April 19, 2024

Navigating Farm Loan Interest Rates

Total operator interest expense over the past year has increase 43%, leading producers to seek answers among a diversified agricultural credit space. From traditional lenders in ag, like the farm credit system and commercial banks or more non-traditional lenders like implement dealers and co-ops – How do these lenders compare?

Host Brady Brewer, accompanied by guests Dr. Jennifer Iftt, Dr. Noah Miller, and Dr. Gerald Mashange, explore how agricultural loan interest rates vary among lenders. In this Purdue Commercial AgCast episode, they unpack a series of recent FarmDoc articles dissecting the nuances of interest rates in ag loans across various groups of lenders, geographic regions, and different types of farms.

 

Additional Resources:

The audio transcript can be found below.

Audio Transcript:

Brady Brewer: Hi and welcome to the Purdue Commercial AgCast, the Purdue University Center for Commercial Agriculture’s podcast featuring farm management news and information. I’m your host, Brady Brewer, on today’s episode and joining me is Dr. Jennifer Iftt, associate professor of agricultural economics and the Flinchbaugh Agricultural Policy Chair at Kansas State University. Dr. Noah Miller, economist at the United States Department of Agriculture Economic Research Service. And Dr. Gerald Mashange, assistant professor of agricultural and consumer economics at the University of Illinois.

On today’s episode, we will be discussing a series of articles that these three wrote for FarmDoc on the agricultural lending market. Specifically, how interest rates for agricultural loans varies across several variables. Before we get into today’s topic I just want to remind listeners you can find all the information for this podcast on the Center for Commercial Agriculture’s website at purdue.edu/commercialag.

So with that, I want to welcome you three. I want to give you guys a little bit of time to introduce yourselves since we have several new people on the podcast. So Gerald, I’m going to start with you. If you want to tell the listeners a little bit about yourself.

Gerald Mashange: Yeah, sure. My name is Gerald Mashange. I’m an assistant professor of the Department of Agricultural and Consumer Economics at the University of Illinois, Urbana-Champaign. I’m originally from Zimbabwe and I did my PhD at Kansas State University. At Illinois, I focus on agricultural finance and risk management, and I’m on the FarmDoc team.

Brady Brewer: Thank you, Gerald. So Noah?

Noah Miller: Thanks, Brady, for having us on. So my name is Noah Miller. I’m a research economist with USDA ERS. I’m originally from northeastern Kansas and did my Ph. D. at Kansas State University. At ERS, I work on topics related to agricultural finance and farm marketing decisions.

Brady Brewer: Thank you, Noah. And last but not least Jenny, do you want to introduce yourself?

Jennifer Ifft: Sure. Thanks for having me on. I’m originally from central Illinois and most recently from Kansas State University. My extension program here focuses on crop insurance and insurance options for livestock producers. I’ll do some work on the farm bill. My research relates to how different policies and regulations affect farmer financial well being. More recently, I’ve been working on non-traditional or non-bank finance trying to understand the magnitude of non-traditional finance as well as the risks associated with that. So it’s really tied in to the topic of interest rates and how competition is changing in the current environment.

Brady Brewer: We definitely are pleased to have you guys on the podcast.

[00:02:47] Farm Loan Interest Rates

Brady Brewer: So Noah, I’m going to start with you. So I mentioned in the intro that this podcast is going to be based on a series of articles that you three wrote for the FarmDoc website at University of Illinois on farm interest rates. Why should we care about farm interest rates? What made you explore this topic in depth?

Noah Miller: Yeah, great question, Brady. So we were interested in looking at interest rates for a couple of reasons. We felt it was timely, given the change in monetary conditions that we’ve been seeing. So, over the last two years, the Federal Reserve’s Open Market Committee has raised the federal funds target rate by 500 basis points. And that’s translated into higher interest rates on newly originated non-real estate and real estate farm loans. And if we look at the farm income and wealth statistics published by USDA, we’ve seen how that’s impacted overall debt servicing costs. So there’s been a 24 percent increase in total operator interest expense from 2021 to 2022, and a 43 percent increase from 2022 to 2023. And that’s not gone unnoticed by farmers. I, I think the results from your Ag Barometer survey that you and Dr. Mintert and Dr. Langemeier have been discussing in previous episodes of this podcast, bear that out. Rising interest rates have been one of the main concerns for farm operators currently. So it seemed that there would be interest in exploring interest rates in more detail.

