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Market turmoil triggers interest rate hikes for ag loans

Ag lenders still have access to capital despite ‘liquidity premium.’

If you’re looking for a farm loan, there’s good news: money’s available.

The bad news is that global market volatility has pushed long-term interest rates higher.

“There’s plenty of capital to go around but the markets are volatile,” says Curt Covington, director of institutional credit at AgAmerica Lending, an agricultural land lender based in Central Florida. “The problem is, it will be more expensive for the time being.”

Liquidity premium

While the Fed recently dropped short-term interest rates to zero, you won’t enjoy much benefit if you’re looking for a 10, 20 or 30-year loan. “The market is charging a liquidity premium in the form of these higher long term rates,” Covington says. “Long term rates go up when there’s uncertainty, and that’s where we are today. While it does not appear that a lender is in danger of not being able to fund a loan today, the borrower will pay a higher rate for a long-term loan compared to just a few weeks ago.”

The current economic crisis is not the same as 2008, say experts. In 2008, LIBOR rates froze, and lenders were crushed because they didn’t have access to capital for loans. LIBOR, which stands for London Interbank Offered Rate, is a globally accepted key benchmark interest rate that indicates borrowing costs between banks.

“Today it’s a crisis in confidence, but it’s not a financial crisis in any respect,” says Covington. “The higher rates are based on concerns over the pandemic, but I don’t see the market having a long-term problem. I expect the markets to correct themselves.”

A number of factors determine loan rates, including a base rate (often LIBOR or the treasuries), and the lender’s expense. In this case, LIBOR and Treasury rates were already adjusting down before the Fed’s latest cut, so the last emergency Fed rate cut didn’t cause as much of a decrease in the LIBOR and Treasury rates as one may expect.

Pause in consumer activity

“Another unique economic response to the Covid-19 pandemic is liquidity in the global financial sector,” says Shawn Smeins, deputy head of Rabo AgriFinance. “Many businesses of all sizes are pulling as much cash as they can from their available credit to weather the pause in consumer activity. At the same time, activity in the global financial markets – an important source for funding in the banking industry – has slowed. Therefore, cost of funds for financial institutions has gone up in a very short timeframe, the by-product of more demand in time of short supply.”

Recession ahead?

Some economists predict the Coronavirus pandemic will push the U.S. into recession. While unemployment claims increase as entire segments of the U.S. economy temporarily shut down, mortgage lenders and investors in commercial bonds and mortgage-backed securities are pricing-in an expected increase in default rates. 

“Decreased optimism in repayment capacity leads financial institutions to price-in perceived risk,” explains T.J. Roemmich, Conterra Ag Capital Senior Vice President. “Tactically, this means lenders must increase the spread requirements on commercial bonds and mortgage-backed securities. In short, banks make hay when the sun shines and capture some of the rate-cut margin in order to sustain general liquidity when financial conditions erode further.”

The refinance question farmers should ask now

The bottom line is, while rates have been historically low, the recent interest rate drop may not be reason enough to refinance. Have you refinanced long-term debt in the last six to eight months?  If so, you have likely already locked in a rate that is competitive in the current market (as of late March 2020), says Roemmich.  If it’s been longer than that, there could still be opportunity to benefit from the lower rate environment.

Meanwhile, the question remains: How long will volatility continue? Covington is optimistic.

“It’s more like a short-time blip,” he concludes. “I absolutely believe the markets will normalize.”

The opinions of the author are not necessarily those of Farm Futures or Farm Progress. 
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