Agricultural & Applied Economics Association

Solutions (Or Resolutions) of Financial Stress Problems from the Private and Public Sectors Author(s): John R. Brake and Michael D. Boehlje Source: American Journal of Agricultural Economics, Vol. 67, No. 5, Proceedings Issue (Dec., 1985), pp. 1123-1128 Published by: Oxford University Press on behalf of the Agricultural & Applied Economics Association Stable URL: http://www.jstor.org/stable/1241384 . Accessed: 09/08/2013 05:46
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Solutions
Problems Sectors

(or
from

Resolutions)of
the

Financial
and

Stress

Private

Public

John R. Brake and Michael D. Boehlje

The current financial stress problem stated succinctly is that farmersand farmlenders are experiencingfinanciallosses, and indeed business failures, in near-crisisproportions.Various data describe the problems including debt-asset ratios of farmers, delinquencies of farm debt, net charge-offsof debt by lenders, loss of capitaland failuresof farmlenders (USDA, Melichar 1985, Bullock, and Barkema and Doye). Unfortunately,no quick turnaroundis in sight unless public policy or acts of nature change the situation. The private sector will bear the brunt of the continuing adjustment,at least until the cost becomes so great that the public is asked to share the burden. While not delineated here, the root causes of financial stress are many (Bullock, Brake, USDA, Melichar1984).The commonelement in farmfinancialproblems, however, is unserviceable debt; and, in lender problems, increased default risk and excessive concentration of the portfolioin agriculture and agriculturally related businesses. The new environmentfacing agriculturerequires significantadjustmentsfor the sector, individualfirms, and public policy. Potential adjustmentsare discussed in following paragraphs. lower-valueddollarand increaseddemandand prices in the export markets, lower inventory carryingchargesfor holdersand purchasersof commodities and thus marginally agricultural higherprices, and lower interestcosts for supreducedprices of ply firmsandthus marginally purchasedinputs. Interestrates, real andnominal, are very high by historical standards. Most analysts agree that reductionin the governmentdeficit would result in lower real and nominalinterest rates and a somewhat lowervalued dollar. The importanceof lower interest rates for agricultureis difficult to overstate; a one percentdecline in interestrates on the over $200 billion of U.S. agricultural debt would result in an approximate$2 billion increase in net farmincome. Tweeten estimates the lower interest rates resulting from a balanced budget would reduce the value of the dollarin foreign marketsby 20%,leadingto a 10%increase in exports within two years and as much as a 20%improvementin the longer
run.

(b) Mothball excess capacity. The U.S. ag-

riculturalsector currentlyhas approximately five to ten percent excess productioncapacity (Tweeten). Thiscontributes significantly to the currentlow rate of returnon farm assets. Yet, the productive capabilityof some of the asset base is deteriorating because agricultural Sector Adjustments of excessive soil erosion. Conversionof 20 to Five major long-runadjustmentsappear nec- 30 million acres of steep, erosive and low essary to obtain a more financiallystable ag- yielding grain land to grass or nonuse is one way to eliminate excess production and rericulturalsector. These include: duce soil erosion.
(a) Lower interest rates. Lower interest

rates would benefit agriculturein four ways: (c) Lower resource values. In a period of lower direct costs of borrowing money, a excess capacity, a normaleconomic response is lower resource earnings and lower asset John R. Brake is W. I. Myers Professor at Cornell University, and Michael D. Boehlje is a professor and head of the Department of values. Land values in parts of the United Agriculture and Applied Economics, University of Minnesota. States are 35%-40% below the peak of the
Copyright 1985 American Agricultural Economics Association

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1124 December 1985

Amer. J. Agr. Econ.

