Ep. 113 Interest Rate Strategies for Today's Farmers

Interest rates have been on a wild ride, and for farmers, the stakes have never been higher. In this episode of AgCredit Said It, host Libby Wixtead sits down with Scott Parker, AgCredit's Vice President of Operations, for a deep and practical conversation about what today's interest rate environment means for agricultural borrowers.

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. AgCredit Said It, where farm finance goes beyond the balance sheet.

Libby Wixtead (00:40):Welcome back to another episode of AgCredit Said It where we take you beyond the balance sheet. I'm your host, Libby Wixted, and today with me I have Scott Parker, AgCredit's vice president of operations. Welcome, Scott.

Scott Parker (00:53):Glad to be here, Libby.

Libby Wixtead (00:54):Yeah, we're glad to have somebody internal come and be on the podcast with us. So we're going to be talking about interest rates today. For those listeners who may not follow interest rates closely, can you give us a quick overview of how rates have changed over the past few years?

Scott Parker (01:11):Yeah, it's been a roller coaster for sure. Basically from 2002 until shortly after COVID, we enjoyed some of the lowest interest rates that anyone has seen over that timeframe, and it made paying interest much more palatable. It made picking an interest rate much more easy. And then we kind of went through a rapid inflation there post - COVID that pretty much increased rates to 40-year highs. And when I say 40 years, that's not even getting back to the 1980s, that was still 1990 - ish. So yeah, it's been a roller coaster and we've come down off those highs, but still significantly elevated from what we came accustomed to during that lower time of interest rates.

Libby Wixtead (02:03):Absolutely. I feel like my generation is like, "What the heck is going on?" When really we don't know what you could say is normal. So how does today's interest rate environment compare to what you've actually seen over your career in agricultural lending?

Scott Parker (02:22):Yeah, so for context, I started my lending career in 2005, January of 2005 to be exact, and I just went back and looked through interest rates. And typically on interest rates, obviously everyone thinks about operating loan rates, which is your federal fund rates, your prime rate, which is the variable rate. And then there's also fully fixed rates, which is primarily priced off of a combination of three and five-year treasuries or bonds all the way up to maybe 20 to 30-year bonds, but it's usually a mixture of all those. So I went back and looked and basically since the year 2000, the five-year treasury was below 5% pretty much since the year 2000 until the recent spike post - COVID. And 80% of that time since the year 2000, the five-year treasury was below 3.75%. Similarly, the Fed rate, which is the rate that's used to create your operating loan rates, your prime rates, it's been below 7.5% since 1992, and 50% of that time since 1992, it's been under 3%.

(03:39):As you can see, both of those rates enjoyed a lot of time well percent. So in my lending career, it was a fairly low interest rate environment, and we just recently saw a spike now, which is just bringing up thoughts of the 80s, but also just thoughts of having to think differently about interest rates and understanding what all rate products are out there that could help you reduce some of your interest costs.

Libby Wixtead (04:13):Okay, so you've talked about the variable rate and then we've talked about our fixed rates. So when the Fed, let's say they lower prime or they increase prime, does that mean that the fixed rates are also lowering and increasing all at the same time? Does a prime rate drive all of that when the Fed decides to do that?

Scott Parker (04:35):Yeah, so there's no direct correlation. If there was, we would all be able to mimic what the market tells us, invest a lot of money, and we wouldn't need to talk about interest rates because we would just make money off of them. So it's not quite that simple. There is no direct correlation, but typically short-term rates reflect short term. What's the market requiring in the short term to cover risk? It's all about risk versus return. Overarching in the lending sphere, the cost of money is not that complex for a subset of specific credit requirements. So if you're a good credit individual and you're talking to three different lenders, there shouldn't be a whole lot of difference between the rates. It's about the products, it's about the value added service and the flexibility of those rates. The underlying cost of money, it all starts in the same spot with US treasuries.

(05:36):If you're dealing with a lender or bonds or CDs, that kind of dictates that. So the short-term money is what the current market dictates. As you get longer out, then it's a different risk profile. There's no easy answer, I guess, is what I'm trying to say. You have to look at the yield curve. If they're trying to cool off inflation, then they're going to raise rates short-term much higher. And there's times where it gets inverted. Everyone talks about an inverted yield curve. A recession is shortly thereafter. And once a recession hits, we've seen in the past those short-term rates quickly come down And the yield curve turns more of a more positive slope where short-term money's cheaper than long-term money. In general, that is always the case. There's just always those blips due to economic or geopolitical issues that causes those fluctuations in the yield curve.

