The Farm Security and Rural Investment Act of 2002: what it means to you

This article details the major provisions of the 2002 Farm Bill, then discusses its expected impact on income, cash flows, and credit risk of farmers as well as debt servicing, credit risk, and the underwriting policies of lenders.

The Farm Security and Rural Investment Act of 2002--commonly known as the 2002 Farm Bill--is expected to have a significant impact on the income and cash flow of most farm businesses. Consequently, the act will also have a major impact on farm lenders and credit requests.

Key Provisions

The new legislation is a six-year bill that is effective for the years 2002 through 2007. As with the 1996 legislation, price support payments are partially decoupled from actual production, so at least part of the payments farmers receive are linked not to current output but to historical yields and acreages. Farmers have the option of maintaining their acreage bases and yields used for the 1996 Farm Bill or updating them based on production during the 1998-2001 crop years. The new program adds soybeans and other oilseeds as a program crop, thus making them eligible for direct payments and countercyclical payments as well as loan deficiency payments.

With respect to conservation programs, the new legislation expands the current Conservation Reserve Program and adds a Conservation Security Program, which will make payments to farmers who adopt various conservation practices. The payments under the Conservation Security Program will include incentive payments to encourage farmers to adopt conservation measures; these payments would be in addition to cost sharing to help defray the incremental cost of adopting the conservation practice.

Finally, a new dimension of the 2002 Farm Bill is a direct payment system for dairy farmers much like that for grain producers: The direct payments on milk production, calculated as 45% of the difference between a price of $16.94/cwt and the Class I Boston actual price for milk, are limited to the first 2.4 million pounds of milk produced by a unit annually. In essence, this program provides direct payments to smaller dairy producers (approximately 120 cows or less, depending on productivity) when milk prices are lower than the $16.94 target price.

The new Farm Bill includes three different payments for producers of program crops (corn, soybeans, wheat, cotton, rice, oilseeds, grain sorghum, oats, barley).

1. The loan deficiency payment (LDP) occurs if market prices are below the loan rate.

2. The countercyclical payment (CCP) is based on historical production and is made to producers if market prices are below target prices.

3. A direct payment (DP), while also based on historical production, is fixed and does not depend upon market prices.

Figure 1 compares the payment mechanisms under the old (1996) and new (2002) legislation. Basically, the new legislation formalizes the supplemental assistance that was part of the 1996 Farm Bill in the form of countercyclical payments and redefines the former AMTA payments as direct payments. In reality, the payments for corn production under the new Farm Bill, compared with previous legislation including supplemental assistance, will increase the per-acre payments modestly (for example, somewhere around $5-15 per acre for corn/soybean farms). Figure 2 shows the sensitivity of the per-acre increases (2002 compared with 1996) for corn, depending on prices and yields.

Table 1 summarizes the payment rates, target prices, and loan rates for the program crops covered under the old and new Farm Bill. The result of the three component price support systems under the new legislation is a truncation of the effective prices that farmers will receive for their crops. As reflected in Figure 3, farmers will effectively receive around $2.42-2.45 for corn under the new Farm Bill. However, note that when market prices are below the target price, price improvement does not result in any additional cash or income in the farmer's pockets, but instead only reduces the size of the LDP or countercyclical payment. Thus prices must rise above the target price for farmers to have more income or cash for debt servicing than they have when prices are low under the 2002 Farm Bill provisions. In fact, that is the exact situation faced this year by many corn/soybean farmers in the Midwest. Market prices have risen, and for those who are not facing drought conditions and yield reductions, their income s will improve little, because higher market prices mean lower government payments. For those who harvest a drought-induced short crop, incomes will be reduced, not only because of the reduced yields but also because of the loss of the LDP and CCP.

Impact on Farmers and Lenders

So what does this new Farm Bill mean to farmers and lenders? The answers to eight frequently asked questions highlight the Act's impact.

1. Will the farm program increase farmers' cash incomes? In general, crop farmers' incomes will increase modestly under the 2002 Farm Bill, probably about $5-15 per acre for corn/soybean farms when compared with previous legislation, which includes all government program payments as well as emergency payments. An important difference between the 2002 bill and the 1996 bill is that the payments are more certain--emergency legislation is no longer needed each year to make supplemental farm program payments.

2. Will the program impact cropping/rotation decisions? Because of the rules that restrict planting of specialty crops on base acres and the establishment of a soybean base, farmers producing such specialty crops as tomatoes, pumpkins, vegetables, and even popcorn may not be able to do so without forgoing government payments. This is a major issue that should be discussed with the specialty crop contractor; a producer should be compensated for any government program payments that would be given up to produce specialty crops.

3. Will farmers likely have to pay higher cash rents to rent farmland? Historically, government farm programs payments are typically bid, at least in part, into cash rents and land values. Consequently, the land rental market will likely experience some upward pressure under the new act. Farmers who are overly aggressive in bidding on cash rents might suffer the winner's curse--winning the land rent bidding contest but actually losing money because the rental rate is higher than the return received from farming the land.

4. Will farmers have more income to use to purchase inputs such as fertilizer, chemicals, and machinery? Sales volumes of such agricultural inputs as chemicals and fertilizer are likely to continue at historical levels and may even increase slightly over time, because acreage in production will be maintained or increase slightly. However, the 2002 Farm Bill will not result in a major infusion of cash and purchasing power for farmers, so they probably will not be aggressively purchasing machinery, equipment, and other capital items.

