The Big Dip

By Des Keller
DTN Contributing Editor

CHARLOTTE, N.C. (DTN) -- When Iowa farmer and financial consultant Chris Barron asked two experts to appraise the year-end value of his family's farm equipment last December, he was shocked by the damages. Overall, their equipment line had depreciated 29% compared to year-end 2013 -- about triple the adjustment absorbed by the state's average land values.

"I don't know how it could go too much lower," Barron said. "But it gave us a reality check."

The farm equipment industry expects price erosion in used equipment to slow to the single digits in 2015. Still Rabobank analysts doubt the industry can stabilize excess tractor and combine inventories much before 2017. While Barron doesn't worry about himself, he knows the glut will compound problems for farmer clients who need to refinance or downsize during the farm recession.

"If farmer Brown had a line of equipment in 2012 appraised at $800,000, he could in theory borrow up to $400,000 against it if he had reasonable plan, cash flow, and capacity to borrow that much," said John Blanchfield, principal of Agricultural Banking Advisory Services, a consulting firm. In the fall of 2015 if that same line of machinery and equipment appraises at $400,000, his maximum borrowing limit will be reduced to $200,000.

Most ag lenders establish parameters for lending against collateral, according to Blanchfield. "For example, a 50% loan to value (LTV) against machinery and equipment is a fairly common baseline. So you can see how this can snowball if the economics of farming continue in a downward trend," Blanchfield said.

John Schuller, market manager with eastern-Iowa-based Green Belt Bank & Trust, is expecting a number of farmer-clients to clear up their balance sheets by selling excess machinery. "We're really looking for that to be the first move," said Schuller, based in Grundy Center.

"During the good years there were assets bought more for tax purposes than necessity," said Schuller. "We're seeing some of those assets sold to address the current need."

The current need, by the way, is working capital -- or cash. "We believe now the outlook is more like $3.50 corn for the next three or four years," said Schuller. "We anticipate a period of two to three years of moderate losses for customers."

The positive, if there is a positive here, is that many producers were prepared for this, to the extent anyone can be prepared for two or more consecutive down-market years. "On average, we've got customers in the strongest position they've ever been in," said Schuller.

The present economic circumstances don't change working capital requirements, said Bill Davis, senior vice president and chief risk officer for Omaha-based Farm Credit Services of America. "But it is safe to state that those margins will be eroding and much more difficult to maintain," he said. Each enterprise of an operation, crop or livestock, is evaluated and each needs to maintain 25% to 30% working capital, as a percent of gross income.

The problem is selling off a significant portion of an operation's equipment (to hit a working capital standard) isn't really feasible unless the operation itself is downsizing, according to Darrell Dunteman, a farm financial consultant with Illinois-based Bonnett and Dunteman. "Even with a downsize replacing 4,000 acres worth of equipment with 2,000 acre equipment may not generate enough cash," Dunteman said.

One major reason is equipment sales trigger depreciation recapture, which can punish an operator just when he has the least ability to pay federal income tax. In recent years many farms have used Section 179 of the IRS Code, which between 2010-2014 allowed them to accelerate depreciation up to $500,000 worth of business equipment in the year the equipment was purchased. Previously, most farm equipment was depreciated over five or seven years.

For example, someone selling a recent model combine for $220,000, with an undepreciated cost of $20,000, would generate a $200,000 gain taxed at ordinary income rates. Just the federal taxes alone could run $60,000, not counting any debt payoff associated with the sale.

Dunteman said he doesn't anticipate that much selling of major pieces of equipment unless an operation is liquidating. As for farms in a strong position, the taxable gain from the sale of equipment may be more than offset by operating losses on the farm's tax return.

"Based on my clients who are debt-free," said Dunteman, "gross income reduction will offset what depreciation was used in the past. There's not much need for depreciation and no need to buy much equipment in this type of market."

OPPORTUNITY KNOCKS

For financially conservative operations, the farm machinery glut presents a rare bargain. "We're not in the position of having an overabundance of used machinery," said Randy Weber, who farms in Illinois and Indiana near Ambia, Indiana. "We've always asked, 'Does the machinery trade make good business sense for the farm. If you make that decision first then look at the tax cuts later, you don't get yourself into a trap worrying about making moves for tax cuts.

"The situation now gives us a great opportunity to do the upgrading we need to do, to buy at a price discount," said Weber.

Others are simply holding off on trade-ups they would have made two or three years ago. "We had planned to trade a soybean planter this year," said Dennis Carnahan of Carnahan & Sons of Vincennes, Indiana. "We wanted about $200,000 out of it but the dealer thought it was worth more like $100,000. So we'll rebuild the old one and run it again," he said.

Like Weber, Carnahan doesn't feel pinched enough to have to sell machinery to generate cash. They used the good years of 2008-2013 to upgrade secondary pieces such as a backhoe, tillage equipment, and tractors used to mow the lawn and work in the barn lot. "We went from 30-year-old machines to five-year-old machines," he said.

As October arrived, banker John Schuller had just finished up a month's worth of farm calls. "Typically you'd hear talk of upgrading items or trading equipment. We're hearing very little of that this year."

DTN Executive Editor Marcia Taylor contributed to this story.

(GH/MZT/SK/CZ)

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