And then the second reason why we’re interested in this topic is that the agricultural credit space is pretty diversified. So on the lender side, you have traditional lenders to agriculture, like the farm credit system and commercial banks. And then there are what we classify as non-traditional lenders, like implement dealers and co-ops. And whether they charge similar rates on different loan types is largely unknown. And how these rates differ across different types of farms is also unknown. So we hope this series of articles would help shed light on these questions.

Brady Brewer: Yeah, we are definitely in a different interest rate environment, right? Between 2010 and 2020, we saw first, lower interest rates or decreasing interest rates for the broader economy and ag in general. And for the vast majority of that decade, the Fed funds rate was at the zero lower bound. In other words, they couldn’t go really much lower and that translated to a super low, historically low, interest rate environment. And we have now left that far behind.

Now you mentioned the 500 basis points. You know, one thing I’m quick to kind of point out to a lot of farmers I talked to is yes, interest rates at 500 basis points was pretty rapid increase in Fed funds rate. But historically, we’re, we are above the historical average when it comes to interest rates, but we’re not that much above, but it’s still a shock to the income statements, right? You mentioned the you know, the interest rate that farmers pay, how that shows up on the income statement is going to change because of that 500 basis point increase.

So, that’s kind of why you guys looked into this. Now let’s get into what data you guys used to actually explore this topic. So, Gerald, I’m gonna ask you this. What, what is the data that you used to analyze the farm interest rates or the interest rates that farmers paid?

Gerald Mashange: Sure, Brady. So our data comes from the U. S. Department of Agriculture’s Agricultural Resource Management Survey, or ARMS. It covers the period from 2008 to 2022. So the USDA is National and Cultural Statistics Service and the Economic Research Service. They start conducting the survey towards the end of December. And what’s great about this data set is that it’s a nationally representative survey of farm operations that includes information on outstanding farm data. This dataset is such a great resource for all, and most importantly, it provides real life data from farmers that helps inform ag programs and policies as well as providing us with timely insights on the state of agriculture in the U.S.

So we focus on the loan label information for our FarmDoc series, and this part of the data has information on an operator’s five largest loans. It tells us who the lender is, the type of the loan, which includes production, intermediate, and farmland real estate loans. The outstanding balance, the origination of that loan, the loan terms, and finally the interest rates on these loans.

So in our first FarmDoc article, we sliced this data to focus on interest rate trends from 2008-2022 by the type of lender. And in our second article, we focused on farm loan interest rates in 2002 by geographic region to study regional differences by lender. And in our final article, we looked at whether different types of farms paid different interest rates.

Now the limitation of this data set is that we cannot differentiate in the loan data between fixed rate and variable rate loans, and also the farm loan data reported cannot control for differences in borrower risk or the funding costs faced by lenders.

Brady Brewer: Yeah, so you, you mentioned that you’re using the USDA Ag Resource Management survey which is a yearly survey that USDA conducts, which we want to be careful. This is not, this is different from the US ag census that a lot of farmers may fill out. Gerald, I wanna follow up on that. So, you know, I’ve used this data before and it’s a really rich data set. Why this data? Is there other data sets you guys could have used for this analysis?

Gerald Mashange: Well, I think the ARMS dataset is probably as good as it gets because you get to see the different types of loans held and who the lender is and those interest rates. But I’d say the next best dataset on ag loans comes from some of the Federal Reserve banks. So for example, the Federal Reserve Bank of Kansas City conducts a quarterly survey of agricultural credit conditions for the 10th district, which includes Colorado, Kansas, Nebraska, Oklahoma, Wyoming, western Missouri, and I believe northern New Mexico. It also provides information for demand for loans, those repayment rates, and the fixed and variable interest rates on those ag loans.

Now, the Federal Reserve Bank of Chicago also conducts a similar survey called the Ag Letter, and so does the Federal Reserve Bank of Dallas and the Federal Reserve Bank of Minneapolis. What’s great is you can actually put these datasets together and you can get a broader idea of, you know, the ag credit conditions across the country.

Brady Brewer: The Federal Reserve is a banking entity so they have to be careful what data they can release so that while the data you just mentioned is, is rich and has a lot of stuff in it. You can’t get down to a more detailed level like you guys did in, in your analysis on the FarmDoc series that you guys wrote because you can’t divide that data up and say, what is it from the farm credit system or non traditional lend or vendor financing versus commercial banks. But it does provide a good checkpoint to, to look at the averages and compare across different data sets.

Gerald Mashange: Absolutely.

Brady Brewer: This data is a little bit hard to obtain, which is why there’s not been a, a ton of work done in this area, because we are dealing with loan data, which for farmers that have gone out and gotten a loan at the bank, you sign a lot of papers, and a lot of that is privacy information that the bank can’t share with certain people, so this makes looking at this from a national perspective sometimes hard because the data is a little bit hard to obtain. But you guys are using the USDA Ag Resource Management Survey.