5. Will land values continue to go up or will they go down? It is likely that the 2002 Farm Bill will increase farmland returns somewhat. This increased return, combined with the lower price risk in crop production, will result in some increase in land values. It is very unlikely that land values will decline as a result of the Act. However, farm program payments could possibly change when the Farm Bill ends in 2007, so caution should be exercised in bidding aggressively for farmland. Higher incomes expected under this legislation will not be permanent for the life of the land.

6. Will farmers experience less financial risk under the 2002 Farm Bill? Crop farmers likely will be exposed to less downside price risk under the current legislation than under previous farm bills. The Act essentially creates an effective floor for corn prices at $2.35-2.50, soybean prices at $5.50-5.70, and wheat prices at $3.60-3.70, irrespective of what happens to market prices. At the same time, if the 2002 Farm Bill results in incentives to increase and/or maintain production, there may be less upside potential in prices than might have occurred otherwise.

7. Can a farmer safely borrow more money based on the 2002 Farm Bill? The modest increases in incomes per acre and the reduced price risk should reduce credit or debt servicing risk for many farmers, and it might be possible to safely borrow more operating funds. A farmer still must contend with production or yield risk so crop insurance may be a critical part of the farmer's risk and financial management strategy. Borrowing more money to buy farm land should be carefully considered in light of the strategic risk that a future farm bill may change the farm program and the amount of payments before the mortgage is paid down.

8. Does the 2002 Farm Bill manage all of the income risk in agriculture? The new Farm Bill, like previous ones, buffers farmers from low prices, but does not provide as much assistance in protecting farmers from low yields. Crop insurance continues to be an attractive instrument to reduce the financial risk exposure from low yields, and the current subsidy for crop insurance lowers the cost dramatically for this risk management vehicle. By participating in the farm program and buying crop insurance, farmers can substantially reduce the price and production risk they face in crop production, thus being subjected to less income risk and having more repayment capacity to safely borrow money.

Final Thoughts

Although the 2002 Farm Bill has significant implications for both farmers and lenders in terms of reduced risk and modest increases in income, there's cause for caution. First, the new bill does not buffer producers and lenders from all risk; yield risk still provides the potential for loss exposure. A producer with a short crop will lose the LDP and CCP if the reduction in aggregate production is enough to result in higher market prices, which appears to be the case this year. Even if prices do not rise, farmers encounter price risk if they exercise their LDP option and speculate by holding the crop for potential price recovery.

Second, better market prices may not result in improved incomes or cash flows for farmers unless they improve above the thresholds noted earlier. When prices improve from their relatively low levels of the past, the increased income from the market replaces government payments, with little or no beneficial impact on the bottom line.

Third, generalizations concerning the impacts of the Farm Bill are difficult to make. In essence, the new Farm Bill will affect different farms in different ways, and it is critical to analyze the individual impacts before making loan decisions.

Fourth, farmers negotiating cash rents under the new Farm Bill must be careful. Cash rents are set in a locale by the lowest cost and/or the most aggressive producers, so the new act could result in increased pressure in cash rent markets because of both the increased income and reduced risk. Ask whether the customer can pay this higher cash rent.

Last, be careful in setting underwriting standards and policy. Although loan requests used to be supported with cash flow budgets based, for example, on $2.00 for corn, some farmers will use corn prices of $2.40 or better in their cash flow budgets in 2003. Competition could encourage more aggressive lending and higher loan-to-collateral-value ratios, even if you would prefer to not use these higher prices. It's critical to discuss the implications of the new Farm Bill for loan policy and underwriting standards before the lending season begins.

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Table 1

Target Prices and Program Payment Rates for Selected Program Crops


Corp (1)        Unit     Target Prices         Direct Payment (2)
                           Old       New        Old       New

Wheat           $/bu      4.00      3.86       0.46      0.52
Corn            $/bu      2.75      2.60       0.26      0.28
Upland cotton   $/lb     0.729     0.724     0.0556    0.0667
Rice           $/cwt     10.71     10.50       2.04      2.35
Soybeans        $/bu       n/a      5.30        n/a      0.44

               Counter-
Corp (1)       Cyclical (3)      Loan Rates (4)
                  New           New     Old

Wheat            0.54          2.58    2.80
Corn             0.34          1.89    1.98
Upland cotton  0.1373        0.5192    0.52
Rice             1.65          6.50    6.50
Soybeans         0.36          5.26    5.00

(1) Addition crops not listed here include oats, barley, grain sorghum,
and other oilseeds.

(2) Direct payment rates were previously referred to as AMTA payments.

(3) Countercylical payment rates are new to the 2002 Farm Bill.

(4) Triggers and LDP if the Posted County Price is below the loan rate.

RELATED ARTICLE: 2002 Farm Bill Workshop

* Understand the price and income support and conservation provisions of the 2002 Farm Bill.

* Assess the impacts of the bill on customer cash flows, debt servicing, and credit risk.

* Explain the implications of the bill to farm customers to deepen the customer relationship.

This workshop is supported by computer software that allows custom design and analysis of debt service, cash flow, and rent and land value implications for specific geographic regions and customer bases. Also included is a set of frequently asked questions (FAQs) that can be used in discussions with customers.

More information, including a downloadable brochure, is available at www.centrec.com

Contact Doehring by e-mail at tad@centrec.com

Boehlje is a professor in Agricultural Economics at Purdue University and a senior associate at Centrec Consulting Group. Doehring is a management consultant at Centrec Consulting Group. Centrec Consulting Group is a management consulting company specializing in agribusiness and agricultural finance.

COPYRIGHT 2002 The Risk Management Association
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