Financing Capital Requirements

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1 Of the independent growers, a typical one produces about four batches of I o thousand birds a year. His capital assets are about as follows: Land, buildings, and equipment, 30 thousand dollars; feed, 4,500 dollars; chicks, 1, 100 dollars ; and fuel, medicine, vaccination, and litter, 650 dollars. A typical producer who operates under contract has a total investment of about 25 thousand dollars, or about 11,500 dollars less than the typical independent operator. The operator who is under contract in an integrated business produces fewer birds and has no capital in birds, feed, and the related items. As prices paid for feed and prices received for birds vary greatly, the grower who operates under contract has far less risk than the independent operator. Integrated farming is not new, but it is becoming more widespread and more complex. In it, the farm operator plays a less dominant role. He is less independent, but his risk is less, and he needs less capital. Financing Capital Requirements Fred L. Garlock MOST OF THE capital invested in agriculture has been provided by the operators and other owners of farms from the cash incomes they received from farming. The proportion of the capital investment that Vv^as financed externally has varied sharply from time to time. In recent years, as in some earlier periods, the rapidly growing need of farmers for capital has forced them to borrow an increasing part of the money. Moreover, advancing technology in 375 agriculture has complicated the work of financial institutions in financing farmers and led to significant changes in their practices. A detailed historical study of capital investment in agriculture, and the way in which it was financed, was made by Dr. Al vin S. Tostlebe and reported in Capital in Agriculture^ Its Formation and Financing Since isyo^ which Princeton University Press published in As Dr. Tostlebe was concerned mainly with the buildup of the capital used in agriculture and the investment necessary to accomplish it, he developed measures of the gross investment in farm machinery, farm structures, and improvements and additions to the land in farms. These investments, added to the increase (or decrease) in crop and livestock inventories and in the cash working balances of farmers, made up the total investment in agriculture for which he accounted. He did not include in this investment the outlays that farmers and others made to transfer ownership of farms and other farm capital within the industry. The total investment made to accomplish the buildup of farm capital that occurred in the first half of this century was placed at 79 billion dollars. Dr. Tostlebe credited financial institutions and other lenders with advancing about 17 billion dollars, or 22 percent of this capital. The remaining amount he attributed to direct investment of cash income that farmers and other farmowners received from farming. Less than half of the amount invested in agriculture during that period was used to increase agricultural capital. The larger part was needed to offset depreciation of machinery and buildings. Many farmers do not recognize depreciation as a cost except for income tax purposes, but a large part of the investment in agriculture each year is required to replace the capital lost through wear, aging, and other causes. These losses hav^e averaged nearly 4 billion dollars a year since 1955.

2 376 Because data were lacking on the volume of credit extended by several important types of lenders, Dr. Tostlebe used net increases in farm debt during 5-year periods as a measure of the contributions of lenders to capital formation in agriculture. This procedure gives an accurate measure of the net contributions of lenders during 5-year periods, but it does not show the total extent to which lenders financed capital expansion in agriculture within those periods. Large amounts of credit are used and repaid within periods of 5 years and still larger amounts in longer periods. This point may be illustrated with some estimates that were made by men in the Department of Agriculture. Farm purchases of all kinds during were estimated to be about 363 billion dollars. The purchases included the usual production and capital goods and also farm real estate and goods and services for household and living purposes. From estimates of credit extensions, it appeared that credits amounting to 125 billion to 130 billion dollars about one-third of the cost of the goods and services bought had been used in making the purchases. Yet farm debt increased only 9 billion dollars because all except a small part cf the credit used was repaid within the lo-year period. No similar estimates of credit extensions have been made for earlier periods, but it is certain that the total amount of credit used in building up the capital assets of agriculture during the first half of this century was considerably greater than is indicated by Dr. Tostlebe's data probably two to three times greater. Even so, it would still be true that in most years the greater part of the capital invested in agriculture came directly from cash farm receipts. Lenders financed an exceptionally large part of the investment in agriculture during the first two decades of this century. Rising prices and rapid farm development favored the use of credit during that period, and farm YEARBOOK OF AGRICULTURE 1960 debts were driven up sharply by the speculation in farmland that followed the First World War. The amount of credit used in financing capital expansion in agriculture dropped sharply in the next two decades. Although the capital investment in agriculture continued to increase, that period included the severe recessions of the early 1920's and early 1930's, which seriously impaired the credit standing of farmers and the lending power of financial institutions. Lenders continued to occupy a minor role as a source of capital for agriculture during the Second World War. Sharply increased farm receipts allowed the operators and other owners of farms to make most of their investments in farm improvements and machinery directly and enabled them also to build up their financial reserves to record heights. During the 5 years following the war, increasing use w^as made of credit as a means of financing capital investment in agriculture. In that period also, however, credit was still of minor importance, compared with cash farm receipts. Two studies of the financing of farm equipment also throw light on the way in which investment in agriculture was financed in the late 1930's and the 1940's. Dr. Howard G. Diesslin, in ''Agricultural Equipment Financing," Occasional Paper 50 of the National Bureau of Economic Research, estimated that the credit used in purchasing new farm equipment dropped from nearly 30 percent of the cost of the equipment in the late 1930's to about 20 percent in In "Financing Farm Machinery and Equipment Purchases, 1947," a Department of Agriculture report, Richard G. Schmitt, Jr., placed credit-financed purchases at only 26 percent of all purchases of new machines and equipment by farmers in No later data of national scope are available on credit-financed purchases of farm machinery. A clue to the