Jennifer Ifft: There wasn’t a lot of external pressure for us to do research on interest rates until about two years ago, you know, and, and so, you know, part of this is, is responding to these, these big changes that we hadn’t seen in a long time.

Brady Brewer: Yeah, the, the percentage of interest rate expense on a farmer’s income statement has been at historically low levels for the past decade or so. So there just hasn’t been a lot of need to look into this because it hasn’t been a big issue for the agricultural sector.

[00:10:42] 3 Major Lender Groups

Brady Brewer: Jenny, I want to turn to you now. Throughout the three articles that you guys wrote you look at the interest rates by major lender categories. What are the lender types that you guys divided the interest rates from?

Jennifer Ifft: So we looked at three major lender types. The first one’s pretty straightforward, farm credit system lenders. These are, you know, for each loan, the producers report what the lender type is. So there’s that one. Also commercial banks, that one’s pretty straightforward. The third category is non-traditional, and so this is going to be largely cooperatives, input finance or vendor, vendor finance from input providers, and then finance from implement dealers or manufacturers. We purposely didn’t include loans from the USDA Farm Service Agency. You know, these loans are really important for producers that, that have difficulty accessing credit elsewhere or just getting started farming, but they’re really not tied to the broader macroeconomic conditions as much as these others. So those would be best to be analyzed separately. There are other lender types as well, but we didn’t have enough data to, to feel comfortable publishing those.

Brady Brewer: Yeah. There are a lot of lenders that service agriculture. If you think about cooperative financing, credit unions, even private equity has become a lot bigger in the agricultural space. But throughout research has been done here recently, those are the three major categories. And I do want to call out, Jenny, you mentioned the non-traditional and vendor financing, I do want to tell readers, we did do a podcast series a little over a year ago on that, led by Jenny, where we looked specifically at the impact of non-traditional lenders in the agricultural space. Because we’ve seen them, really increase their significance and market share in the agricultural sector here over the recent past.

Let’s first look at the time trends. What differences do we see across the ag interest rates as we look across these three lender categories across time?

Jennifer Ifft: Yep. Well, I got another definition for you, Brady. This one’s pretty straightforward too. So we looked at three major loan types. So non-real estate short-term, I’m going to refer to those as production loans, operating loans. And then we have long term non real estate loans. So I may refer to these as intermediate loans.

So intermediate loans, it’s, you know, mostly machinery, equipment, breeding stock. And then you have long term real estate, which I’m going to refer to as real estate loans. So if you look at these over time, first of all, if you go back to 2008, median rates were actually a little bit higher for these lender categories in 2008 than in 2022. However, once we get the 2023 survey, I’d expect those to be higher higher than 2008. 2022 is really just at the start of this increase. But the broad trend is interest rates were pretty high in 2008, declined till about 2014. Pretty stable then, they were up a little bit again in 2018 and ’19, and then down to historic lows in 2020, 2021, and then back up again in 2022.

Brady Brewer: And do we see any differences across the time between the, the different lender categories?

Jennifer Ifft: Definitely. If you start, I’ll start with a real estate, real estate. We just looked at farm credit system lenders and banks. And those have been, those have been pretty close throughout the study period. They weren’t statistically different in most periods. Which we were a little bit surprised at first, but it’s important to note that this is only the interest that’s reported by farmers. It doesn’t look at loan terms, like we said before, whether it’s fixed or variable rate, we don’t know that in every year. And we don’t also don’t account for things like patronage, which is paid out to farm credit system borrow, but the, the real estate interest rates were the closest. And then you did see large differences. So for the short term rates, the lowest median rates were typically vendors or farm credit system lenders, although those differences did tighten in 2022. For intermediate loans, the non-traditionals, that’s mostly implement dealers, but the non traditional lenders had the lowest rates in almost every year. And then the farm credit system also had relatively low rates with the differences decreasing by 2022.

Brady Brewer: Yeah. So you mentioned the, the patronage for the farm credit system. So as a reminder, farm credit system is a cooperative financer. If you get a loan from the farm credit system, you are a member owner of that particular system. So you get, instead of dividends, you get patronage at the end. And I know a lot of farm credit systems. And I’ve heard farmers and lenders say it as well. That’s a lot of times when farm credit quotes an interest rate, they will quote a farmer, a net interest rate, which is net of patronage. So in other words, the interest rate they pay is higher, but they realize it on the back end, they’re going to get a share of the profits of that farm credit systems or that entities profits at the end of the year so that they, they essentially calculate what the net cost of that loan would be, which they call a net interest rate.

