Episode 74: Navigating Interest Rates in Agriculture: Insights from Dan Ebert

In this episode of AgCredit Said It, host Libby Wixtead dives deep into the ever-relevant topic of interest rates with Dan Ebert, Chief Operating Officer at AgCredit. Together, they explore the historical trends of interest rates, their impact on agricultural loans, and what farmers can expect in the future. Dan shares valuable insights on how interest rates have evolved over the past decades, the primary factors influencing ag loan rates, and the importance of risk management. Whether you're a seasoned farmer or new to the industry, this episode offers practical advice on financial planning and preparing for future interest rate changes. Tune in to learn how to navigate the complexities of farm finance and ensure a stable financial future for your agricultural business. 

 Main Topics Covered

1. Historical Trends in Interest Rates: 
   • Overview of interest rates from the pre-Great Recession period to the post-COVID era.  
   • Analysis of historical data on U.S. Treasury rates and their implications.
2. Factors Influencing Ag Loan Rates:
   • Explanation of how consumer loans are tied to the prime rate set by the Federal Reserve.  
   • Discussion on the correlation between farm credit bonds and U.S. Treasury rates.  
3. Impact of High Rate Environment:
   • Increased cost of capital and its effect on farm operations.  
   • Relationship between interest rates and land values.
   • Challenges faced by farmers due to high borrowing costs and compressed margins.  
4. Risk Management Strategies:
   • Importance of managing costs and maintaining capital strength.  
   • Use of FSA and other governmental guarantees to mitigate risks.  
   • Ensuring adequate collateral to secure loans.  
5. Future Interest Rate Predictions and Planning:  
   • Uncertainty in the market regarding future interest rate trends.  
   • Advice for farmers on evaluating risk tolerance and financial planning.  
   • Emphasis on maintaining strong working capital and avoiding complacency.  
6. Long-term Financial Planning:  
   • Preference for fixed rates for long-term financing to avoid the impact of fluctuating rates.  
   • Importance of not relying solely on borrowed capital for operating needs.
   • Learning from the financial challengers of the 1980s to avoid similar pitfalls.

 

Transcription

Speaker 1 (00:08):Welcome to AgCredit Said It your go-to podcast for insights on farm finance and maximizing your return on investment. Join us as we talk to industry leaders, financial experts, and area farmers, bringing you skillful advice and strategies to grow your farm's financial future ag credit setting where farm finance goes beyond the balance sheet.

Libby Wixtead (00:38):Welcome back to another episode of Ag Credit Said It. I'm Libby Wixtead and today we are going to be talking about interest rates, which seems to be a very popular topic these days. We are lucky to have an internal employee with us. Dan Ebert is our chief operating Officer, so welcome to the podcast, Dan.

Dan Ebert (01:02):Thank you. Glad to be here.

Libby Wixtead (01:03):We are happy to have you. We are going to go ahead and jump right in. As a lender, we are always thinking about interest rates and that is the main topic when we have people come and talk to us. Can you walk us through some historical trends in interest rates and how they've evolved over the past decade, particularly in ag?

Dan Ebert (01:29):Okay, let's go back to the timeframe just prior to the great recession of 2007, 2009, rates probably were at that time in a more normal range historically with long-term real estate lending rates in the seven to 8% range. We then saw an extended period of abnormally low rates in the four to 5% range as the nation and the world tried to recover from the impact of the recession rates then drifted up and down within a range that would still be relatively low historically speaking in the 7% range. Then as we well know, covid hit and we saw rates plummet and stay there for another round of rates that were essentially at all time lows, at least from a modern day perspective. Rates then began to increase back to the seven to 8% range and even higher as the post covid economic recovery played out amid high inflation rates that had not been seen since the 1980s.

(02:25):That leads us in a position where we feel like rates are unusually high, but perhaps they're really a little more normal than what we perceive them to be. We took a look at some month end data going back as far as the 1950s and using US treasuries as a benchmark one year, treasuries have averaged about 4.65% and 10 year treasuries have averaged roughly seven or 5.55%. That spread is 90 basis points, so if you look at this morning rates with one year treasuries at 4.3 and 10 year at 4.4 rates would appear to be still somewhat low and the long end of the yield curve needs to go higher to get back to the normal 90 basis point spread, which would mean 10 year yields at 5.2% or an increase of 80 basis points from where they are now. The other alternative to normalize would be for the one year to drift downward while the 10 year stays where it is until we reach the historical 90 basis point spread.

