed foods and farm products, illustrates this relationship. The faster growth in farm prices from Q3 2010 to Q4 2014 weighed on profit margins, while the subsequent decline in farm prices in 2015 and 2016 contributed to profit margin growth. This dynamic shifted again in 2017 as farm prices began rising due to higher livestock prices. If the trend of higher farm prices continues, food manufacturer profits could begin to normalize in 2018.

TimberU.S. timber markets continue to be characterized by regional differences. Tight supplies in the Pacific Northwest (PNW) are driving log prices higher, while large log supplies in the U.S. South are limiting the potential for substantial price increases in the near-term. In Q4 2017, log prices in the PNW increased 20% compared to Q4 2016,19 while log prices in the U.S. South declined 2.5%.20

Timber demand drivers remained strong in Q4 2017. Housing starts reached an annualized level of 1.3 million starts in November, representing a year-over-year increase of 13%, and in line with our long-term forecast published in 2016.21 Softwood log exports by volume were unchanged YTD through November relative to the same period in 2016, but log export prices rose 13% due to strong demand from China and South Korea.22

In the U.S. South, stable log and lumber demand drivers and historically low log costs are driving significant investment in wood processing capacity. Forest Economic Advisors

Source: Haver Analytics

Figure 7 | Food Manufacturer Profits and Food Price Indicies

Food Manufacturer Pro�t Margins (LHS) PPI–Processed Foods (RHS) PPI–Farm Products (RHS)

80

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4.5%

5.0%

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100= 2010 Q1

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estimates processing capacity in the region will increase by 1.4 billion board feet through 2020, representing an 8% increase from 2016 levels and a 20% increase from 2009.23 Increased processing capacity will lead to increased log consumption in the region, and bring supply and demand conditions into balance.

Endnotes1 Excluding the Northeast, values in constant 2016 dollars. 2 Interest rates are MIM internal estimates derived from Kansas City Federal Reserve Agricultural Finance Databook

and anecdotal evidence. 3 USDA World Agricultural Supply and Demand Estimates Reports, January 2018.4 USDA NASS Quick Stats, January 11, 2017.5 USDA Foreign Agricultural Service Global Agricultural Trade System, January 12, 2018.6 Emergency Citrus Disease Response Act of 2016, 26 USC § 263A (2017),

www.congress.gov/115/bills/s71/BILLS-115s71is.pdf.7 USDA NASS Quick Stats, January 11, 2017.8 Promising new citrus varieties for greening tolerance, University of Florida, December 18, 2017.9 USDA NASS, September 2017 Forecast.10 USDA Fruit and Tree Nut Outlook, September 2017.11 FAS Global Agricultural Trade System, January 2018.12 Livestock Marketing Information Center, January 2018.13 USDA Foreign Agricultural Service Global Agricultural Trade System, January 12, 2018.14 USDA Foreign Agricultural Service Global Agricultural Trade System, January 12, 2018.15 2017 Beef Exports, Beef Central, January 3, 2018.16 USDA Foreign Agricultural Service Global Agricultural Trade System, January 12, 2018.17 Livestock Marketing Information Center, January 2018.18 Before-tax operating profits as a percentage of sales.19 RISI Log Lines, November 2017.20 TimberMart South Quarterly Market Bulletin Q4 2017.21 Millennials, Housing, and the Timber Demand Recovery, MetLife, 2016. 22 FAS Global Agricultural Trade System, January 2018.23 FEA Quarterly Forecast Service – Lumber, November 2017.

L0218502817[exp1219][All States] © 2018 METLIFE, INC.

www.metlife.com/ag

All information contained herein has been obtained by MetLife from sources believed by it to be reliable. The analysis, opinions, forecasts and predictions contained herein are believed by MetLife to be as accurate as the data and methodologies will permit. However, MetLife makes no representations or warranties, either expressed or implied, to any persons as to the completeness, accuracy and reliability of such information, forecast and/or predictions and expressly disclaims any liability with respect to any of the foregoing.

MetLife’s Agricultural Finance Group ranks among the most active private agricultural, agribusiness and timberland mortgage lenders in North America, with a total agricultural mortgage portfolio of almost $15 billion.* We specialize in providing intermediate and long-term fixed and adjustable rate mortgage financing.

Our regional network keeps us close to our markets and better positioned to serve your long-term mortgage financing needs on a variety of property types, including dry land and irrigated farms, permanent plantings, ranchland, food and agribusinesses, timberland and forest product companies.

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Agricultural Market Research

Eric RamaHead of Agricultural Research

Blaine NelsonAssociate, Agricultural Research

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