So it’s a little hard to compare this. And, you know, you mentioned the duration or the, the fixed versus variable. We also don’t know a lot of other stuff about the farmer and we’ll get into that here later. So we do want to put a slight asterisk on this is that, you know, we can’t really compare the difference of interest rate for farmers of the same risk and stuff like that. There’s, there’s very valid reasons that a particular type of farmer may go to a particular lending institution, which just necessitates maybe a higher risk profile, which would lead to higher interest rates being charged to that lending institution’s customers. So we have to be a little careful of how we make some of, of these statements because we can’t control for farmer type in this type of, of analysis.

So, Noah, I want to turn to you. Jenny gave a little bit of an overview of the different type of, you know, some of the differences we saw between the different lender types of interest rate. Maybe my question to you is you know, what else are we, should we look at here when we look at the different lender types, the farm credit system, commercial banks, and vendors, and why might we see some differences in, in the different interest rates these different lending institutions charge?

Noah Miller: A couple of things here. So one thing I think the note really is sort of the distance between the interest rates that we see for the different lender types. So in general, for short-term non-real estate, those production or operating loans, the differences between farm credit lender rates and vendor rates equaled about 54 basis points on average. And then when we look at banks, they typically, like Jenny mentioned, charge higher. And that, on average, was about 52 basis points more than farm credit system lenders. That being said, the difference between these lender categories was often quite small. And in many years, when we did our statistical tests on these rates, we found them not to be statistically different, meaning that we don’t have statistical evidence that there is a large difference in the actual rates that these lenders charge.

If we look at long term non-real estate debt, those intermediate loans, we see that on average vendors, like Jenny said, are charging lower than the other lenders. But really it depends on who you’re comparing it to. So vendors charged on average 35 basis points less than farm credit lenders, but they charged 84 basis points less than commercial banks. So it’s really interesting to see how those magnitudes are different when you compare different lender types, right?

And then, like Jenny said, for real estate loans, those margins were quite small in terms of the interest rate spread. And so, for real estate loans, because we didn’t have a lot of vendor data or non-traditional data for that, we just focused on the farm credit system lenders and the bank lenders, and for that the, the average difference we saw in rates across the time period was, was 29 basis points.

Brady Brewer: So it sounds like on average, anywhere from a quarter of a percent to half a percent, but not statistically significant for a lot of the data that you were looking at. Now, you mentioned the vendor finances. One question I have is when I hear vendor finances, I think equipment credit or credit for a particular farm input.

So something we’re not seeing here in this data is how the interest rate or loan product that the farmer is getting from some of these non-traditional lenders, how is it being bundled with non loan products, right? Yes, the interest rate might be lower, but the total price that the farmer is paying for, for product may be the, the same, if not higher, if they were to use a commercial bank right. Cause we have to think about this entire, what the farmer is purchasing and they’re purchasing a product to get seed or, you know, a crop in the ground and a loan is just one input here. And that’s all we’re observing. We’re not thinking about the other inputs that the farmer is using to purchase it, which in the non traditional sense is typically bundled.

Noah Miller: Right. So, yes, that’s exactly right, Brady. So the non traditional debt, we often see it’s a bundled product, right, with loan and non loan products. And that is not what you typically see, and therefore, the interest rates are maybe, you need to take that with a grain of salt when you see such low rates on the non-traditional vendor side.

Jennifer Ifft: I’ve done research on seed corn financing and what we found is those that even if you had a promotional financing, sometimes your lower discount rate would still make that more costly.

Brady Brewer: Yeah. So we got to take into account the full bundle. That doesn’t mean the farmer is paying less overall to get the crop in the ground. Noah, I do want to ask one, one final question that’s thinking about how this is self reported farm data.

Gerald Mashange: The fact that it’s self reported means that it is based on individual records, therefore it may not line up directly with what a bank on average charges, right? Because it is based on one’s operation rather than bank reported rates like those in the Kansas City Federal Reserve. And then secondly, I would say is that it is not an exhaustive survey in terms of the loans that are reported. So typically we ask producers to report on the top five loans and we provide additional space to add additional loans. So if producers have a large portfolio of loans, we may not be capturing that entire loan portfolio.

Brady Brewer: If the farmer has more than five loans, we, you know, they could have a loan with a non traditional lender, but if it’s not one of the five they report, then we won’t know about that. Now, most, most farmers have less than five. I say most, it’s a growing share that has more than that, so we are missing out on some with this data set, but, you know, I would say by and large, we’re capturing a good majority of the farm, the loans that the farmers that responded to this survey have.

