U.S. farmers have “significantly” increased their debt levels in recent years, raising questions whether producers will face financial stress if incomes fall or interest rates spike higher, the Federal Reserve Bank of Kansas City said.

Real farm debt has risen by nearly 5 percent annually since 2004, the fastest upswing since the prelude to the 1980s crisis, Kansas City Fed economist Brian Briggeman said in a report last week.

“Over the past year, historically low interest rates and rising incomes have allowed farmers to service elevated debt levels that are concentrated among a few farm types,” Briggeman said.

However, a financial shock “could increase financial stress quickly, especially among livestock producers and young operators,” Briggeman said. “A surge in financial stress among livestock producers, who hold half of all farm debt, would be of particular concern to agricultural lenders.”

Increasing farm debt has been driven in part by a 40-percent rise in real farmland values since 2003, Briggeman said. Much of the increase was concentrated among large operations with more than $1 million in annual sales. For large operations, total real farm debt doubled between 2005 and 2009, to $60 billion.

Total debt held by smaller operators remained mostly steady during the period, at about $160 billion, Briggeman said, though their share of farm debt fell to 70 percent from 85 percent.

While the U.S. farm industry generated robust income growth since 2004, profits were highly variable and primarily confined to larger operations, Briggeman said. Livestock producers and operators younger than 35 “missed out on these stronger profits, creating financial stress for many of them,” he said.

In 2008, nearly a third of all livestock producers and young farmers had a debt repayment capacity ratio, or DRCU, above 2, indicating “severe” financial stress, Briggeman said.

DRCU is outstanding farm debt divided by how much debt the farmer can afford to pay with net farm income at current interest rates, with a ratio of 1 indicating income is sufficient to service debt.

Farmers with DRCUs above 1 “would be unable to service all debt using net farm income alone,” Briggeman said. They would “be under extreme financial stress because their debt would be double the amount they could afford.”

Currently, farm interest rates are near historical lows, averaging around 6.5 percent for operating and real estate debt. But an increase to the 2007 average of 8.5 percent would place some producers under financial stress, Briggeman said.

Large farms would feel little impact from a 2 percentage-point rate rise, he said. But younger producers, who have lower incomes, are more susceptible to a rate shock, and the proportion of those with DRCUs above 1 may expand to 55 percent from 50 percent under that scenario, Briggeman said.

A combination of sharply higher interest rates and a steep income decline would cause even greater financial stress for farmers. The last such period occurred in the 1980s, when farm interest rates doubled from 1976 to 1981, reaching a peak of 18 percent in 1981, and farm incomes declined by 30 percent.

Under this scenario, the number of financially stressed farms would jump “significantly,” Briggeman said, with the percentage of large farming operations facing DRCUs greater than 1 rising to 24 percent from 10 percent.

“The greatest stresses would emerge for livestock producers and young operators —farming operations with the weakest net farm incomes,” he said. “Livestock producers and young farmers would again experience the most severe financial stress because their weak net farm incomes would not be enough to absorb the shock.

The full report is available here: http://www.kansascityfed.org/publicat/mse/MSE_0610.pdf