(06:37):Typically, long-term rates are more forward-thinking. They've already taken account what's maybe not happened yet in the short-term.

(06:45):So for example, right now the Fed's talking about, "Well, maybe we want to increase rates because inflation isn't cooling off enough." Well, we've kind of seen our long-term rates increase a little bit because of that sediment trying to predict what the Fed is going to do with the short-term interest rate policy. And right now it's on that fulcrum point where it could go up 25 basis points, could go down 25 basis points. We anticipate a more normal yield curve where we see short-term rates continue to be cheaper than long-term rates. So to answer your question though, when the Fed rates, that doesn't necessarily mean long-terms are coming down. Most likely the market's already priced in that movement in short-term rates into the long-term interest rate bond or treasury market. Yeah. I guess the more simple way to put it is short-term rates is truly a function of the Federal Reserve policy.

(07:43):What are they trying to do? Are they trying to cool down inflation? Are they trying to motivate the market to grow, the economy to grow, which would mean lower rates? Typically, the long-term rates are going to try to get out in front of that one way or the other. But traditionally, your short-term rates are going to be cheaper than long-term rates. And like I said, if that gets inverted, that's a telltale sign of a recession hitting potentially shortly thereafter. Historically, we've seen that cause rates fall down to the historical lows that we saw after the 2008 mortgage crisis and other previous events.

Libby Wixtead (08:27):Why don't we look back at the past interest rate cycles and what lessons stand out for farmers and agribusinesses?

Scott Parker (08:37):Yeah, so the thing that I think that I've seen because of what happened here in the last couple years with a large increase is you got to pull back and think about what different rate products are out there to maximize what the market's giving us. During that time from 2002 until shortly after COVID, it was a pretty easy decision. Fixed rate loans were very attractive. In agriculture, equipment and land were much cheaper than they are today, so your interest cost was not as inflated for the asset you were purchasing. For $5,000 an acre dirt at a 5% interest rate, that was 20. What is that math? $250. Now we're 15,000 acre dirt at 7%, so that number's more than doubled on a per acre basis. So it's a bigger piece of the pie, and we all know that pie is getting windled down with increase in expenses everywhere else.

(09:49):So that's the biggest thing that I see is we didn't have to worry about the interest costs as much as we do today because we're getting hit both with inflated prices for pretty much everything tied to agriculture as well as interest rates that are two, 3% higher than what we've normally were accustomed to for that 20, 25 year period.

Libby Wixtead (10:13):How have farmers historically managed through higher interest rate periods successfully?

Scott Parker (10:19):Flexibility. Best way to handle the changes in interest rate markets is to make sure you're working with a lender that's communicating with you on their interest rate options that are out there and really making sure you understand the flexibility of those products. Typically, there's only three types of products. You can do a straight variable rate, which you're living and dying by the Fed policy. There's adjustable rate mortgages where you can fix it for a period of three, five, seven years, and it could be amortized over a normal 20 to 30-year period or fully fixed. So in every rate market, the yield curve can tell you what product may give you the best value, but we all know that if you're going to create value on the interest rate side, you're going to have to take some risk. That's just the function of the market. If you don't want risk, then you have to have a fully fixed rate, so the market doesn't reward you for that.

(11:23):So you manage it by understanding your personal risk bearing ability, both just your personal attitude towards it as well as what your personal financial situation allows you, how flexible your financial position allows you to be.

Libby Wixtead (11:42):Yeah, I think that's a very good point there on how flexible your financials are and what you can handle. I think that's the conversations I have is what's your risk tolerance with a lot of my clients currently? Scott, we want you to look at your crystal ball and tell us what's exactly going to happen. I'm just kidding. How does inflation, the Federal Reserve's decisions and the broader economic, broader economy influence what farmers may see in borrowing costs?

Scott Parker (12:14):Yeah, so hopefully we're kind of through the real volatile period of what policy or politics may do to the interest rate market. Unfortunately, like you said, we don't have a crystal ball. We can't predict what additional geopolitical risk there is from issues that are going on in the Middle East or Russia, Ukraine or China, Taiwan, name your pick. There's so many things out there that could truly be an event that we can't prepare for. But just from a broader data standpoint, that's what our Federal Reserve is looking at. That's what the world is looking at, and people want to revert back and think about what happened in the '80s. Well, the '80s was a direct issue of our country and our economy. The world has changed tenfold in terms of it's really a global financial machine that's been built versus just one country having to rely on their own unless they're a developing country, which obviously we're not in that realm anymore.