early 1980s. Given current prospects for prices, interest rates, and expected input costs, farm asset values may fall further. The financial stress of farmers further compounds the problem because a major strategy for alleviating financial stress is asset liquidation. Such liquidations increase the supply of land on the market and further contribute to land price declines. (d) Reduce debt. The total debt load of agriculture is not evenly distributed. About onethird of the farmers owe approximately twothirds of the debt. For many of these farmers, earning capacity of assets is not sufficient to cover debt service costs with current interest rates and profit margins. This "excessive" debt must either be redistributed or eliminated. Redistribution may occur through debtfinanced purchases of assets from those having cash flow problems by financially sound farmers or other investors. A reduction of the industry debt load will occur by repayment of debt with earnings from either on-, or off-farm sources, by substitution of equity from outside the agricultural sector for farm debt, or by discharge of debt by agricultural lenders. Probably a significant amount of agricultural debt will be discharged or written off over the next three to five years by the public and private lending institutions that service agriculture. This discharge of indebtedness will represent significant costs to lenders in the short run, but it will reduce the sector debt load and improve agriculture's financial condition in the long run. (e) Restructureasset ownership. Some farmers with very high debt loads cannot afford to own all of their assets, and these assets must find new owners. This asset restructuring in many cases will accompany the redistribution and restructuring of debt. Lenders will inventory some assets in lieu of the note or mortgage, but these assets eventually will be placed on the market. Accompanying this restructuring of the ownership pattern of assets will be a set of important issues concerning the tenure arrangements in agriculture including the institutional structure and property rights of tenants versus landlords, the advantages and disadvantages of the separation of ownership and operation of real estate, and the volatile issue of outside equity in agriculture.

Firm-Level Adjustments Although the theoretical basis for the sequence of adjustments that financially stressed firms undertake is not well developed, the process does appear to be relatively well structured irrespective of type of industry. Farm firms are facing severe financial stress similar to that encountered by firms in other industries. Learning from their experience and understanding this generic sequence of adjustments to financial stress problems suggest the choices that farm and agribusiness firms face: (a) Increase net income. The first focus of any firm in financial stress is to increase income through expanding sales, increasing productivity, or reducing costs. Much of the focus in agriculture in recent years has been on cost containment as a response to financial stress. While opportunities to increase income from the farm have been limited, some farmers have utilized nonfarm income (from labor or capital) to augment farm earnings as well as to diversify income sources and reduce financial risk. (b) Restructure liabilities. Many farmers are unable to increase income and cash flow sufficiently to alleviate financial stress, so the second adjustment is to restructure liabilities to reduce debt service requirements. Liability restructuring takes many forms including deferment of principal and interest payments, reamortization of principal over longer repayment periods, and even discharging or writing off part of the debt obligation by the lender. (c) Restructure assets. For many farm businesses, restructuring liabilities will be inadequate to alleviate financial stress. Many farm operators own fixed assets that they can no longer afford, given current high interest rates and low rates of return. Without reasonable expectations that cash flow margins will improve sufficiently to cover ownership costs, the property must be transferred to a new owner. Restructuring assets, if done properly, can reduce the proportion of low yielding, low liquidity assets of the firm. Proceeds can be applied to debt obligations or reinvestment in higher-yielding, higher liquidity assets. Restructuring assets may involve a sale-leaseback arrangement where the ownership rights are transferred but the use rights are retained.

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Brake and Boehlje

Financial Stress among Farm Firms 1125

Sale-leaseback relieves the financial burdens of ownership but retains the use of the property so that the productivityof the firm is not impaired.Sale-leasebackalso helps to restructure asset ownership without depressing values through excessive liquidations. ically follows rather than precedes the asset restructuringoption because, in most cases, this step will result in some loss of control by the entrepreneur(Boehlje). In one sense, the sale-leaseback of assets is a form of equity infusion; the operator rents the equity of the landlordrather than investing directly in the firm. An equity infusion might come from a family member or an unrelated investor. In some cases, the equity investment occurs through a conversion of debt to equity by this borrower-lender agreement.In agriculture conversion frequently involves contract indebtedness; many installment land contracts are currentlybeingrenegotiatedwith the seller (equity holder) taking back title to the property or restructuringthe contract into a risk and return sharingarrangement with the purchaser. The result exhibits many of the characteristicsof an equity position.
(e) Merger/acquisition. The final alterna-

closure moratoria,and inventoryingassets or facilitating changes in asset ownership patterns.

