Midwest and Midsouth farm income and quality farmland values continued to decline during the second quarter of 2016, according to the latest Agricultural Finance Monitor published by the Federal Reserve Bank of St. Louis. The survey was conducted from June 15-June 30, 2016. The results were based on the responses of 32 agricultural banks located within the boundaries of the Eighth Federal Reserve District.

The Eighth District comprises all or parts of the following seven Midwest and Midsouth states: Arkansas, Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee. The survey also included three special questions about the financial condition of agricultural borrowers and if they are turning to other financing sources to meet their credit needs.

Farm income falls along with household spending and capital expenditures

Amid a decline in crop prices, lenders reported that farm income continued to trend lower during the second quarter of 2016, compared with the same period a year ago. Based on a diffusion index methodology with a base of 100 (results above 100 indicate proportionately higher income compared with the same quarter a year earlier; results lower than 100 indicate lower income), the farm income index was at 24 for the second quarter, up slightly from the previous quarter's record low level of 20. Looking ahead at the third quarter, lenders said they expect farm incomes to continue to be under downward pressure from a year earlier.

"In general, farmers in our region have only been able to survive declining commodity prices the past 24 months due to conservative spending, improved efficiency, and good crop yields," an Arkansas lender said. "A reduction in the yield or quality of crops, increases in input costs, or continued low commodity prices could be the tipping point for many under-capitalized operations. No producer can out-yield low prices."

Household spending and capital expenditures were also weak in the second quarter, compared with this time a year ago, with the household spending index at 66 and the capital spending index at 34. Lenders said they also expect this trend to continue in the third quarter.

Declines in quality farmland value moderate; ranchland or pastureland values and cash rents plunge

After dropping 6.4 percent on a year-over-year basis in the first quarter, quality farmland values declined only 0.7 percent in the second quarter. However, the majority of lenders indicated that they expected values to continue to trend downward into the third quarter. Meanwhile, cash rents for quality farmland tumbled 10 percent during the second quarter. Year-over-year ranchland or pastureland values fell 7.4 percent, compared with last quarter's 0.1 percent increase. Cash rents for ranchland or pastureland plunged 20.7 percent from last year, compared with a decline of 2.2 percent reported in the first quarter.

Special questions on agricultural borrowers' financial health

The second quarter survey also asked lenders three special questions regarding the financial condition of agricultural borrowers and their use of additional sources of agricultural financing to meet their credit needs. The first question asked lenders to assess the overall change in the financial condition of their agricultural borrowers (farmers and/or ranchers) compared with the prior year, based on five categories ranging from significant deterioration to significant improvement.

The lenders' responses showed that 14 percent assessed their borrowers as having experienced significant deterioration in their financial conditions, with 66 percent reporting modest deterioration. Meanwhile, 17 percent of the lenders said their borrowers had experienced no change, while 3 percent said their borrowers' financial conditions showed a significant improvement.

The second question asked the lenders to assess which of the following three categories of borrowers are most exposed to a prolonged downturn in farm income: highly-leveraged land owners with little equity, tenant farmers with cash rental arrangements, or farmers or ranchers with livestock operations.

Close to 50 percent of the lenders responded that tenant farmers with cash rental arrangements as the group most at risk to a prolonged downturn in farm incomes. Meanwhile, 38 percent of the lenders thought highly-leveraged land owners with little equity would be the most exposed, with 14 percent ranking farmers or ranchers with livestock operations as the most exposed.

The third question asked lenders if they believed farmers and/or ranchers in their areas have increased their borrowing this year from other sources to meet their agricultural credit needs. These other sources included other commercial banks, federal guaranteed programs, the Farm Credit System and captured finance companies.

A majority of lenders indicated that borrowers have increased borrowing from federal guaranteed programs, but not from the other sources.