3 development that probably occurred is afforded by data on sales of new automobiles collected by the Board of Governors of the Federal Reserve System. The Board's data indicated that credit-financed sales, which were about 45 percent of all sales of new passenger cars in the late 1940's, had risen to about 65 percent of all sales by As I note later, there are additional indications that the credit-financed part of the investment in agriculture has risen sharply in recent years. The buildup of the capital used in agriculture occurred gradually over a long period, and it involved considerably less actual investment than the present value of agricultural assets might suggest at various times, the physical assets of agriculture have increased greatly in price, particularly since In addition to the capital investments covered by Dr. Tostlebc's study, large investments have been required to transfer farms and the other farm capital goods from generation to generation and among individuals within generations. The entry of a young man into farming may add nothing to the capital used in agriculture, but it often involves a large investment of owned or borrowed capital by the young man or his family. Capital-transfer problems of large dimensions similarly arise in connection with other transfers of farms, including those for farm enlargement, and in such other areas as transfers of feeder cattle from the range to feedlots. Some types of capital transfers have been studied quite thoroughly, but only bits of information are available on other types. No measures are av^ailable of the amount of credit used in transferring feeder cattle from the range to feedlots, for example, but it is known that cattle feeders usually can borrow the entire purchase price of the feeders. Many follow this practice. There is no measure, except an estimate for 1954, of the value of farms that change own- 377 ership each year, but it is known that only about one-twelfth of the farms transferred during recent years were transferred by gift or inheritance and that most transfers involved purchase and sale. In their studies of the farm real estate market, William H. Scofield and Paul L. Holm, of the Department of Agriculture, have collected data on the capital-transfer problems that arise from sales of farm real estate. They found that sales of farm real estate, like sales of new passenger cars, are increasingly financed through the use of credit. Approximately two-thirds of all sales in involved use of credit, compared with a little more than 40 percent in the early 1940's. Of the credit-financed land transfers, more than 40 percent in , compared with about 33 percent in 1955, were financed by the sellers of the land. In the sales financed by sellers, land contracts often are used, and the credit extended usually represents a larger part of the sale price than in sales financed with loans from financial institutions. An increasing proportion of the farmland bought is used to enlarge existing farms (42 percent in , compared with 26 percent in ). Farms can be enlarged also by renting additional land, a method that has been used extensively. Renting has some advantages over ownership if the renter is secure in his tenure. It involves a smaller financial commitment. Often the landowner shares risks of the operation by paying a share of the expenses and accepting a share of the crop as rental. With the reduction in number and the increase in size of farms, however, it is becoming harder to lease the additional land needed to create efficient operating units. This element often throws the balance in favor of buying, even though a large debt must be incurred to make the purchase. The increasing use of credit to finance capital formation in agriculture, purchases of farm real estate, and other