(13:22):So inflation is the one thing we have to pay attention to. The Fed is purely focused on inflation right now to determine which way they want to move the Fed rate. Earlier this year, they were predicting maybe 50 to half a percent to 1% drop in the Fed rate going into 2026. And about two months ago, it was a pretty strong likelihood that we were going to see a half a percent increase by the end of this year.

(13:54):Over the past 30 days, inflation numbers have cooled off, so we have seen maybe it's more of a flat to 25 basis points plus or minus by the end of the year. So I think what we can say for sure is we don't see any major change in policy that says rates are going to go up or down. As I said earlier in the podcast, the longer term rate, the bond market, the treasury market,

(14:24):They're trying to get out in front of what the Fed policy is. So we have seen long-term rates increase, what, 34, maybe a half percent in some cases during the summer months because the market was saying, "Hey, inflation isn't cooling off. I think we're going to have to raise the Fed rate here sooner than later." So I think that's why we saw long-term rates increase. So once that gets more certainty in the market and let's say the Fed doesn't increase or lower rates, you may see some of those long-term rates trickle back down to where they were pre the Iran conflict.

Libby Wixtead (15:03):What should farmers keep in mind before assuming borrowing costs will quickly return to previous lows?

Scott Parker (15:13):Yeah, so I think you just have to keep an eye on what the general economy is doing. If the recession words start flying around and GDP is set to drop or go negative, those are some of the triggers that could potentially push us significantly lower in interest rates. I think we're going to be in a more traditional interest environment where rates are going to be in that five and a half to seven and a half percent range depending on if you're looking at short-term or long-term rates. I think that's just where we need to expect that we're going to be for a while, and that's where knowing what products are out there and working with a lender that can explain all the different rate products and features and benefits is important.

Libby Wixtead (16:08):So if interest rates would happen to decline, should farmers look into maybe getting some lower rates on some higher cost loans? Is that a possibility?

Scott Parker (16:21):So we're always looking for ways to save our borrowers interest cost, and that's one thing you want to make sure as you work with your lender, you understand what their options are and how frequently they can look at it and what the process is to lower interest rates. Anytime rates drop, whether it's short-term rates or long-term rates, it's an opportunity to have that conversation.

Libby Wixtead (16:45):So that's another thing to keep in mind too with the high costs that farmers are seeing is that they can somewhat control that interest cost if they are somewhat paying attention to what's going on in the rate environment. How can rising interest costs affect decisions around land purchases, equipment upgrades, or operating lines of credit, especially with the input costs going up? I see the operating lines of credit being a hot topic here going into the fall.

Scott Parker (17:13):Yeah, almost every line of credit is priced with a variable interest rate. Right now, that rate is lower. It's the lowest rate out there in terms of pure costs, so it is the cheaper rate, so that is a benefit, but like we talked about, it's an elevated rate compared to what we've seen historically. In Ohio, we have the Ag Link program, so we have a very high percentage of our borrowers utilizing that program that can save borrowers anywhere from one to 2% depending on the timing of the bond and the product that the state offers.

(17:50):And then the only other way to save money on interest is to figure out ways not to borrow as much. So we understand that that's easier done, but there's no one silver bullet. When rates are high, it takes a combination of a lot of things to reduce that interest cost and using a variety of interest rate products to reduce costs, just reducing your borrowing needs, and looking for those other third party supplemental programs to help reduce costs like the AgLink program are the three primary ways. Decisions around land and equipment. So land is a longer term investment, so you have to think about it from a longer term perspective of interest costs. So you just have to think about how long do you think that loan's going to be? How long is it going to take you to pay that loan off? If you think you can pay it off in 10 years, why do a 30-year fixed?

(18:45):Just something to think about. If you really think you can pay it off quicker, then maybe an adjustable rate or variable rate could make sense. But if you're really wanting to be safe, then a fixed rate could be the right choice. Equipment, those loans are typically five years and less, so you probably could take a little bit more aggressive stance and maybe go with a variable rate on those to try to save a little bit of money, knowing that you're going to have that loan paid off fairly quickly, less than five years typically.

