Red flags for farm banks: Soaring inflation, deep drought

Farmers and the bankers who lend to them are grappling with the one-two punch of soaring inflation and long-term drought.

The toxic cocktail arrives as pandemic-era government subsidies unwind, leading to forecasts for falling farm income that could present new risks for agricultural lenders and knock-on effects for rural communities.

Small towns throughout the central and western U.S. depend upon farm owners spending their profits at local businesses and fueling regional economies. Without that spending, small businesses could suffer and eventually fail to make their loan payments.

From California to portions of the Mountain West and Midwest, farmers are struggling to plant everything from soybeans to wheat due to a lack of moisture that has left their soil dry, cracked and often ill-equipped for the spring planting season. Commodity prices are strong — due to waning supply — but farmers may not be able to capitalize.

“We are under a severe, severe drought — about as bad as we’ve ever seen,” Shan Hanes, president and CEO of the $140 million-asset Heartland Tri-State Bank in Elkhart, Kansas, said in an interview. “Wheat, for example, is completely gone this year. It doesn’t matter how great wheat prices are if you don’t have any.”

The U.S. Department of Agriculture estimated domestic winter wheat production will drop 8% this year as a result of a drought in the Plains, while global harvests will also fall because of the destruction from Russia’s war in Ukraine, which is a major wheat producer.

Wheat prices have surged more than 35% this year in response to these factors. But, as Hanes noted, farms in the hardest-hit pockets of the drought’s grip will not benefit. Most have insurance that will cover much of this year’s losses, he added, but the longer the dry conditions persist, the harder it becomes to plan for the future.

In time, farmers may pull back on investments — and loans to fund them — as well as spending, hampering the economies of surrounding communities.

The USDA forecasts that 2022 net farm income, a broad measure of profits, will drop by $9.7 billion on an inflation-adjusted basis, or 8%, from the prior year.

Compounding matters, soaring inflation is driving up costs for everything from fertilizer to  equipment, making it too expensive for many farmers to profitably plant crops this year or to feed their livestock.

The U.S. Labor Department said the consumer-price index in April eased slightly from 8.5% in March but held near a four-decade high at 8.3%. Inflation has exceeded 6% for seven consecutive months — triple the Federal Reserve’s targeted 2% rate. Pandemic-induced supply chain challenges and pent-up demand intersected to drive up prices to generational highs this year.

“Inflation is very, very real,” Hanes said. “Fertilizer costs alone have nearly tripled” over the past two years.

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James Mintert, director of Purdue University's Center for Commercial Agriculture, said farmers who can procure strong crop yields this year — from wheat to corn to soybeans — are optimistic about revenue for the year ahead. But they, too, are wrestling with lofty costs that will cut into profitability.

"It’s hard to overstate the magnitude of the cost increases producers say they are facing,” Mintert said.

The Purdue University/CME Group Ag Economy Barometer, a measure of farmer sentiment, produced a reading in April that was 32% below what it was the same month in 2021.

Creighton University’s May Mid-America Business Conditions Index, an economic indicator for an agriculture-heavy, nine-state central U.S. region that stretches from Minnesota to Arkansas, showed business managers expect continued economic growth this year.

However, four of 10 supply managers surveyed expect supply-chain challenges to worsen this year and another 40% expect problems to persist at current levels, indicating inflationary pressures could fester.

“Supply-chain disruptions and labor shortages remain as chief challenges for firms in the region,” said Creighton economist Ernie Goss.

Against that backdrop, agriculture bankers say farmers likely will need to borrow more to cover higher costs. This could fuel loan demand this year. But it also could raise credit risk and diminish loan growth over the long term.  

“Inflation, and how long before it gets under control, is on everybody’s mind,” Dave Kusler, president and CEO of the $60 million-asset Bank of Hazelton in North Dakota, said in a recent interview. “There’s a lot of uncertainty in 2022.”