Recent data suggests the U.S. economy is likely to continue strengthening in 2018 and 2019 which could lead to in interest rates increasing quickly, a hurdle for farmers operating lines of credit.
The Federal Reserve has been open about their intention to increase interest rates gradually throughout 2018. However, with the unemployment rate at an all-time low of just 3.8%, and key sectors of the economy booming (think: housing) there’s a chance the frequency of increases could change.
“Given the increased expectations for the U.S. economy, attention has now turned to whether the Federal Reserve Board of Governors (FRB) will respond by raising interest rates more quickly,” Jackson Takach, an economist at Farmer Mac wrote in The Feed. “The FRB is still expected to raise interest rates gradually, despite a change in leadership, and two additional 25 basis point rate increases look likely in 2018. But the probability of an additional rate increase has grown as expectations about the economy have improved throughout the year.”
What could that mean for farmers? While a strengthening macroeconomy is a net positive for U.S. agriculture, farmers with operating lines of credit could see interest rates become a significant pinch point over the coming months.
“You don't worry so much on the fixed rate financing on real estate, but where this really hits home is interest rate on operating lines,” explains Curt Covington, executive vice president at Farmer Mac adding that for many producers an increase in interest rates would eat into their margins. “Many of these farmers continue to survive because they are they are doing business in a low interest rate environment but that low interest rate environment on a variable rate loan can go away tomorrow.”
Following several growing seasons of low commodity prices and commodities like corn, soybeans and milk still struggling, farmers are relying on operating loans more than ever before. Still, it’s important to keep in mind that unlike the 1980’s on-farm leverage is still quite low.
“Well certainly there's a lot of hardship out there. There's no doubt about that. Fortunately, for the sector as a whole, the leverage on the farm is still very, very low,” Takach says. “So when you think about interest expense as a component of total earnings or profits, we're still like 12 or 13 cents of every dollar of earnings is spent on interest. In the 1980s that was 35 cents. We're a long ways off from really having a problem with interest expense causing a problem with delinquencies and defaults.”
That doesn’t mean things will be easy, he says.
“There will be pockets where it's going to be tougher and individual farmers may have more or less levers than the average showed,” he explains.
Long story short: Covington says to worry about interest rates in regard to operating lines, not fixed rate financing. He’s advising producers to consider their options to refinance operating loans and restore liquidity to the balance sheet.
“Our word to those borrowers and farmers out there [is that] if you have access to long term capital and you are concerned that interest rates are going to go up on your operating loan, maybe now is a good time to buffer that by refinancing and building liquidity on the balance sheet to carry you for the next couple of years,” he says.