(03:26):For comparison purposes, the highest rates since the 1950s occurred in the 1980s when one in 10 year treasuries averaged 9.74 and 10.6% respectively. Contrast that with the averages since the start of 2020, which shows one in 10 year treasuries on average being 2.63 and 2.68%, notice that not only are the rates low, but the yield curve is very narrow, almost inverted whether we recognize it or not. We have been living in a very low rate environment. The 1950s were followed by a general uptrend for 30 years to the highs of the eighties and then a 30 to 40 year downtrending rate environment culminating with the remarkable lows post covid, your guess is as good as mine regarding what the next short or long-term trend might be, but do would tend to believe we'll probably see a generally higher rate trend versus going back to the extreme lows we have grown accustomed to.

Libby Wixtead (04:26):Yeah, I think a lot of our farmers now and just I guess in my generation we think these lower rates are normal and that's where when you guys have come back and told us that the rates that the seven to 8% is really where the normal is and that's hard for us to really adjust to that, but just based off of what you said, we are in a normal environment, our normal is the abnormal.

Dan Ebert (04:57):Yeah, it's just hard to know and you've got to just keep it in perspective depending on where you want to look at in a time horizon, and so if you go back far enough you can find similar trends that may have existed, but in general, I think we're at the mid to upper range of the rates we would expect.

Libby Wixtead (05:18):What are some primary factors that are influencing the rates for AG loans?

Dan Ebert (05:24):Consumer loans are generally tied to the prime rate, so they are somewhat arbitrarily set by the Federal Reserve as they adjust the underlying fed rate up and down to regulate the rate of inflation and the level of unemployment. Ag operating loans are often tied to the prime rate, so there's good correlation for those types of loans. However, term loans for equipment and real estate different at those rates tend to follow the general market rates that are determined more by the supply of funds available to lend versus the demand to borrow. More specifically, the farm credit system gets their funds to lend from the bond market through the Federal Farm Credit Banks funding corporation, better known as the funding corp. The cost of those funds correlates reasonably well with US treasury rates moving up and down somewhat in tandem US treasury notes are typically the safest haven for investors, so they typically demand the lowest rates.

(06:21):Farm credit bonds will be priced higher with the spread changing over time based upon the public's perception of the strengths and weaknesses of the farm economy. Loan growth in the system has been relatively strong in recent years driving up demand for farm credit debt. The response from the market has been favorable with an adequate supply of buyers seeking to purchase farm credit bonds leading to a steady market environment. An extended ag downturn could lead to higher funding costs simply due to perceived risks in the ag lending environment. As margins tightened on the farm and potential defaults in the system's loan portfolio, increase available returns from other investments, also impacts the expected returns on funds flowing into the farm. Credit bond market investors seek an adequate return to their funds based upon a risk return formula that meets their personal needs or the required returns for the business. They represent.

Libby Wixtead (07:18):AG loans are priced a little bit differently because of where we get our funding through those farm credit bonds. I just want to just reiterate that our funding is different and that's how our rates are priced a little differently.

Dan Ebert (07:32):Yes, there's no direct correlation with the Federal Reserve and how they set the prime rate through the underlying Fed funds, but there is a lot of correlation over time as rates go up and down. It's just kind of market driven.

Libby Wixtead (07:47):Yeah, so the prime rate has been a big topic here with a decrease in the prime rate with the decrease of the prime rate that's not directly correlated to those fixed rates, is that correct?

Dan Ebert (08:05):You're correct. Yeah, we can get into that here in a little bit.

Libby Wixtead (08:08):Okay, so I think this question, this next question is a question that I get a lot in the office here lately with my customers and I think a lot of people are wanting to know how does ag credit keep up with and how do we anticipate any of the interest rate changes, especially with the period that we're in with economic uncertainty or the inflation that has been occurring?

Dan Ebert (08:39):Great question. Like everyone else, we must look back at history to see what rates have done over time and how rates have reacted in the past during similar economic time periods. The classic example would be the 1980s when inflation was very high and rates double digits and stayed there for close to a decade. Since then, we have seen rates go up and down several times in response to recessions periods of strong economic growth and other factors. Currently, the market is anxiously awaiting how the political changes taking place in January will play out. The marketplace is currently concerned inflation may be more difficult to contain going forward and therefore rates have not reacted quite like many expected when the Fed lowered rates by 50 and 25 basis points respectively. In September and November when the Fed made their first rate cut of 50 basis points on September 18th, 10 year treasury rates were at 3.67%.