Libby Wixtead (19:15):We kind of mentioned this a little bit earlier when we were talking about the impact of interest, and I made the comment about young beginning farmers, and this next question makes me think about how interest rate changes can impact your cash flow, working capital and overall repayment capacity.

Scott Parker (19:36):Yeah, so any expense directly affects those three primary financial ratios. As we talked about, as the cost of equipment and the cost of land, just the cost of capital has significantly increased. You just have to think a little bit harder about how that interest cost affects your cash flow and your return of your ROI in terms of what you're going to get back from investment. So the pencil's got to be a little bit sharper. A few other things that you might want to consider is the timing of that interest payment.You may want to make interest payments monthly so you're not hit with that big interest bill at one time of the year. If it is going to be an annual interest payment, tying that up with your cash flow appropriately. And for our grain farmers, maybe that's matching up your marketing program to your larger payments, whether it's interest or principle and interest or whatever it may be.

(20:42):So having a plan, knowing what your costs are, your breakeven, what price of corn do you need to have to cover all your fixed costs to help you maybe make that marketing decision all plays a role potentially in helping those cash flow, working capital, repayment capacity, because a lot of times those three things are just their tightness for one time of year or one period of the year.

(21:10):So you just want to make sure things are aligned appropriately so that the cash is there, you're selling the grain maybe ahead of time when there's a price that you know covers a certain percentage of your cost.

Libby Wixtead (21:27):Yeah, I will say I had this conversation with one of my clients the other day and we kind of had that light bulb moment because I had encouraged them to create a cash flow with all of their payments through January through December and then had that light bulb moment of, "Oh, why don't I just contract, forward out contract in each of those months to cover my payments and then I'm not going to have that cash flow pinch and also can be forward thinking on making money on that." So I'm glad you brought that up on that because that was a very, very big light bulb moment for that customer, especially this time of year when every little penny matters. So we've talked a lot about different products, variable rate versus fixed rate. How does AgCredit work with borrowers to model different rate scenarios and understand the potential for cashflow impacts?

Scott Parker (22:29):Yeah, so the biggest thing that we can help our borrowers with is just showing them the raw numbers. We can show them what their after interest rate is after our patterns program. We can show if that loan stays on the books. We can show our borrowers how much money they'll save in the first five years of the loan comparing a variable rate, a fixed variable or a fully fixed rate so they can see, "Hey, if I do a five-year adjustable rate mortgage and it's going to save me a half a percent, how much money does that save me over that five-year period compared to a fully fixed rate?" And then it's really a decision, is that worth the risk of rates not changing for five years or increasing? If you look back over time since 1990, there really wasn't any period where if you did a five-year loan, you didn't have an opportunity to either lock in another rate at the same level or a rate below that initial rate.

(23:38):There was never a period longer than five years where you didn't have that option. So that's something we can do because at the end of the day, it's about how much money you can save. Is the reward greater than the risk for your personal financial position?

Libby Wixtead (23:56):Okay. What financial information should producers have updated before talking to their lender about rate risk?

Scott Parker (24:06):Yeah, obviously we want them to have a good idea to know where they are from a repayment capacity standpoint, which that's something that we can help them with as long as we have a good balance sheet in two to three years of earnings, that gives us a lot of baseline information, but that doesn't answer a key question that we need to know when it comes to talking about interest rates, and that is where are you at in your operation? Are you looking to grow in the future? Are you looking not to. You don't anticipate any large purchases in the foreseeable future? And more importantly, equipment's a big one. Is there a risk that you're going to have to replace some big pieces of equipment?

(24:51):And you start throwing some of those factors into an interest rate discussion, what you have to watch out for is you don't want to take too much risk if you have more uncertainty in the future in terms of what your operation may need or growth opportunities. So it's really a very individual prescription about what may or may not fit for an individual operation. So you have to start with the basics, the data that we know is to be true, and then we start have to throw in those what if scenarios and then make a decision.

Libby Wixtead (25:32):Yeah. So how often then should farmers review their debt structure and interest rate exposure?

Scott Parker (25:39):Definitely, it's an annual sit down at a minimum with your financial advisor or lender is strongly encouraged. I don't necessarily expect a farmer to be paying attention to the interest rate and bond market on a weekly basis or even monthly basis, but I think it's something that you should keep somewhat of an eye on a quarterly basis, just knowing if the Fed has moved their rates or if US Treasuries has changed much quarter over quarter, just to get an idea of what may be going on. That being said, at AgCredit, we strive to look at that weekly, daily, in some cases for our members. That's what your lender should be doing. That's what we're here for.