[00:22:09] Geography

Brady Brewer: So that’s looking at it by time and by lender type, so Gerald, I want to move on to you now and think about it from a geographic perspective. So the first article was looking at it by the lender group and from 2008 to 2022. But how does the farm loan interest vary across the U.S. when we think about it from a geographical perspective?

Gerald Mashange: In our second article, we looked at regional differences and meaning interest rates by lender for borrowers in 2022. And the regions we looked at were the South Atlantic, Midwest Plains, and the western part of the country. So we first looked at aggregating across all lender types, and we saw that median interest rates for production loans range from 5% to 5.9%. But these rates were only statistically different between the Plains and the Atlantic regions. The Plains had the highest median interest rate at 5.9%, and the South and Atlantic had the lowest at 5%. When we looked at intermediate loans, they also ranged from five to 5.9% too, and they were not statistically different among regions. The Plains had the highest interest rate while the South and the Plains had the lowest at 5%. And lastly, with the real estate loans, they range from 4.7% to 6.5%, so quite larger and a larger spread too. But median interest rates were lower and statistically different in the Midwest from the West and the South. And the South had the highest interest rates at 6. 5%.

Now, when we considered regional differences in interest rates by the lender type, we also saw differences of up to 200 basis points for commercial banks and 180 basis points for farm credit system lenders. And interest rates for farm credit system lenders were not statistically different across regions in almost all cases for each type of loan.

On the other hand, those interest rates for short term loans for banks were lower and statistically different in the Plains at 6%, than in the Atlantic at 6.5%, and the South at 6.8%. And for intermediate loans for the banks, interest rates were lower and statistically different in the West and at 5.1% and in the Plains at 6.8%. And lastly, with real estate loans in the South were higher at 6.5%, and statistically different from the Western Atlantic regions, which both had a rate of 4.5%. And generally, we saw no statistical difference across regions for lenders. So I’m emphasizing these interest rates as to show you that there is multiple differences across region by lender. And this was fascinating to see as we went through the analysis.

Brady Brewer: Gerald, I can think of, as you were talking, several things came up to my mind of maybe why we see some of these differences. I mean, first is different crops are grown in different regions of the U.S. So loan requirements are different. The risk of the agriculture in different areas is different. Weather patterns is different. So that’s one thing, but why any other reason why we maybe see some, I mean you mentioned 200 basis points for some of the commercial banks across different regions. That’s a two percentage points is a pretty big difference. Any, any idea why or conjectures why we maybe see some pretty large differences across these geographic regions in terms of the farm loan interest rates?

Gerald Mashange: Yeah, it probably has to do with the specialization of the producer. That’s really, really important as well. And also typically just thinking about the growing season as well different biological cycles of whatever is being produced. That factors in a lot in terms of this too. And I think depending on the geography, the competitiveness of the loan market too. That plays a major role in this.

Brady Brewer: The ag lending market that the farm is in also It impacts what they’re going to pay for their loan. If there’s more competition, more incentive for the ag lenders to compete and lower the price of their loan product.

Gerald Mashange: Absolutely.

Brady Brewer: And I think the risk that you mentioned, right? You know, I, I mentioned different cropping systems, all that stuff, the, the, there’s just a whole lot that goes into this, I think, lends, the geographic region. I mean, here in the Midwest, I pay a lot of attention to the St. Louis Fed data. So I’m in Indiana right now. You know, we’re in the, the northern half of Indiana is the Chicago Fed district. The southern half is the St. Louis. And we see some pretty stark differences with the surveys that those Federal Reserve Banks do. Just because of the different agricultural types. And both of those are covering the Midwest, but north Indiana is a lot different from southern Indiana, a lot more livestock in southern Indiana. So there’s just going to be some differences in what farmers pay because of, because of who they’re lending to.

[00:26:39] Farm Types

Brady Brewer: So I think that’s a good segway into your third article that you guys wrote in this series of FarmDoc articles, where you looked at explicitly, does interest rates vary by different farm types, specifically crop versus livestock? So, what did you guys find, Gerald, I’ll pitch this one to you, what did you guys find? Do different farmers pay different interest rates?

Gerald Mashange: We found interest rates varied more by farm typology than farm specialization. So we grouped our data by farm commodity specialization. So whether the operator had a crop or livestock operation. And we looked at foreign business typology. So that’s where the operation was either a rural residence, intermediate or commercial farm.

We did see that commercial bank rates on animated debt reported by livestock operators were higher and statistically different from farm credit system lenders and vendor rates. However, commercial banks had lower rates than farm credit system lenders for short term debt made to intermediate farms and intermediate debt made to commercial farms.

