Southern Ag Today

Author: Ryan Loy

  • Crop Insurance as a Safety Net for Operating Loan Obligations

    Crop Insurance as a Safety Net for Operating Loan Obligations

    Using crop insurance to guarantee debt obligation coverage is one of many ways insurance can be used as a risk management tool. Additionally, adequate crop insurance will often be a lender requirement on operating loans. Operating loans are typically revolving lines of credit that assist in covering pre-harvest expenses (e.g., seed cost, fertilizer, fuel, etc.). Table 1 below contains example revenue and pre-harvest expenses that might be incurred by a soybean and cotton producer in the southern region. Assume an example soybean producer in Crittenden County, Arkansas and a cotton producer in Lubbock County, Texas, where the farm-level soybean and cotton Actual Production History (APH) yields are equal to the state average of 50 bushels per acre and 1,196 pounds per acre, respectively. Furthermore, we assume the Projected Price for the 2024 growing season to be $12.60 per bushel for soybeans and $0.87 per pound for cotton. 

    Table 1. Simplified Sample Budget for a Southern Soybean and Cotton Producer

    Revenue  SoybeanCotton
    APH YieldPer Acre501,196
    Projected Price (USDA-RMA)$12.60/bu$0.87/lb
    Expected Revenue (446 Acres)$280,980.00$464,072.00
    Pre-Harvest Expenses
    Expected Pre-Harvest Expenses (446 Acres)$144,058.00$247,084.00
    446-acre farm size was derived from Farms and Land in Farms, February 2023 Summary. Pre-harvest expenses are derived from budgets across the southern region.

    Consider a producer who finances an operating loan to cover their pre-harvest expenses (e.g., $145,000 based on a 446-acre soybean operation). Additionally, they elect to use Revenue Protection (RP) crop insurance to guarantee a level of revenue. For example, at a coverage level of 50%, a soybean producer would be guaranteed $140,490 based on an expected revenue of $280,980 ($280,980 * 0.50 = $140,490). The question becomes, at what level will the RP guarantee cover the entire operating loan obligation in the case of a complete loss? Additionally, we consider a producer taking Catastrophic Risk Protection Endorsement (CAT) coverage that triggers in the event of a yield loss of 50% or more. CAT coverage provides producers with low-cost coverage on 50% of APH yield and 55% of the RMA projected price (Biram and Coble, 2023). We assume total yield loss (e.g., 0 bushels per acre). Tables 2 and 3 below highlight realized returns to a soybean and cotton producer net of their operating loan obligation. Returns are compared over an interest rate range of 5% to 10% (.5% increments), and RP elected coverage levels from 50% to 65% (5% increments).

    Table 2. Returns Above $145,000 Operating Loan (Soybean)

    *Note: CAT coverage levels based on data in Table 1 for yield and projected price are 25 bushels and $6.93, respectively. CAT coverage administrative fees are $655.00 for each crop per county. Per acre RP premiums for Crittenden County, Arkansas Soybeans are $7.20, $9.06, $10.51, and $13.87 for 50%, 55%, 60%, and 65% coverage levels, respectively.

    Table 3. Returns Above $250,000 Operating Loan (Cotton)

    If the dollar value within Tables 2 and 3 is positive, then operating loan debt is covered with additional funds to pay other obligations. If the amount is negative, a producer would be unable to re-pay their entire operating loan only using RP or CAT indemnities. It’s important to note that pre-harvest expenses are only an estimate. We assume an annual interest rate with the producer paying the operating loan in one lump-sum at the end of harvest; that is, if the annual interest rate is 5% and payment is made at the end of harvest (assuming 9 months) with an operating loan of $145,000, the final payment will be $150,529 (principal plus $5,529 accrued interest).  

    Crop type plays an important role in this decision since positive cash flow is heavily dependent on coverage levels and operating loan interest rates for a specific crop. Also, under no circumstance does CAT coverage ensure either producer can cover their operating loan debt at the representative loan, farm size, and crop type. Tables 2 and 3 show that operating debt coverage based on a 50% RP coverage level will be negative regardless of crop type. Increasing coverage to 60% would mean a soybean producer could guarantee covering their operating loan, while a cotton producer needs at least 65% coverage to guarantee operating debt repayment in the event of a catastrophic loss.  