Libby Wixtead (26:22):So what questions then should farmers be asking their lenders right now?

Scott Parker (26:28):They should be asking any questions they want.

Libby Wixtead (26:33):I like it. I

Scott Parker (26:34):Mean, really, there's no such thing as a bad question. We're here to answer questions to our best for ability, give them the information we have. Unfortunately, we can't necessarily predict the future, but we can give ranges for a period of six to 12 months and not be too far off. That's the nature of the business. We do have the flexibility with our rate products, so again, there's no rate product at AgCredit that's going to basically not allow you to take advantage of a lowering rate environment in the future. Making sure you understand all your options and just asking any questions and every question you can ask helps us come to that conclusion of what will be the best rate product or option for you.

Libby Wixtead (27:26):How can farmers, let's say they're going between AgCredit and another lender, and they're trying to talk rate and they're trying to compare apples to apples, but really it's apple to orange, what questions can they ask so they fully understand what rate products they are trying to compare?

Scott Parker (27:48):I'll go back to an earlier comment I made around the cost of money. The free market we have in the United States ensures that there's not a huge discrepancy in what someone's able to get from an interest rate for a similar credit risk. So if you're getting quoted one rate from one lender and you're getting a rate from another lender, when I say lender, I'm saying reputable lender, and there's a significant difference in that rate, more than a half a percent, that should be a red flag that maybe you're not comparing apples to apples. There's just a lot to an interest rate more than just an actual number. We're going to ask a lot more questions at AgCredit because we truly want to educate our borrowers and understand, make sure they know exactly what kind of interest rate they're getting. And that's the biggest thing they need to do is just continue to ask questions.

(28:45):Well, what if this happens? What if rates go down in 90 days? What if rates go down in 12 months? What if rates go down while we're already negotiating or repricing the loan? If I pay extra, can I lower my payments over the remaining life of the loan? There's just so many things that you don't necessarily know what's going to happen, and the only way to get an idea is just to ask all those questions, and a good lender will want to walk you through all those options versus just give you an interest rate because any lender can throw out their best rate,

Speaker 1 (29:25):But

Scott Parker (29:25):If they don't fail to tell you the features and benefits of that rate, then what good is that to you necessarily?

Libby Wixtead (29:32):Yeah, absolutely. Okay. Lastly here, Scott, if you had to leave Farmers with one message about interest rates and financial planning, what would it be?

Scott Parker (29:44):We have so much information that comes at us today,

(29:50):Social media, just all the people we interact with on a daily basis to run a farming operation, the news, it's constantly coming And it's hard to decipher what's real and what's fake. I hate to say it, but it's really hard. And you can't be everywhere all the time. You can't know everything about everything that you need to do or all the decisions you need to make on a daily basis. So what I encourage you is to make sure you use partners within your operation that you can trust so that you don't have to be the expert. And I'll throw in a plug for AI. I know some people may not like it, but if you don't know what questions to ask your seed dealer or questions to ask your loan officer, I encourage you to play around with one of the AI tools and just ask it and see what it says.

(30:51):And it's going to give you real time questions that are somewhat aligned to what's going on in today's economic world to help you focus and narrow in on the topic that you're interested in. And then just use that to become more educated, use it to ask more questions. And over time, I think that'll help you realize who those trusted partners need to be, who rises to the top and can be the most benefit to you and your personal situation.

Libby Wixtead (31:26):Yeah, absolutely. I think the listeners who have heard me as a podcast host understands that I have told them, get your board of directors for your operation and those professionals that you trust. And I would agree with Scott here that AI is a great tool to use and you just have to obviously use your mind and make sure that the information you're receiving is correct. But I think it is a great tool to use and just get those questions down and maybe understand, let's say your loan officer is throwing out all this lingo that you don't understand. Stick it into AI and see what you can learn from it. I agree with Scott on that being a great tool. Scott, I would like to thank you for sharing your expertise on interest rates for us and our listeners today. We really appreciate you taking the time to be with us.

Scott Parker (32:16):Appreciate your guys' time and glad to be on the podcast.

Libby Wixtead (32:19):Thank you to everyone for tuning in to another episode of AgCredit Said It. We'll talk to you next time.

Speaker 1 (32:32):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.