Debt Restructuring

This refers to rescheduling of loan commit(d) Equity infusion. An equity infusion typ- ments by refinancingor rewritingshort-term

tive is to merge and/orbe acquiredby another firm. This choice is commonly used in the nonagricultural sector where the firm has goodwill value because of market position, is less reputation,etc. The merger/acquisition with the typical likely to be used in agriculture farmfirm;instead, the assets are severed from the firm and liquidated. For larger farm businesses as well as agribusinessfirms, the merger/acquisition step is more common,e.g., acquisition of financially stressed and bankrupt SouthernPlainscattle feedlots duringthe 1970s by investor groups, and the CasePrincipal Forgiveness or Write-Down InternationalHarvester merger.

or intermediate-term debt to a long-termbasis if justified by real estate collateral. Alternatively, each class of loans-short, intermediate, and long-term-may be rescheduledover a longer repayment period. The premise of restructuringis that additionaltime to repay the principalreduces annualobligations. Debt restructuring can be done voluntarily, and it can be useful for some percentage of farmersin trouble, i.e., those who need marginal help ratherthan massive help. For borrowerswhose short-or intermediate-term debt is a high proportionof total debt, substantial improvementin cash flow may result from restructuring.However, the long-termbenefits of restructuringshould not be overestimated (Boehlje, Thamodaran,and Barkema). While restructuringis typically done on a voluntary basis by the lender, it may be encouraged by a government guarantee of the loan. FmHA has used this approachof providing a guaranteefor 90%of the loan obligation or principaland interestif the lenderwill write down the debt by at least 10%(principalor interest rate equivalent) and then restructure the loan so that a cash flow budget shows obligations can be met. Restructuring farmer debt involves few costs to borroweror lender if the situationis analyzed carefully beforehand. There are no public costs unless loan guarantees are involved. Probablymuch of the potentialvolunhas already occurred, tary debt restructuring however.

Short-TermPublic Policiesto Aid Transition A number of transition policies involving credit or lender adjustments are being discussed to deal with currentfinancialstress of farmers (Brake, Boehlje, and Lee; Doye and Jolly). Five of the more frequentlydiscussed policies are debt restructuring,principalforgiveness (write-off), interest buy-down, fore-

A write-down might recognize that the value of the asset has fallen below the loan amount. Or, a write-down may be negotiated to ease impossible debt service requirements.Whether the write-down will resolve the problem depends on the debt service obligationin relation to income. A write-down initiated by examiners can create a problemfor lenders because it represents a direct loss of equity on the books. The lender might not agree with the examiner's

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1126 December 1985

Amer. J. Agr. Econ.

analysis;yet, the examinerforces the lenderto reduce asset values, in turn, eroding lender equity. A principalbuy-down is typically initiated through a public credit policy. An FmHA guarantee, for example, might apply if the lender writes down part of the outstanding principal and restructurespayments to ease the debt service burden of the borrower. While principal forgiveness or buy-down helps farmersin financialstress, it may lead to ill-will on the part of other farmers.They see financiallytroubled farmersgaining "unfair" advantages.Principalforgivenessrepresentsa cost to the lender, and a principalbuy-downis a cost to taxpayers. Both, however, do ease the debt burdenof the financiallystressed borrower.
Interest Buy-Down

it otherwise, but they would resist for those who might survive by other means.
Foreclosure Moratoria

This policy involves interest rate reductionon an existing loan. The buy-down refers to the government paying a part of the cost of an interestrate reductionif the privatelenderwill reduce the interest rate. On a 14%loan, for example, a 4% buy-down would lower the interest rate to 10%. Some part of the cost would be borne by the government and the remainderby the private lender. An interest buy-downspeaks directlyto the basic problem facing financiallystressed farmers-too much debt service. Interest rate buy-downs can be implemented in many ways including a direct governmentpayment, an increased tax writeoff for farm interest payments, a public guaranteeto reduce the risk faced by lenders (allowinglenders to charge a lower rate), and the use of tax-exemptrevenue bonds to obtain lower cost funds for agriculture. The effectiveness of an interestbuy-downis directlyrelatedto the amount.Whileit is relatively effective in reducing the debt service burden, it is also expensive. A four-percentage-point reduction in interest rates on all debt owed by farmerswith debt/assetratios over 40% would require about $4 billion (Doye and Jolly). The effect on lenders of an interest buydown depends on the fractionof cost paid by the governmentand expected loss throughdefault if the borroweris not given some relief. Probably lenders would utilize an interest buy-down for borrowerswho could not make