    References

    Biram, H.D. & Coble, K. H. (2023). A Brief History of Crop Insurance. University of Arkansas System Division of Agriculture, Cooperative Extension Service Fact Sheet No. FSA70. (Link)

    USDA-NASS. (2023, February). Farms and Land in Farms 2022 Summary. Retrieved October 12, 2023, from https://downloads.usda.library.cornell.edu/usda-esmis/files/5712m6524/bk129p580/2z10z2698/fnlo0223.pdf.

    USDA-NASS. (2023, January 12). Arkansas Crop Production. Retrieved October 12, 2023, from https://www.nass.usda.gov/Statistics_by_State/Arkansas/Publications/Crop_Releases/Annual_Summary/2022/arannsum22.pdf.

    USDA-RMA. (2023, October 1). RMA Price Discovery. Retrieved October 12, 2023, from https://prodwebnlb.rma.usda.gov/apps/PriceDiscovery/Reports/CurrentPeriods.

    Loy, Ryan, and Hunter Biram. “Crop Insurance as a Safety Net for Operating Loan Obligations.“ Southern Ag Today 3(43.3). October 25, 2023. Permalink

  • What Does a Government Shutdown Mean for Farmers?

    What Does a Government Shutdown Mean for Farmers?

    As we approach the end of the U.S. government’s (USG) fiscal year, the probability of a government shutdown seems imminent. The USG has until tomorrow (September 30th) to reconcile differences in government spending before they ultimately shut down for an unknown period (Cassella, 2023). The issues arise in Congress where disagreements on government spending based on ideological lines have paralyzed the passing of funding bills needed to keep the government running beyond September 30, 2023. To avoid a government shutdown, Congress has several tools at its disposal, ranging from passing a short-term Continuing Resolution to passing all 12 appropriations bills (e.g., funding allocations for government agencies). Keep in mind that President Biden must also sign whatever Congress passes by the end of day on September 30th (Committee for a Responsible Federal Budget, 2023). Otherwise, a shutdown is nearly impossible to avoid. Incidentally, the 2018 Farm Bill also expires tomorrow. While we touch on that below, farm bill reauthorization is currently taking a backseat to efforts to fund the government.

    What does a shutdown mean for farmers?

    Besides a shutdown impacting everything from social security, national parks, and air travel, the agricultural sector may also be heavily affected. Namely, the Farm Service Agency (FSA), Natural Resources Conservation Service (NRCS) and Rural Development offices are expected to close (Bickelhaupt, 2023). For a producer who participates in government programs, these agencies likely will not hold sign-ups, accept acreage reports, or issue participation payments during this time. While the length of a government shutdown would ultimately determine the overall impact to the farm sector, folks expecting payments for participation and/or wanting to enroll in a new program will likely feel the impacts shortly after the shutdown. 

    What about farm bill expiration?

    Importantly, the prospect of a government shutdown and the expiration of the farm bill are two separate issues – they just happen to be occurring at the same time.  However, the difficulty incurred in avoiding a government shutdown further highlights the challenges Congress faces in reauthorizing the farm bill. For producers, the impact of an expiring farm bill would likely not be felt until early 2024, because the current programs like Price Loss Coverage (PLC) and Agriculture Risk Coverage (ARC) run through the end of this calendar year (Zimmerman, 2023). If farm bill expiration were to stretch into the New Year, USDA would need to pay out commodity price supports as laid out in the 1938 and 1949 Farm Bills; meaning, the USDA would be forced to purchase commodities such as milk, wheat, and cotton, at “parity prices” that are on par (in terms of purchasing power) with levels in the early 1900s (e.g., $50.70/hundredweight for milk based on May 2023 data). These price supports could mean that the U.S. government would “outbid” commercial markets and ultimately raise the price of retail commodities (Congressional Research Service, 2023). With respect to farm bill expiration alone, government programs such as SNAP (Supplemental Nutrition Assistance Program) and crop insurance would likely not feel the same impacts. SNAP is an appropriated entitlement, and Congress likely would continue funding SNAP via the appropriations process (although we discussed above how that process has unfolded this year) and thus could continue most programs. Crop insurance is permanently authorized and funded by the Federal Crop Insurance Act that does not expire with the 2018 Farm Bill (Congressional Research Service, 2023).   

    References

    Bickelhaupt, H. (2023, September 18). A Government Shutdown Could Impact Farmers. Retrieved September 20, 2023, from https://ilcorn.org/news-and-media/current-news/article/2023/09/a-government-shutdown-could-impact-farmers.

