Author: Kevin Kim

The overall farm financial health remained resilient and strong in the past few quarters. The agricultural loan default rates for both production and farmland loans have decreased in 2022. Observation from the Farm Credit Administration (FCA) also shows that the percentage of nonperforming loans is at 0.47%, a very low number compared to previous years. The total number of farm bankruptcy cases (Chapter 12 bankruptcies) was 169 in 2022, the lowest number since 2004. However, the outlook appears less positive.

We just began the first quarter of 2023 with great uncertainty. On April 28^th, it was reported that the GDP growth rate in the U.S. slowed considerably. The annualized rate of growth was only 1.1%, half of what was forecasted. March inflation rate was higher than the expectation and reached 4.2%. There are signs of recession, including the yield curve inversion observed in the U.S. treasury. There have been massive layoffs in the tech sector, reduced corporate investments, and major bank failures on the West and the East coasts. 

The agricultural sector is expected to be affected by these uncertainties. USDA’s forecast made earlier this year shows net farm income is predicted to drop significantly in 2023, by more than 13%. If we do enter a recession and consumers tighten their budgets, there is a possibility that the impact will be even more severe and extend beyond 2023.

What can we do in the face of all these economic uncertainties? If the farm business is expected to be under financial stress in the worst-case scenarios, taking certain actions can lessen the impact. These actions fall into three strategies to improve the financial situation of the farm business.

Managing Cash Flow

Control costs. Reducing costs is an ongoing challenge for agricultural producers. Evaluate all procedures and purchases and seek ways to improve cost efficiency. 

Reduce or postpone capital purchases and family withdrawals. Critically evaluate purchases and consider repairing for another year rather than replacing.

Other income sources. Consider ways to leverage any excess capital and labor. For example, do you have the equipment/labor/time to provide custom work for other producers?  

Marketing.  Sharpen your marketing plan, and be ready to act on opportunities to lock in profitable prices. 

Renegotiate leases. Approach the landlord with a proposal to reduce the lease payment or shift from a cash lease to a shared lease agreement.

Managing Liabilities

Renegotiate loan terms. Extending loan terms will ease cash flow pressures by lowering loan payments. Refinancing carryover debt or paying interest only for a short term could be negotiated. 

Reduce debt. Reducing debt will certainly relieve some financial stress, but be careful about sacrificing valuable working capital. Although not easy to find, outside equity investment may be a viable source of capital and/or debt reduction.

Refinance. Carefully weigh the advantages of extended loan terms vs. today’s higher interest rates.  Refinancing may not save as much as expected.  If the broader economy moves into recession, watch for declining interest rates and future refinancing opportunities.

Managing Assets

Liquidate cash and investments. If the farm business has maintained a financial reserve of cash or investments, this may be the time to use it to reduce or avoid debt.

Sell inventory and capital assets. If the farm business is holding inventory and waiting for higher prices, consider selling that inventory to reduce debt. If you can do it without affecting operations, selling land or equipment that is seldom used may be a good strategy to generate funds.

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Kim, Kevin, and Brian E. Mills. “Economic Uncertainty and Ways to Prepare for the Worst.” Southern Ag Today 3(19.3). May 10, 2023. Permalink

Photo by Mikhail Nilov: https://www.pexels.com/photo/a-person-typing-on-laptop-7731373/

Rising input and labor costs have already created significant concerns for agricultural producers today. One of the major causes of rising costs is the high inflation rate which now stands at the highest level in the last four decades.

Among some of the options available for the Federal Reserve System (the Fed) for lowering the inflation rate, adjusting the federal funds rate tends to be one of the first options to consider. Indeed, the Federal Open Market Committee (FOMC), a committee within the Fed, raised the federal funds rate multiple times this year. These federal funds rate hikes already had a significant impact on consumer loan rates, including agricultural loan rates. How does this work, and what should we expect for the rest of 2022 and 2023?

First, the federal funds rate is the interest rate at which depository institutions trade federal funds (balances held at the Fed) overnight. The federal funds rate is important because it is the central interest rate in the U.S. financial market. It influences short- and long-term interest rates such as mortgages, loans, and savings. While it is certainly possible that these consumer loan rates may not react to the changes in the federal funds rate, they tend to move in the same direction. This means that when there is a federal funds rate hike, consumer loan interests are likely to increase.

At the beginning of 2022, the effective federal funds rate was at 0.08%, which was significantly lower than the 10-year average of 0.72%. The Fed has maintained a low level of the federal funds rate since the COVID-19 pandemic to ensure enough financial capital is circulating in the economy. Yet, prolonged low federal funds rate and interest rates contributed to the rapid increase in the inflation rate, and the Fed is now rapidly increasing the federal funds rate. From 0.08% in January, the effective federal funds rate now stands at 3.83%.

How have farm loan interest rates reacted to the federal funds rate hikes? USDA’s Farm Service Agency (FSA) provides farm loan interest rates which are updated monthly, and we can observe how farm loan interest rates have changed in the past few months. Operating loan interest rates, ownership loan interest rates, and emergency loan interest rates have all spiked in the past twelve months. One year ago, interest rates for operating, ownership, and emergency loans were at 1.75%, 2.875%, and 2.75%, respectively. Interest rates have more than doubled since then, reaching 4.5%, 4.375%, and 3.75% on November 2022. While the magnitudes have varied, we can see that the farm loan interest rates have moved in the same direction as the federal funds rate. Farm loan interest rates issued from commercial banks are not available on a monthly basis, but these rates also tend to move in the same direction.  

What should we expect for farm loan interest rates for the rest of the year and 2023? The consensus is that the Fed will increase the federal funds rate significantly for the rest of 2022 and 2023. The current forecast is that the FOMC will increase the federal funds rate to 4.4% by the end of this year and to 4.6% by the end of 2023. This will inevitably result in continued increases in farm loan interest rates as well. This means that cost of financing will increase for the next few quarters, especially for new loans and existing floating-rate loans that do not have fixed terms. We expect the federal funds rate to lower to 3.9% and 2.9% for 2024 and 2025, making it doubtful that we will return to the favorable loan terms from 2020 or 2021. 

Author: Kevin Kim

Assistant Professor

kevin.kim@msstate.edu