(09:37):Many people thought long-term rates would moderate afterwards. However, by November 7th when the Fed made their second cut this time 25 basis points, 10 year treasuries had actually increased to 4.39% or about a 72 basis points increase versus an expected reduction of some amount. Today, as the market expects the Fed to make one more 25 basis point cut tomorrow, 10 year treasury rates remain the 4.4% range. You might wonder why this has happened. No one knows for sure, but we do know that historically the yield curve will have an upward curve as you go out further into the future. In other words, you would expect longer term rates to be higher than shorter term rates. Since we have been in an inverted yield curve for much of the past several years, that is longer rates have been lower than shorter term rates, the market may just be reaffirming the need for the yield curve to normalize. Therefore, either short-term rates need to go down further without any adjustment to long-term rates or long-term rates need to go even higher.

Libby Wixtead (10:46):So what you're telling me is our equipment type loans, interest rates, we would like to see those go down or what people think is our real estate loans, our longer term loans would like to see that increase just to get that normalization of that yield curve. Right now we're very opposite and just very inverted and that's causing a lot of the uncertainty.

Dan Ebert (11:14):Yes, there's no doubt that these last few years have been kind of a very different time than what we would normally experience. We've either had an inverted yield curve or a very flat curve, which has its benefits as a borrower at times, but it also impacts how the economy reacts and then how people then tend to want to look towards the future

Libby Wixtead (11:39):And just we've been in some very, very different in just strange times here as a lending cooperative. What is the impact of a high rate environment?

Dan Ebert (11:53):I think the impact is pretty simple. The cost of capital during periods of high rates leads to much higher interest costs for our member borrowers. This is seen most rapidly in the cost to borrow money to operate. There is a lot of difference in the cost associated with a million dollar line of credit depending on upon the interest rates. When rates were at the bottom, the net cost of a million dollars after patronage may have been at 3% or lower. This would equate to $30,000 of interest. If rates rise to the 6.5% level after patronage, then your costs more than double to 65,000 on an after patronage basis. Unfortunately, as has been the case the past two years, this often happens at the same time, margins are compressing in the commodity markets leading to economic stress to the ag economy, especially those who use borrow capital to run their operation.

(12:50):Interest rates also tend to impact the value of land. Low rates tend to lead to higher land values while high rates tend to lead to decreased land values. This certainly played out in the 1980s when the higher interest rates led to a steep decline in land values. Land is the largest single part of the average farm's capital base. Higher land values support the ability to borrow funds as a need for capital arises. If we were to see a reverse in land values than the capital base of our borrowers erodes reducing their capacity to borrow additional capital, they're being pressed by low income due to high input costs and low commodity prices. Leveraging of capital is a very positive thing when the return on the borrowed funds exceeds the cash flow drain on the operation to cover p and i payments. Conversely, it can quickly become a very negative issue when the cash flow from the leveraged capital cannot meet the cash flow needs to service the debt. Think about the pain you feel when you get your finger caught between a bar and a rock. That leverage is very painful

Libby Wixtead (14:01):For our customers right now. That cost to borrow, especially on their operating loans has doubled and that has been the impact that I've really seen with my customers is the interest cost here this fall going into this next year. They've really felt that this year, especially with the low yields we've had and the higher input cost, it is really playing a role and like you said, those land values right now for us and at least in our area has stayed high for right now. So that is a good thing, like you said, that we can leverage against that, but if that would happen to turn on US, history has kind of showed that's where people could get into trouble with not being able to leverage that value of the land. How does AG Credit approach risk management to protect both the association and its members then?

Dan Ebert (15:04):Well, just like we counsel our borrowers to do, we try to manage our costs and maintain an adequate level of capital strength on our balance sheet to ensure we can meet the needs of our borrowers during the tough times. We adjust our lending standards to match the risk in the marketplace as well as evaluate individual loan requests for the risk involved. We use FSA and other governmental guarantees to reduce both the credit risk and the capital risks associated with a growing loan portfolio. Ag credit also looks to adequately secure loans at an appropriate level based upon the level of risk associated with the loan request. Having hard collateral to collect a loan in the event the borrower is unable to cash flow, the repayment from normal operations reduces the risk. Since our borrowers are the owners of the business, it is their capital we are using when we leverage our capital to make new loans. Being prudent in how we handle their capital investment in the association is just good business. This is all overseen by our board of directors, which is primarily made up of members of Ag credit elected by their peers.