And lastly, we also saw that vendors provided lower rates to commercial farms on short term debt. but lower rates to rural residence farms on intermediate debt. And interestingly, interest rates charged on real estate loans did not vary in a statistically meaningful way across lenders, farm specialization, or farm business typology.

Brady Brewer: So this means you take two farms that are roughly equivalent, we don’t see a whole lot of difference in what they’re getting charged, but when you start to look at crop typology, that type of stuff, going across the U.S., we do see some differences. Which I think means that the differences we see can be pretty easily explained. You think that’d be a pretty accurate summarization of that, Gerald?

Gerald Mashange: I agree with that. I think we definitely did see that through our analysis.

Brady Brewer: Jenny, as we think about these different crop typologies, and we’ve mentioned this several times throughout this podcast already, but that’s the risk of the farm. How much do we think the risk that the farmer poses to the bank is impacting the rates that we see reported?

Jennifer Ifft: Well it would be shocking if there was no impact. But the question is, how much? And there’s another question that I don’t have an answer to, but I would like to talk about is, you know, when a producer gets into a worse financial situation, does their existing lender continue to work with them, but charge a higher interest rate to compensate for that extra risk that’s going on? Will that producer go out and try to find someone else, a different lender that, that would be able to provide a more competitive rate?

Brady Brewer: I think that’s an important question, Jenny. Theory would tell us that they probably should go out and explore the markets a little. This increases the probability you’re going to get a loan if their risk does increase. There’s been some papers out there that show that this type of behavior does happen. How prevalent it is, we don’t exactly know. I, I think your question for the farmer that does continue to work with their, let’s say they have one lending institution. That would be a super interesting question to ask some farmers about of, did you get charged a higher interest rate as your risk level went up?

Jennifer Ifft: I mean, I’ve heard more anecdotes about them moving on to a different lender, but it’s still, it’s still anecdotes.

Brady Brewer: And when they move on to a different lender, is it a different type of lender as well? Is it from one commercial bank to a commercial bank, or do they switch to the farm credit system, or maybe the non traditional financers? You know, when they switch, what does that look like?

Jennifer Ifft: Well, you know, we’ve both done some research on this, you know, farms can switch between banks. I think that does happen, but sometimes you’ll add an extra line of credit with a nontraditional lender or a vendor on top of your existing, you know, say you have a real estate loan, but farm credit or a bank. So I do think that could take difference.

Brady Brewer: And I know right now part of the motivation for doing this is the increase in interest rates. Anecdotally, I’ve heard from a lot of the ag lenders I work with here in Indiana that when it’s even shown up in the Federal Reserve data that the demand for loans is down because farmers are now currently using working capital, right? So I think it’s also we have to ask not just where they go get their loans once their risk increase, but they can become a lender for themselves, right? Dipping into their own pockets and their working capital. The farmer has multiple options. So their capital structure may change as well, right? They may reduce liquidity in order to ensure that they can get a loan from another lender at the same time. So their balance sheet may change.

Something we haven’t brought up that I want to, that I want to talk about a little bit, and that’s on the bank side. So we’ve been approaching this so far in this episode from the lender perspective, but banks also have to make sure that they have funds available to lend to agriculture as well. And that’s going to impact what gets charged to the farmer. And that is, you know, so we call this the cost of funds. So Gerald, how does the cost of funds impact this?

Gerald Mashange: Well, the prevailing interest rate environment really does determine a lender’s cost of funds. So the Federal Open Markets Committee has increased the federal funds rate at a rapid rate, and this has raised the cost of capital for ag lenders in such a short amount of time. So as long as the federal funds rate remains high, farmers will continue to face high farm interest rates.

Now, the Fed has signaled that they do plan on making rate cuts this year looking at the dot plot it looks like that’s going to be about three cuts totaling about 65 basis points but again, too, you also see on the money market side as well that the rates we’re seeing on CDs and money markets actually starting to slow go down a little bit So it does seem as if the market is slightly adjusting to that expectation of lower rates But again, we only know what we know up until this point in time, and a lot can change until the next Fed meeting, but that’s really what’s driving these funding costs for lenders.

Brady Brewer: Yeah, the Fed has seemed very reluctant to lower their Fed funds rate up to this point. You know, I think a lot of the talk I’ve heard is they don’t want to have a repeat of the 1970s and 1980s. So just as a quick reminder, back then when they had rampant inflation, they were in a very similar situation. The fed raised interest rates, inflation was on its way down and they actually took their foot off the gas pedal, lowered their fed funds rate and inflation came back up. So I think they don’t want to have a repeat of the mistake that happened several decades ago of lowering the Fed funds rate too early. And I think that’s really driven some of the Fed policy, or maybe I should say lack of Fed policy that we’ve seen so far with not having lowering of the fed funds rate to date.