Moratoriahave received substantial discussion. The purposeof a foreclosuremoratorium is to stop proceedingsto enable the financially stressed producer to gain temporary relief from excessive financialobligations.A key to the success of this approach is a relatively in the conditionof the indusquick turnaround try. Moratoria as applied under the FrazierLemke Act in the 1930saffected only real estate loans (Mungerand Feder). The farmwas appraised,and the courtgranteda moratorium for three years. The farmerkept the property in his possession, continuedto farm, and paid rent for its use. Withinthree years the farmer could pay the appraisedvalue and redeem his property; if not redeemed, it was sold. The farmerwas not liable for loan amountsgreater than the lesser of the appraisedvalue of the property or its sale price. The moratoriumapproach limited farmer losses, althoughit requiredsome paymentfor use of the property. The main advantage, however, was that the courts could force creditors and borrowersto work out their differences. The experience of the 1930s was that relatively few farmers took advantageof this approach. Creditors quickly made adjustments in lendingpractices, reducingnew loans in states which had moratoria.If applied today, one might expect that moratoriawould raise interest rates to compensate for increased risk and costs in agricultural lending, decrease credit availability,but stabilize asset values since fewer assets would be forced onto the market. More recently, attemptshave been made to develop targeted or limited moratoriawhich limit the lender's rightto foreclose. For examallows the lender to ple, a limited moratorium foreclose but only after he has made a good faith attempt to use all public sector credit assistance programsavailable. Or, the lender might be restricted from foreclosing for nonpayment of principal, i.e., the lender could foreclose only if the borrowerfalls behind on interest payments. In essence, conditional moratoriaare a means to encouragethe reluctant lender to cooperate with and assist those borrowersfacing financialstress.

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Brake and Boehlje

Financial Stress among Farm Firms 1127

Facilitating Changes in Asset Ownership Patterns

A numberof means could aid in this approach. For example, lendinginstitutionsmightbe encouraged to take title to property in lieu of debt obligationsand lease the propertyback to the originaldebtor. Then other resources such as machinery and equipment would not require liquidation. The lender would be converting a nonperformingasset into one generatingat least some return.To avoid the problemof lenderilliquidity from holding such assets, the government would likely need to provide funds (perhaps through the Federal Reserve discount window) in the amount of the transferredassets. Such governmentfunds could be provided at lower cost than funds from the private sector, partly offsetting the lower return earned on rental. The lendermightbe requiredto remove the assets from its portfolioover a two to four year period. The original debtor would have first option to buy. Government programs could also be initiated to hold repossessed land off the market. For example. FmHA is, in some places, already holding foreclosed land off the market for one to three years. Private lenders could be assisted in other ways in holding land off the market. Bank regulations typically require that real estate assets taken over by the bank be valued at marketfirst and then be writtendown annually to discourageholdingof such assets. The bank loses equity and is encouragedto dumpassets. Some states even prohibitownership of farm land by lenders or corporations,thus forcing repossessed farmlandonto the market. An alternativeapproachwould be for a state or the federal governmentto charteran entity real estate debt and to acquire nonperforming the assets securing that debt from lenders. Acquisitions would be held off the market, perhapsleased back to the originalfarmer,or put into a conservation reserve program. Fundingcould come from sale of state or federally issued tax exempt bonds. Programsto stabilize asset values have advantages and disadvantages. They are beneficial for farmersin financialtroubleprimarily by maintainingcollateral values on their individual balance sheets. Such policies also permit lenders to exercise forebearancebecause of being in less severe financialcircumstances themselves. Therewould be mixed benefitsfor

farmers not in trouble. Asset values would remain at higher levels, so individualbalance sheets would be less negatively affected. Untroubled farmers, or other investors wanting to expand their asset base, however, would have to pay more to acquireassets. Lenders, of course, would be most affected by such policies since the basic purposeof the policies would be to protect them. Consumers and taxpayers would benefit from the increased stabilityassociated with meaningfulprograms to keep asset markets from overreacting downward.
Other Approaches

