Farm Financial Decisions in a Higher Interest Rate Environment

farmer looking at phone while leaning against tailgate of white pickup truck in a rural setting

Higher interest rates should cause producers to change and sharpen financial habits. We sponsored a panel at the 2024 Commodity Classic to help producers step back and analyze if past practices make sense in a higher rate environment.

Valerie Weis, a commercial lender specializing in swine at Farm Credit Services of America (FCSAmerica), Joe Outlaw, an agricultural economist with Texas A&M University, and David Widmar, co-founder of Agriculture Economic Insights (AEI), touched on topics ranging from early payment discounts to equipment purchases to paying down long-term debt.

Where are Interest Rates Headed?

Borrowing needs for this planting season are the highest many producers have experienced during their careers, Outlaw said. In addition, interest rates have risen for the first time in four decades. Interest expenses across the whole farm sector are likely to hit $35 billion, up from $20 billion to $25 billion in recent years, he said.

Questions about interest rates come up in discussions with nearly every customer, as well as in surprising places, Weis said: “I was in church and my grandpa leaned over. ‘Interest rates going to go lower? Or should I lock in that new farm?’ “

Many have focused on the expectation that the Federal Reserve will lower interest rates in 2024. But dig into the views of the individuals who make up the Federal Reserve and the direction of interest rates is unclear, Widmar said. Individual forecasts from Fed members range from no rate cuts in 2024 to some sizeable cuts. Their forecasts for 2025 and 2026 get even murkier, Widmar said.

“Unfortunately, I think one of the big insights here is there’s still a lot of uncertainty around this interest rate story,” he said. “We’re entering a different era and we’re going to have to start thinking about this interest rate story and how a higher interest rate is going to turn into higher expenses.”

Rates eventually will come down – and likely sooner than input costs, Outlaw said. “What we find in economics is that input costs are very sticky on the way down. That’s a really non-technical term for ‘companies have a hard time moving them down.’ “

Extended Loans Come at a Cost

While interest rates get a lot of attention, it’s important that producers think about how much debt they are using in their operation and the debt they carry.

In the 1980s, short loan terms at high interest rates required producers to make aggressive payments. In the 2000s, payments drifted lower as rates declined. Now that we’re back in a higher rate environment, Widmar said, one would expect annual payments to rise as well. But the data indicates the increase isn’t as dramatic as anticipated. The reason: Extended loan payments designed to keep payments low.

Longer repayment periods are nothing new, but they have become more common in the past year, he said. And they come at a cost in a higher rate environment.

The Federal Reserve uses a hypothetical farm machinery loan for $1,000 to show the impact of extended repayment periods. Total interest expenses (shown below) are at an all-time high, with that $1,000 borrowed in 2023 now paid over five years and accruing $160 in interest expenses compared to $120 in 1987 when interest rates were in the double digits but repayment periods shorter.  

“We can always ask for shorter payment periods,” Widmar said. “But we can also think about the composition of debt we have on our farms.”

Paying Down Long-Term Debt: What to Consider

It might have felt good in the past to pay down long-term debt. But now is the time to step back and analyze if this is the right decision.

Weis said she asks her customers a number of questions as part of the decision-making process, including:

  • What do you think your operation is going to look like in the future? What decisions are you looking to make?
  • Are you looking to buy another farm and is that going to be at a higher interest rate than what you currently have?
  • Can you accept earning less interest on your cash than you are paying in interest to preserve a lower rate and retain liquidity for possible opportunities?

If a producer is not going to take on new debt in the next three to four years, Widmar said, paying down some debt might be a viable strategy. But paying down debt, particularly if you plan to make a major investment, burns through working capital and provides an operator with less liquidity.

“Working capital is our first line of defense in terms of risk management. We really need that liquidity if we’re going to go through a downturn in the farm economy.”

Weiss said during the last downturn, when rates were low, lenders could extend a 15-year loan to 20 years at roughly the same interest rate to lower payments and help restore working capital or provide cash flow relief.

Many existing long-term loans are locked in at rates “that have threes and fours in front of them,” she said. “Even if you take the same amount of debt and roll the loan term back out five years, at today’s interest rates, you all of a sudden have a higher payment, not a lower one.

“When I talk to producers, it’s really about structuring that balance sheet -- making sure they’re providing the best utilization for cash . . . and aren’t leaving purchases sitting in that higher interest-rate operating loan. Pull it out into a term loan. That helps with working capital and liquidity.”

There is no single-answer or silver bullet for managing debt in an environment where commodity prices are declining and interest rates rising, Widmar said. There are trade-offs with every decision. The key is to revisit past strategies and look at them with a fresh eye, he said.

Working Capital to Debt

When an audience member asked how much working capital producers should have for every dollar of debt, Weis prefaced her answer with the standard measure that lenders like to see: $1.50 in working capital for every dollar of short-term debt.

“Now it’s easy to put that into a ratio and say, ‘Yep, I met my ratio.’ But,” Weis cautioned, “it’s harder to look across an operation and say, ‘Do I really have the liquidity that my operation needs to have?’ “

The right amount of liquidity -- or working capital -- differs from one operation to the next, depending on size, scope, geography, commodity and more, she said.

That’s the hardest thing about determining the right levels of working capital and debt – “it varies,” Widmar agreed. “I think everyone is going to have a different preference (for that level) at different points in a career. They’re probably going to be a little more aggressive in some of these (working capital) ratios at the beginning of their career, and they’re going to be a little more conservative at the end of their careers.”

One way to approach working capital is to understand where you are at, set a goal and know why that is the appropriate level to maintain, then work toward it, revisiting the goal regularly and adjusting as needed, Widmar said, advising producers to involve their lenders and other trusted financial advisors in these conversations.

More Financial Topics for a Higher Interest Rate Environment

Prepaid discounts and their opportunity costs, machinery and more are included in the full Commodity Classic session recording. 


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