So there’s six we’re recording this here in mid April of 2024. There are six FOMC meetings left here in 2024. Gerald, if, if, you know, if you look at the dot plot, you said three, that means every other FOMC meeting from here on out, you could probably expect a 25 basis point decrease, but we’ll see. It could be that we don’t see a Fed funds rate decrease for the next couple, and then they lower it 50 basis points. They, it may not be as drastic as what they’re expecting right now or what they’re predicting. We may only see two rate decreases. There, there’s a lot open for interpretation and left undecided in terms of FOMC policy.

Gerald Mashange: Yep, totally agree with you, Brady, there.

Brady Brewer: So that has a potential for a large impact of the interest rates that farmers are paying. Something else we haven’t discussed so far that I want to bring up, and that’s regulation. So we’ve divided the interest rates by three lender categories. All three are regulated differently. How do we think this impacts the interest rates that farmers receive?

Jennifer Ifft: It’s a good question. One thing that it actually doesn’t relate to regulation, but I’ll make this point and maybe it’ll spark some conversation. So I have had some conversations with nontraditional lenders and it seems like, you know, in our low interest rate environment, it was harder for them to compete on interest rate alone. And they’re reevaluating that, you know, their, their competitive position right now. And that does relate to cost of funds to some degree. So, I don’t know how much we’re going to pick that up in the in the 2022 ARMS data, but I think it’s definitely something to look at last year and this year and moving forward you know, or some types of lenders and I think the competitive position of farm credit system lenders and banks who can control and deposits that’s changed as well.

So, you know, how that plays out. And who people are getting loans from is another question, but, you know, I have heard that, especially on the non traditional side, that they are, you know, thinking through how they could expand their lending portfolio, potentially because they have a lower cost of funds.

Brady Brewer: Yeah, and their lower cost of funds is typically their own balance sheet, or they have access to equity markets. Jenny, I think a question that, you know, or at least a, something that comes to my mind when, when you mention that is, when you’re looking at maybe either the bond market, your own balance sheet. Given the broader economic engine, i. e., are we in a, in a recession, or what’s going on, maybe, on Wall Street. Investors require a rate of return, so that’s going to be a little bit more variable. So, if we get into an environment where investors are demanding a higher return, ag loans have typically been a very safe investment for people that get into the ag lending markets. But it’s not going to be the super lucrative market that maybe some other sectors of the economy are. You’re going to make 3-5%. It’s a pretty guaranteed 3-5%, but you’re not going to hit the 10, 12, 13% required rate of return that maybe some other sectors are going to give you and that’s just because ag in general has a very low default rate or non performing loan rate. So again, it’s a pretty safe investment But it’s not going to be that home run investment so something i’ve always been interested in and something I don’t have an answer for is what happens when the general economy maybe moves a different direction. Do, do we see, to your point about right now the non traditional lenders may have a cheaper cost of funds than a commercial bank because deposits are paying more? If the general economy moves a different way, do we see the required rate of return increase and that increase the cost of funds that some of these other players in the ag lending markets currently enjoy?

Jennifer Ifft: Right. And I hope we don’t see a recession, I kind of don’t like talking about it, but I think if we do see, you know, a decline in the farm economy the demand for credit could change is that, you know, producers are going to need that operating line is going to become real important. Liquidity is going to become an issue, but you might see lower demand for investment. So, it could look pretty different,.

But back to the point about you know, the, the ag loans are seen as safe. I think, I mean, you have outside investors trying to get in agriculture, whether, you know, it’s farmland, technology, but finance is a part of that as well. So some of these non traditionals, you know, are because that, you know, whether it’s pension funds or venture capital, you’re trying to find a way to make investments in the ag sector.

Brady Brewer: Yeah, it is a diversification attempt for some of these large investors. I know one of the most famous ones is what is it? The Harvard Pension Fund one of the there’s a lot of major universities and major employers I should say not just universities that have foundation accounts or certain investment monies available that invest in agriculture as, as a way to diversify their portfolio, but also because they see a lot of potential in agriculture as well. And this brings a lot of capital for non traditional lenders that become available to loan to farmers.

Jennifer Ifft: You know, and I’ve had people that work in these pensions funds say that there’s just not enough value in farmland markets to be able to invest what they could. So, you know, looking to these other, other areas is important for them.