    Cassella, M. (2023, September 19). How a Government Shutdown Could Leave the Fed Flying Blind. Retrieved September 20, 2023, from https://www.barrons.com/articles/government-shutdown-fed-inflation-data-48058234?mod=livecoverage_web.

    Committee for a Responsible Federal Budget. (2023, September 5). Government Shutdown Q&A. Retrieved September 21, 2023, from https://www.crfb.org/papers/government-shutdowns-qa-everything-you-should-know#whatservicesaffected.

    Congressional Research Service (2023, August 21). Expiration of the Farm Bill. Retrieved September 20, 2023, from https://crsreports.congress.gov/product/pdf/R/R47659.

    Zimmerman, S. (2023, September 12). How the Looming Government Shutdown is Complicating the Farm Bill. Retrieved September 21, 2023, from https://www.agriculturedive.com/news/farm-bill-budget-government-shutdown-food-prices/693425/.

    Loy, Ryan. “What Does a Government Shutdown Mean for Farmers?” Southern Ag Today 3(39.5). September 29, 2023. Permalink

  • The Federal Funds Rate Impact on Agricultural Lending

    The Federal Funds Rate Impact on Agricultural Lending

    Since March 2022, The Federal Open Market Committee (FOMC) has enacted eleven interest rate hikes accounting for a 525-basis point (5.25%) increase (FRED, 2023). We discuss how increasing this rate impacts agricultural lending in 2023.

    The Fed Funds rate indirectly impacts the cost of other market interest rates such as those for agricultural operating loans. The FOMC influences rates by managing available cash (money supply) in the financial sector. In terms of supply and demand, if cash is limited then the cost to borrow available cash (interest) increases, and borrowing is deterred. The Fed utilizes these tools, in either direction, to slow down the economy in times of rising inflation or to reinvigorate economic activity in recessionary times. 

    According to the Kansas City Fed (2023), operating loan rates are typically higher than the effective federal funds rate. A survey of lending terms to farmers for the tenth financial district showed that, on average, a producer is paying an 8.03% interest rate compared to 3.66% the previous year. Agricultural lending has become increasingly expensive, creating additional financial stress in the agricultural sector. Table 1 is derived from budgets across the southern region. Included are estimates of primary pre-harvest expenses that might be included on an operating loan. 

    Table 1. Southern Region, Select Pre-Harvest Production Costs

    Cost CategoryCorn ($/Acre)Cotton ($/Acre)Rice ($/Acre)Peanuts ($/Acre)
    Seed$104.00 $118.00$44.00$97.00
    Fertilizer$303.00 $192.00$178.00$64.00
    Pesticides$88.00 $197.00$151.00$77.00
    Fuel (Irrigation & Equipment)$25.00 $37.00$23.00$68.00
    Q2 2023 Interest (8.03%)$41.76 $43.68$31.80$24.57
    Q2 2022 Interest (3.66%)$19.03 $19.91$14.49$11.20
    Note: 2023 and 2022 rates are based on prevailing operating loan rates in the second quarter of each respective year.

    Interest costs for Q2 2022 and 2023 (see Table 1) represent the cost of borrowing the capital needed to cover the listed production expenses at either 2022 or 2023 rates. Interest is estimated by totaling the select per acre production costs and multiplying it by the prevailing interest rate ($520*0.0803 = $41.76). It’s worth noting that these expenses are only a subset of production costs.  The impact on interest expenses will increase as individual operating loans include other costs of production. Additionally, higher interest rates are putting considerable pressure on the financing cost of equipment and land ownership.

    Producers are now faced with paying over double the cost per acre in interest for 2023 than if they were to take out the exact same loan in 2022.  Keep an eye on decisions out of the September FOMC meeting as it may hint to the Fed’s future choices to raise rates through 2023. If inflation continues to decrease and underlying economic activity slows, the need for further interest rate hikes may diminish.    

    References

    Board of Governors of the Federal Reserve System. (2023, July 27). Open Market Operations. Retrieved July 27, 2023, from https://www.federalreserve.gov/monetarypolicy/openmarket.htm.

    Federal Reserve Bank of Kansas City, (2023, July 19). Ag Credit Survey. Retrieved July 19, 2023, from https://www.kansascityfed.org/agriculture/ag-credit-survey/.  

    Loy, Ryan. “The Federal Funds Rate Impact on Agricultural Lending.” Southern Ag Today 3(34.3). August 23, 2023. Permalink