Three additional approaches deserve brief mention. Farmprice and income policies have been a traditionalapproachto raise farm income and ease financialproblems. Improved income from such policies would increase the debt service capacity of farmers and would stabilize asset values at higher levels. But, in the currentsituation, the traditionalapproach falls short because (a) cash shortfallsfor the bulk of distressed farmers are so great (Bullock, USDA), (b) the policies are very expensive, and (c) needed adjustmentsof capital and resources out of the sector are restricted. Monetary and fiscal policies clearly affect farmerwell-beinggiven their direct impact on debt service costs, carryingcharges, and dollar exchange rates. Lower real and nominal interest rates would be helpful to the entire agriculturalsector. Given marketindicationsthat resources includinghumanresources need to exit agriculture, increased attention should be given to programsand policies to help people make the transition out of farming. For too long our efforts have worked to avoid exit ratherthan to assist in the adjustment out. Research studying displaced farmers gives disturbing results (Heffernan and Heffernan). Three quartersof displacedfarmersstay in the community, but close to one-half appear headed toward poverty. The personal trauma, social upheaval, and loss of productivity to the economy fromignoringthis problemare a high price for society to pay. ConcludingComments The first wave of financiallosses and business failureshas hit U.S. farmers.It shows signs of continuing, even worsening. The fallout from

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1128 December 1985

Amer. J. Agr. Econ. ture." Dep. Agr. Econ. Staff Pap. No. 84-19, Cornell University, 1984. Brake, John, Michael Boehlje, and Warren Lee. "ShortTerm Transition Policies to Ease the Financial Crisis." Draft manuscript, Dep. Agr. Econ., Cornell University, 1985. Bullock, J. Bruce. Farm Credit Situation: Implications for Agricultural Policy. Dep. Agr. Econ. FAPRI Staff Rep. 4-85, University of Missouri, 1985. Doye, Damona G., and Robert W. Jolly. "Projected Cash Shortfalls and Costs of Stress Alleviation Policies." Selected paper presented at AAEA annual meeting, Iowa State University, 7 Aug. 1985. Harl, Neil E. "Proposal for Interim Land Ownership and Financing through an Agricultural Credit Corporation." Mimeographed. Ames: Dep. Econ., Iowa State University, 10 July 1985. Heffernan, William D., and Judith Bortner Heffernan. "Survey of Families Leaving Farming." Draft manuscript, Dep. Rural Soc., University of Missouri. Melichar, Emanuel. "Agricultural Banking Experience, 1984." Presentation to Senate Committee on Agriculture, Nutrition, and Forestry. Mimeographed. Washington DC: Board of Governors of the Federal Reserve System, 7 May 1985. . Farm Wealth: Origins. Impact, and Implications for Public Policy. Dep. Agr. Econ. A.E. Res. Pap. No. 83-40, Cornell University, 1984 Munger, James A., and Ernest Feder. The Frazier-Lemke Act: Its Impact on Farmers and Lenders. Washington DC: U.S. Department of Agriculture ARS Rep. No. 43-43. Tweeten, Luther. "Farm Financial Stress, Structure of Agriculture and Public Policy." American Enterprise Institute Conference on U.S. Agricultural Policies, Washington DC, 28 Jan. 1985. Dep. Agr. Econ., Oklahoma State University. U.S. Department of Agriculture, Economic Research Service. The Current Financial Condition of Farmers and Farm Lenders. Agr. Info. Bull. No. 490, Washington DC.

that situationis now beginningto take its toll of farmlenders. A numberof possible or likely adjustments to this new environment have been discussed under sector, firm, and shortterm public policy responses. Many of these, and others, will be implementedas firm owners and public policy makers react to economic realities. Clearly,resourceshave been, and will likely continueto be, revalueddownwardandforced of assets and out of the sector. Reorganization liabilitiesat the firmand sector levels will proceed rapidly. More conservative financial strategies and rules of thumb by farmersand lenders will replace those of the last three decades. A majorpoint of this paperis that policies need to consider market stability and to minimize downward overreaction and an overly rapid rate of change.

References
Barkema, Alan D., and Damona G. Doye. "Farm Survival under Financial Stress." Selected paper presented at AAEA annual meeting, Iowa State University, 7 Aug. 1985. Boehlje, Michael D. An Assessment of Alternative Policy Responses to Financial Stress in Agriculture. Dep. Agr. Econ. A.E. Res. Pap. No. 85-2, Cornell University, 1985. Boehlje, Michael D., R. Thamodaran, and Alan D. Barkema. "Agricultual Policy and Financial Stress."' CARD Series 85-2, Center for Agr. and Rural Develop., Dep. Econ., Iowa State University, 1985. Brake, John R. "Aggregate Production, Income, and Financial Effects of the 1980-83 Recession in Agricul-

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