Wednesday, March 10, 1999

Congressional Hearing

Re: Risk management under the new farm bill

Good morning. Thank you Chairman Lugar and the entire Senate Agriculture Committee for giving me this opportunity to present today. My name is Bill Biedermann, Vice-President/Director of Research and Co-owner of Allendale Inc. Allendale Inc. is a research and brokerage firm located in McHenry IL. We are a Guaranteed Introducing Broker with R. J. O'Brien. Allendale Inc. has approximately 2000 clients throughout the US and Canada. Allendale Inc. provides a daily research product, the Allendale Advisory Report which is subscribed to by thousands of producers throughout the breadbasket of the US. Our average producer farms approximately 1500 acres and has 89,000 bushels of on farm storage.

The 1996 Farm Act is no doubt an expansionary policy that has opened the door to big business farming. The last expansionary policy occurred from 1973 to 1984 and corn prices reacted by declining from $4.00 per bushel in 1974 to $1.80 in 1977. But the 1996 Farm Act is much different than the expansionary policy of the late seventies because it is a "free market" policy which is designed to force intense competition by striping the target price income support program from the producers tool box. This competitive environment will reward those who are efficient, creative, entrepreneurial and good risk managers. The 1996 Farm Act is however not all bearish and financially brutal. In fact, the 1996 Farm Act also opened the door to private industry to develop new risk management tools that can provide stability and profitability. The Act has allowed the industry to substitute the old target price income support program with new tools that are built better, pay on every acre and have no payment limitations. These tools are now being used to secure incomes, collateralize operating and margin loans as well as eliminate the need to "sell the high" of the market. However, without proper utilization of these tools, the producer is faced with significant financial losses due to the impact of lower prices from the expansionary policy. Therefore, those who employ these new tools will successfully managed their risk and be in a position to take advantage of the labor, land and equipment opportunities.

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The decline in the market is no surprise and the efficient producer is prepared for increased competition and increased opportunity.

The 1996 Farm Act was authored with the knowledge that some agricultural producer's would be financially stressed as the market responded to the expansionary policy and as the industry adjusted to the impact of a more competitive free-market environment . According to USDA's Economic Research Agency's Agricultural Information Bulletin number 726, a report on the 1996 Farm Act, published in August 1996, the Act would cause fewer but larger farms (page 10), supports contract crops (or contract farming) (page 5), a higher rate of failure, a decline in producer credit worthiness and consolidation of farms (page 17). USDA's ERS also listed actions producers needed to take in order to survive in this more competitive arena (page 19). Some of these actions include increased risk management education, use of futures and options and increased use of insurance products.

USDA doing its job

The USDA's Risk Management Agency put together a full court press geared to partner creativity in the public sector as well as prepare the Extension Services' for new risk management practices. RMA also pushed hard to heighten producer awareness of the need for a strong risk management program. USDA also granted funding to Universities, Associations and private industry for the purpose of educating rural America how to successfully mange the risks taken by the producer under the new Farm Bill. Finally, the USDA RMA and Universities worked with private industry to develop new products that offer the producer adequate risk management tools. These tools, when fully employed, can offer more benefits than the previous farm program.

The ARM Program

In 1998, Allendale Inc. announced a complete risk management package called the Allendale Risk Management (ARM) Program. Corporate alliances were established with Rain and Hail, one of the nations largest crop insurers and Amcore Bank, the third largest Ag lender in IL. The test group in 1998 experienced a variety of APH's, insurance rates, market and weather conditions as well as a wide range of actual fall yields and adverse basis levels. Revenue results were however very consistent and rewarding. For example, one client in west central Illinois had a good yield of 185 bu per acre and received a net gross income approximately $450. Net gross income is defined as income after cost of insurance, options, storage, interest and marketing/merchandising fees. Add to this the LDP and transition payment, and adjusted net gross income easily exceeded $500 per acre. On the other side of the spectrum, a client in eastern Iowa experienced green snap which resulted in severe yield losses that averaged 40 bushel per acre.

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While his neighbors experienced incomes of $70 per acre plus government payments, Doug experienced $350 per acre plus government payments. When surveyed in the fall about the results of the program, Doug replied by saying "I thank God every day that I did the ARM program." And then went on to say "It is so bad around here, I can't even tell people what I did." This year, Doug is farming and is in a position to expand when the right opportunity comes along.

The ARM program combines revenue insurance with marketing. Through the ARM program, we bring the Insurance Professional, the Banker and the Broker to the Producer's table to establish a management team focussed on the same goal… to lock in a profit based on normal yields. However, the ARM program also guarantees operating notes no matter what adversity strikes. These tools are better than the old farm program because there are no payment limitations and it pays on every acre. Another attractive feature of the ARM program is that all components of the program are fully regulated. From banking and insurance to futures and options. Thus we have eliminated the risks associated with unregulated cash contracts. Furthermore, the ARM program is being used by many banks to collateralize operating and margin loans. This unique feature is revolutionalising the lending industry by allowing operating loans and margin requirements to be segregated into separate notes. This feature also allows banks to release land and other "hard assets" held for collateral against operating notes and rewrite this collateral to long term expansionary loans as our clients prepare to take advantage of the opportunities offered by the 1996 Farm Act.

