INDIANAPOLIS (DTN) -- Wells Fargo economist Michael Swanson likens the new risk profile in agriculture to the climate in Fargo, N.D. Sure, the annual average temperature is 41 degrees, "but if you dress for that weather, you'll be uncomfortable three months of the year and dead the other nine," Swanson told the Agricultural Bankers Conference here this week.

Given extreme volatility in commodity markets in the last five years, America's farmers need to be able to adapt to the extremes of frigid prices as well as the balmy summer days of $8 corn. "It's going to be just like the weather in Fargo," Swanson said. "There will be some minus 4 degree nights. If you don't deal with them, you will be dead before it gets back to 41 degrees."

While the lenders gathered here expect some of the highest farm incomes in history for U.S. grain producers in 2011, they aren't buying the notion that farming is staged for a permanent golden era. Speakers repeatedly emphasized that commodities are cyclical and that when corrections occur, they could be steeper and more extreme than at any time in the past 25 years. Several commodity advisers even bucked conventional wisdom and laid out scenarios where corn could plunge under $4 by next fall -- but they didn't rule out $10 should weather take a swipe at yields.

Barry Flinchbaugh, an emeritus agricultural economist from Kansas State University, chastised fellow economists who tout net farm incomes of $115 billion as "the new normal." Flinchbaugh has taught a farm policy class for 41 years and is skeptical that profit margins will be maintained at today's levels. "At last count, I've lived through four of these new normals and the old cost-price squeeze always comes back," he said.

Swanson didn't offer any price forecasts but stressed, "People just don't have enough risk in mind."

Much like the erratic movements in stock markets, the swings in commodity prices today are 40% greater than standard deviations the previous four years, Swanson said. "That's nothing to sneer at."

Two factors are contributing to that extreme. Population growth projections are highly unpredictable and probably a relatively minor factor in this price peak, he said. Far more important is the spending power generated by the world's growing middle class and political decisions to build a biofuels industry that now consumes 5.1 billion bushels of the U.S. corn crop, up from only 630 million bushels at the turn of the century.

"Without a policy decision by the U.S. on biofuels, we wouldn't have had $6 corn. Population growth and incomes by themselves couldn't do it," he said. The problem is that critics are pushing Congress to revise or revoke the Renewable Fuels Standard mandating ethanol blends, a move that could have consequences if enacted.

U.S. farm exports have surged from 25% of U.S. production in 2004 to over 40% today. "That's a blessing and a curse. We're not used to the volatility that export dependency brings with it," Swanson added. Americans have produced largely for domestic consumption in the past, so they've been buffered from currency risk and political interferences like embargoes. In any trade dispute with China, it's not hard to imagine that soy or cotton exports could be held hostage since they are by far the two largest items the Chinese import from us, he said.

Unlike the 1970s, there's growing evidence that farm lenders are curbing the farm economy's euphoria. Examiners for the Federal Deposit Insurance Corporation admitted that they have no evidence of a bubble in U.S. farmland values or that loose lending practices were contributing to excessive real estate inflation. Controversial studies issued a year ago by the FDIC were meant to alert farm lenders "for the need to be vigilant and not to let our guard down" said Allen McGregor, an FDIC supervisory examiner from Grand Island, Neb., who authored one of the reports.

In fact, McGregor and other FDIC officials complimented lenders for imposing strict limits on the amount of financing they offer for farm real estate loans, usually set as a percentage of loan-to-value or a dollar cap, whichever is lower. In many instances where Midwest farmland is selling for $8,000 to $10,000 an acre, rural banks and Farm Credit System lenders are only financing about half of the purchase price.

Still, farm bankers need to encourage their clients to use today's bonus incomes to bolster their liquidity and working capital, urged Curt Covington, senior vice president of Bank of the West, Fresno, Calif., and Bob Craven, director of the Center for Farm Financial Management at the University of Minnesota.

The dairy industry's bust in 2008-2009 not only sent incomes spiraling, but also deflated cow prices and operators' net worth in a flash. Back then, lenders calculated the so-called "burn rate" -- the number of months an operation can live before depleting assets.

The dairy lesson taught ag bankers that farmers need more cushion to withstand those spirals, Covington said, because many California dairies have eroded working capital ratios to near zero. The financial standards industry is recommending that livestock operators with regular and steady cash flows need a minimum of 10% to 20% working capital as a percent of gross revenue. But most other farm operations need 30% or 50% cushions. Some of those current assets will be in grain in inventory or prepaid expenses, for example, but Covington stressed that "cash was king."

"Some farmers will see the biggest tax bills they've ever seen in their lives this year," said Craven. To dodge that, they've been stocking up on new equipment, grain bins and storage sheds, often paying the six-figure bills directly out of working capital. "That's depleting their ability to do something with those funds" if markets turn, he said. "Working capital should be their first line of defense."

Marcia Zarley Taylor can be reached at Marcia.taylor@telventdtn.com

(CZ)

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