Brady Brewer: So at the beginning we mentioned that one of the reasons that you guys wrote these three articles was the higher interest rates. But I think another motivation is thinking about what the environment ag is getting ready to get into. So one thing that we haven’t really mentioned is thinking about how this impacts farming, because of what incomes are going to do here for the 2024 growing season or 2025 growing season. What’s happening to the farmer balance sheet. So, Gerald, I want to pitch this question to you. What do we need to be thinking about? Think about the USDA’s farm income forecast, what farmers can expect to happen on their income statement, their liquidity, their working capital management. What could be an additional year of higher interest rates? How could this impact the agricultural sector?

Gerald Mashange: The economic research service published its February 2024, Farm Income Forecast and farm profits are expected to fall in 2024. Now, the net farm income forecast is expected to be 116.1 billion in the calendar year 2024. Which is a decrease of 39.8 billion from last year. Total crop and animal and animal product receipts are expected to fall. And the other contributing factors to the lower forecast are lower direct government payments and higher production expenses. Now, this high current high interest rate environment is going to continue to be an important topic for farmers this year. Fortunately, those three rate cuts we mentioned earlier, our forecast is for the year by the Federal Open Market Committee. So bringing the federal rate, federal funds rate down by 75 basis points from the current 5.25-5.5 percent range. And this will bring some relief for borrowers if the Fed’s expectations do materialize.

Another big topic to look out for is that a large share of farmland loans could be repriced at higher interest rates. So farmland debt makes up about 70 percent of all outstanding agricultural debt. So according to the Kansas City Fed survey of agricultural credit conditions, commercial banks are scheduled to reprice about one fifth of farmland loans every six months, and more than half will assume a new interest rate over the next 18 months. What will be important this year for farmers is that, given all the headwinds they’re facing, is good working capital management.

Brady Brewer: Yeah, so some pretty important implications for agriculture. I think you mentioned especially those for variable rate loans, we could see, you know, it’s not just the new loans being made, but it’s the, the prior loans that are on a variable rate interest could get repriced here over the next year. And that could really increase the percentage of a farmer’s revenue that goes to interest rate payments.

Also, I think the working capital management right now, everything I’ve heard is there’s a lot of working capital out there, but I’ve also heard farmers using their working capital instead of going in and getting an operating note that decreases working capital pretty quickly.

So you mentioned the, the farm income forecast is lower for 2024 relative to 2023 and 2022. A big thing I’m paying attention to is how long. So if we have lower working capital. It’s not just the farm income forecast for the 2024 growing season. It’s what is, what are prices going to do in 2025 as well? Because I think that’s where we could see some shortfalls if we see, continue on that downward trend of, of farm income. These, these higher interest rates could have a real impact to a farmer’s ability to make profit here in a year, year and a half.

So I have one more question, as we were going through and talking about some of the differences we saw, I, I kind of heard that whenever you talked about real estate loans, there wasn’t that much of a difference. So Noah, do you want to maybe expand upon what difference you saw around the real estate loans that were made and the data set you had, and maybe why you didn’t see much of a difference?

Noah Miller: Real estate loans, we really saw that across lenders, everything converged to about the same rate. So, farm credit system lenders were charging the same rate as banks in general across all these different breakdowns that we did. So, across geography, across farm type, across commodity specialization. And one of the things that may make this unique is just based on real estate loans themselves and how they’re backed by the collateral that backs them is similar so therefore the rates themselves are similar where as a short term production or intermediate loans those might have different collateral backings so that might impact that interest rate differentiation we see across lenders.

Brady Brewer: Yeah, ag is a very collateral based industry, right? Farmland is a big asset, and for a lot of those real estate loans, they’re going to be secured by the asset that you’re purchasing. And quite frankly, it’s not a very risky asset. It typically doesn’t go down in terms of valuation, so I would assume that this creates some competition in the real estate loan markets which leads to what we see in terms of no difference among the, the interest rates for real estate loans.

Jennifer Ifft: So from a producer perspective, you may, like for real estate, those other loan characteristics, whether it’s patronage, variable versus fix rate, might be more important. And also shopping around, and I think most producers do this, but you know, it’s not, it’s not just inputs. It’s also credit where that can be important.

[00:44:35] Conclusion

Brady Brewer: So with that, that concludes our discussion on farm interest rates. Please visit us at the Purdue Center for Commercial Agriculture’s website at purdue.edu/commercialag for more farm management news and information. You can also go to the FarmDoc website and that is farmdoc.illinois.edu. You can also go to the Kansas State Ag Manager website, and that is just agmanager.info. On behalf of the Center for Commercial Agriculture, I’m Brady Brewer, and we thank you for listening.

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