4 378 transfers of farm capital, raised the farm debt from less than 8 billion dollars at the end of the Second World War to nearly 21 billion dollars at the beginning of (These figures do not include price-support loans of the Commodity Credit Corporation.) Moreover, all types of lenders report that the average size of their loans to farm borrowers has been increasing rapidly. As a percentage of the value of farm assets, farm debts rose from less than 8 percent at the end of the war to 10 percent at the beginning of They probably will continue upward. All indications point to the conclusion that more and more credit is being used to create each additional dollar's worth of capital in agriculture and to effect the necessary transfers of capital within the industry. The main financial institutions from which farmers borrow and the amounts of farm loans (in millions of dollars) held by each in mid-1959, were: Commercial banks, 6,423; life insurance companies, 2,741 ; Federal land banks, 2,238; production credit associations, 1,500; and Farmers Home Administration, 890. The total was 13,792 million dollars. About three-fifths of all farm debts are owed to these institutions, although farmers obtain credit from a variety of other sources sales finance companies, merchants and dealers, small loan companies, credit unions, relatives, and other individuals. The demands on the institutions that finance farmers are being increased by the growing complexity of the industry and the uptrend in farmers' needs for credit. Application of the new technologies, shifts in types of enterprise, and farm enlargements are making good management more essential to success in farming and complicating the task of financial institutions in evaluating applications for loans. These changes have made it necessary for financial institutions to get better qualified personnel and to improve their methods in financing farmers. YEARBOOK OF AGRICULTURE 1960 Spurred by the recession of the early 1930's and the wave of mortgage foreclosures that followed, the Farm Credit Administration and life insurance companies moved rapidly to improve the caliber of their appraisal staffs and the methods they used. THE PRODUCTION credit associations and the Farmers Home Administration (including its predecessor agencies) have tried ever since they were first organized in the mid-1930's to get persons familiar with and experienced in farming to handle their loans to farmers. Many commercial banks have appointed men with agricultural backgrounds and educations to handle their agricultural loan business. About 1,200 commercial banks had such officers in Usually in cooperation with the State agricultural colleges, lenders also have arranged for periodic farm credit conferences to improve their understanding of changes in farming and the farm credit problems. The conferences often provide opportunities for demonstration and discussion of innovations in agriculture. One such conference group the National Agricultural Credit Committee comprises chiefly farm-mortgage lenders. It meets every 4 months to review recent experience with agricultural loans and to assess the current situation and outlook in agriculture. The Farm Credit Act of 1959 (Public Law ) repealed the limit of 200 thousand dollars on Federal land bank loans to one borrower and authorized the Federal land banks to make unamortized or partially amortized loans under regulations issued by the Farm Credit Administration. These changes reflect the increase in the capital required for eflficient farming and in farmers' needs for credit. The removal of the maximum loan limit will enable the Federal land banks to serve borrowers whose needs for credit have outgrown the previous limit on loans by land banks. The provision for unamortized or only partly amortized loans recognizes that some bor-

5 rowers can better use their incomes to maintain or increase their capital assets than to reduce their debts. In the field of production credit, the growing size and costliness of the machines and equipment used in agriculture are bringing some change in the terms of loans made by financial institutions to farmers. Sales contracts that spread payments over several years have long been used by manufacturers and dealers in selling heavy machinery, automobiles, and trucks to farmers, and banks have discounted or bought substantial amounts of these contracts. Some of the direct loans of both banks and production credit associations to farmers have contained similar provisions. Chiefly, however, the direct loans of these institutions to farmers even for costly equipment have had maturities of a year or less. This does not mean that farmers have been required to repay their loans as rapidly as this if they needed more time. Usually lenders have renewed the loans or extended the payment dates, as needed by farmers. Lenders, however, have retained the option to collect when these short-term loans were due, even though they often have not exercised it. The production credit associations have been making more loans with the longer maturities. Some range up to 5 years. These intermediate-term loans give borrowers more protection against untimely demands for payments than do the shorter term loans. They are especially well adapted to the financing of such costly items as bulk milk-handling equipment and heavy machinery. Whether the lead taken by production credit associations wdll be fouow^ed by banks is not yet clear, but in nonfarm industries, intermediate-term loans largely replaced short-term loans as a means of financing purchases of heavy equipment as long ago as the 1920's. The Farmers Home Administration has always used intermediate-term loans to finance the working capital requirements of its borrowers, but it 379 serves only a small segment of the farm population. RAPID TECHNOLOGIC progress in some farm enterprises has changed greatly the relationships between farmers and their suppliers or processors of their products. They are the enterprises in which contract farming has come into prominence notably production of broilers, eggs, and hogs and feeding of cattle. A variety of contracts is used in each of these enterprises, but more and more the contracts are getting away from the ''debtor-creditor" relationship and making the processor or supplier the sole enterpriser or a joint enterpriser with the farmer. From a viewpoint of financing, the main feature of these contracts is that usually the grower is not obligated to pay for the production items that the supply company or processor furnishes as its part of the deal. The supplier or processor takes a loss if its share of the product sales proceeds does not cover the cost of the items. Frank D. Hansing, of the Department of Agriculture, studied the broiler industry in Delaware and found that most of the growers were operating under contracts of this kind. He asked the growers why they preferred contracts whether it was because they did not have the resources to produce independently. Most of them replied that they could raise the money to produce independently if they wished, but that they did not want to accept the risks of independent production. This response reveals a motivation that underlies many changes in the methods of mobilizing capital for farming. The amounts of capital required for efficient farming are now so large and profit margins in some farm enterprises are so low that farmers seek ways of reducing their risks. Suppliers and processors increasingly find it necessary to share farming risks in order to maintain or increase their business with farmers.

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