In 1999, Allendale Inc. has expanded the ARM program to American Agrisurance and has opened the program to other banks. One of these banks, Farm Credit of the America's has embraced this product and others are coming on stream. I randomly took four clients from our files. Their projected net gross incomes and collateral guarantees are as follows:

Kirk CO $369/acre income $273/acre collateral guarantee

Maxwell IA $301/acre income $225/acre collateral guarantee

Urbana OH $321/acre income $251/acre collateral guarantee

Aledo IL $324/acre income $234/acre collateral guarantee

Although these are not barn burner incomes, it is impressive to show a profit when prices are at $2.40 and basis levels are adverse. It is also impressive to have collateral levels that will finance the bulk of the operating notes. And we must remember that transition payments and LDP's will be additional income. Thus, these producers could be in the $350 to $450 per acre income category with normal yields. It is also important to realize that these producers have eliminated their risk. Thus they are no longer dependent on the day to day move in the market, nor worried about every threat of adverse weather. In fact, if the market moves higher, they will benefit from such a move; while if the market moves lower, their income is fully protected. With ARM, producers can be more focussed on their farming operation and how to add more acres into the profit profile the ARM program creates.

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Other Concerns

Others have expressed concerns that the insurance industry is reducing the need for futures and options. As of today, I can tell you that the effect is actually the opposite. Now, for the first time in agricultural history, the producer can use the futures and options in a manner that will not force him or her out when margin calls occur. Due to the bushel guarantees offered in the new assurance programs, we can hedge 100% of the insured yield without collateral risk to the bank. As a result, we can provide the banking industry with a collateralization model that allows them to make all margin calls without threatening the operating line of credit. This is a major milestone in the use of the exchange.

What Can Be Done to Improve the Agricultural Program

After working with producers all around the nation (and globe), I think the there are a few things you could do in Washington to help the American Farmer and level the playing field without completely changing the Farm Bill.

Further improve the APH formula. The success and profitability of a farm is highly dependent on the APH formula. Narrowing the spread from actual yield to APH would be very helpful. Also, extending the attachment rule for how new land is treated under the APH mix would be a very helpful as many agents do not know the rules and have literally messed up many farmers APH mix.

Work on a basis product that would establish benchmarks. For instance, when basis (or cash price) in MN and ND is 65 to 80 cents under the futures, there is little hope for financial survival. But there could be a risk management tool that is based on freight rates that would limit the adversity that basis has on a local area.

Create a short term set aside program to temper LDP exposure and the bearish impact of the expansionary policy. In keeping within the context of "freedom to farm" while maintaining a realistic view on the cost/benefit ratio of LDP's, we bring to you the idea of a one year CRP program. Under this program, producers could voluntarily bid acres into a program where USDA could accept the number of acres that they want so as to temper the negative impact that the current policy is having on price. But I only have one word of caution about change… any change. The producer has already set up his/her risk management plan based on the current farm program. Any change (including the rumored proposed changes to reduce the marketing loan price) would be suicidal if it were done for the 1999 crop.

Continue to subsidize the insurance premiums 30%. Last fall, we surveyed producers in 22 states and gleaned a general trend towards reducing insurance product coverage in 1999 in an effort to cut costs. But when Congress approved the 30% premium subsidy, we saw an immediate response. Producers today are employing a higher level of insurance than earlier anticipated. This will reduce the producers' financial risk of loss, reduce the tax payers' long term cost of disaster payments, and increase the stability of the agricultural Congressional Hearing/Risk Management Page 5

banking system continue to raise the percent coverage of APH to 85% in all states. Nearly every client we interviewed who qualified for 85% coverage was able to substantially increase income versus the 65-75% program. even though in some cases premiums were as high as $50.00 per acre, the net return to the producer was about a $30/acre increase.

In conclusion, the 1996 Farm Act is accomplishing exactly what it was intended to do. Producers are being forced to become more efficient and are using insurance and marketing tools including futures and options to manage risk. But the key to their success is a level playing field and the ability to afford these tools. A more effective APH program, a limit on basis adveristy, a minor set aside program and continued premium subsidies for CRC insurance as well as a move toward greater percent coverage will allow producers to remain in business for years to come.

We as an industry need you to address these simple issues and are confident that you will continue to make decisions that allow those who are managing their risks thrive in the years to come.

Thank you for the opportunity to share our experiences with you. I hope that you find this information useful.