Libby Wixtead (16:13):Yeah, I want to go back to the FSA guarantees. That is such a great way for our company and for our customers to use that program through Farm Service Agency for that reason. Also, I want to go back to the strong collateral piece of it. I know sometimes it seems like a lot of our customers think that we're a little hard on what we're requiring for collateral, but that is protecting us and protecting them as well and that we don't want to have to collect on our customers and take that collateral to repay that loan, but that is one way that we can protect our company, so we are still here. So looking ahead, do you see interest rates staying high for a long period of time or do you anticipate some relief in the near future and how can farmers plan for both scenarios?

Dan Ebert (17:26):Interestingly, there does not seem to be any consensus in the marketplace regarding where interest rates may end up shaking out. While there are expectations for the Fed to further reduce rates over the next year or two, it is all subject to market forces that are yet to play out. And again, it all goes back to perspective. Are the current rates actually high or are they actually at a more normal level? From a historical perspective, I think we could see some reduction in rates, but would be surprised if we see a strong movement downward and unless inflation actually moderates to below 2% and government spending slice deficits or actually addressed effectively any significant recessionary forces should they occur will also play into the equation. Black swan events to the upside or downside can never be ruled out as far as for farmers planning. Basically they just have to kind of look inward and say, Hey, how much risk am I willing to take and get in tune maybe with their own personal financials, their balance sheet, and work with their account officers to see what level of risk they can take on.

Libby Wixtead (18:37):Yeah, it's what your appetite for risk is, and a lot of conversations I think we've had here, we're recording this in December, is what is the cost to hold my grain? What is the interest cost? Thinking about our grain inventory loans right now, our operating loans, because we are trying to cut some costs, and one of those is with the interest cost. How much do you want to pay if you have to borrow? Does that make sense for your operation? So with that advice on how to plan, what is your long-term advice for farmers and agricultural businesses when it comes to financial planning and preparing for future interest rate changes?

Dan Ebert (19:25):Well, each person or operation has to evaluate their personal risk tolerance and analyze the potential impact of changes to interest rates on their ability to generate a profit and maintain an adequate capital position. Variable rates are the cheapest rates often in the marketplace at any point in time. However, as they fluctuate over time, they can significantly impact your bottom line, especially if they go up and stay there for a prolonged period. Fixed rates often are higher than variable at the point of origin of a loan, but they come with the knowledge that the payment will not go up if rates go higher in the marketplace. I personally have the bias towards fixed rates for long-term financing. Since I experienced the high floating rates of the 1980s, both personally and professionally, paying double digit interest rates on land debt for over 10 years was tough, led to many operations not being able to survive back then.

(20:21):There were often no options other than a variable rate. Today, there is a much broader array of interest rate options to fit the needs of each operation. Maintain a strong working capital position so you don't have to rely on borrowed capital for all your operating needs. Don't allow yourself to be lulled into complacency by periods of abnormally low interest rates or years of unreasonably high returns to capital. So when the tough times hit, you find yourself unable to dig out of the hole you've gotten yourself into. That was the story of the 1980s and no one wants to see that repeated.

Libby Wixtead (20:56):Oh, no, absolutely not. I think that complacency comment is very true. Even for now, we've had some high returns in the last couple of years and then we've had the year that we've had this year, and now I think some of my clients feel like they really have to work at it now, and we really have to complete that plan and know how we want to market our grain in the next year or how we need to finesse some of our cashflow needs, and they just haven't had to do that the past couple of years. So I really liked that last comment. I appreciate that. I want to say thank you. We appreciate you Dan joining us and taking time out of your busy season here to join us, so we appreciate you being here. So thank you.

Dan Ebert (21:46):Glad to be here, and I wish everybody a good year in 2025.

Libby Wixtead (21:51):Yes, and the same here from everybody at Ag Credit. We wish you guys a very bountiful year here in 2025. Thank you guys for listening. Just remember, be sure to subscribe to the podcast so you get notifications in your inbox when a new episode drops, and we will see you guys next time. Thanks for listening.

Speaker 1 (22:20):Thank you for listening to AgCredit Said it. Be sure to subscribe in your favorite podcast app or join us through our website at agcredit.net so you never miss an episode.