Tuesday, August 09, 2011
Agricultural Interest Rates Are Going Up (Updated and Corrected)
The decline in the commodity and equity markets, following the downgrade of the US credit rating last Friday by Standard and Poor’s will certainly affect agriculture. Every farmer should determine what that will mean to his operation, and the answer will be different for everyone, depending upon his exposure to unpriced commodities, as well as his financial position.
Equity and commodity markets tumbled severely on the first trading day after the action by the rating agency, which may have had more impact on the economy than Congress, the White House and the Fed combined. Farmers are not only challenged by the commodity market, but are also in jeopardy from how the credit rating action will be factored into interest rates that farmers have to pay.
(New information with clarification on Farm Credit and Farmer Mac Securities) Agricultural interest rates will hinge on two factors, how the securities market accepts the downgraded bonds of the Farm Credit Funding Corporation and how the commercial banks respond should Farm Credit interest rates rise. Regina Gill and Glenn Doran, executives with the Farm Credit Funding Corporation, with is part of the Farm Credit System and under the regulatory auspices of the Farm Credit Administration, said conventional wisdom would have interest rates rise when bond ratings are lowered, but “This is an unconventional case.” Gill and Doran in a telephone conversation August 9, indicated that even though Farm Credit securities have had a spotless record for many years, their rating cannot be higher than the credit rating for the US Government, and they were subsequently downgraded by Standard and Poor’s.
Gill said the market for Farm Credit bonds remains solid, and she currently does not see any increase in costs that would be reflected in higher costs to Farm Credit customers. Those bonds are sold to investors to provide capital for the five Farm Credit banks for lending to farmers and agribusiness and had been rated as a AAA until Standard and Poor’s took action to lower the rating the AA+. That is contrasted to the Farmer Mac securities, which are unrated, but their lending process is also under the regulatory oversight of the Farm Credit Administration. There is no connection between the bonds sold to provide capital to Farm Credit and those sold to provide capital to the secondary market serviced by Farmer Mac.
There are two scenarios that could occur, and no one is making any predictions. In the first,Farm Credit costs could increase because of the lower credit rating, and that has the potential of being passed on to borrowers in the form of higher interest. While that occurs, commercial bank lending rates could remain steady with the decision by the Federal Reserve Board to hold interest rates steady for the next two years as reported in the media.
A second scenario that could occur, if Farm Credit loan rates do rise, would also have commercial bank lending rates also rise to remain competitive. Banks obtain their funds through Federal Reserve channels, but can set their lending rates to market levels. That would cause nearly all agricultural interest rates to rise as the non-agricultural sector enjoyed a continuation of the lower interest rates that have been prevalent the past several years.
Commercial banks may try to keep pace and raise their interest rates, believes economist Bob Young of the American Farm Bureau , “The impact on (the farmer) in particular, will be higher interest rates that folks will have to pay at Farm Credit System and then your local banks are going to see that and charge higher rates as well, etc. And so basically farmers and ranchers will end up having to pay higher interest rates than they otherwise would have to pay.”
The agricultural interest rates will not only affect real estate and machinery loans, but operating loans, says Young, “It’s not just credit associated with buying land at or credit associated with buying equipment. Its credit associated with the operating costs associated with putting that crop in the ground. It’s buying the seed; it’s buying the fuel, buying the fertilizer. It’s buying the chemicals it takes to produce that crop and protect that crop. It’s all those things that farmers are going to have to pay more for as we move forward.”
Young believes the lower credit rating will lower the value of the dollar, which fosters more commodity exports because of lower prices that foreign buyers see, a situation that reverses for imported goods, “I think as the value of the dollar goes down it’s going to make U.S. commodities in general, but agricultural commodities certainly, that much more competitive in the world markets. And so you could actually talk about the ag sector, from that perspective, actually doing a little better but for the rest of us that buy stuff at the store, we’re going to have to pay a higher price for imports and recognizing the amount of stuff that we import in this country you’ll see an upward push on inflation rates as well come out of this. “
Standard & Poor’s Monday issued further downgrades of its credit ratings on government-backed bonds, and commented more about its action on August 5, saying, “We have also lowered the ratings on the senior debt issued by the Federal Farm Credit Banks to ‘AA+’ from ‘AAA’. The ratings on the individual farm member banks are not affected.
“The downgrade of the senior debt issued by the Farm Credit System reflects a one-notch reduction in the U.S. sovereign rating. Under our GRE criteria, the Farm Credit System is classified as having a very high likelihood of receiving support from the government if needed. The Farm Credit System’s stand-alone credit profile is ‘aa’. Thus, under our criteria, the notches of uplift that we factor into the ratings on debt issued by the System decrease to one notch from two notches when the sovereign has a ‘AA+’ rating rather than a ‘AAA’ rating. The issuer credit ratings on the four Farm Credit System Banks that we rate are unaffected by the downgrade of the U.S. sovereign given their ‘a+’ stand-alone credit ratings and high likelihood of support classification under our GRE criteria. The implicit government support that we factor into our ratings for the Farm Credit System debt and the four rated banks considers the system’s mission to provide stable and reliable funding to the U.S. agricultural and rural sectors.”
The Farm Credit Administration has not issued a public response to the Standard & Poor’s action. The FCA Board has its regular monthly meeting scheduled for Thursday, Aug. 11. The agenda has been posted, and one item for action is entitled: “Capital Adequacy Risk Weighting Revisions: Alternatives to Credit Ratings – Advance Notice of Proposed Rulemaking”
Summary:
The lowering of Farm Credit System bond quality ratings by Standard & Poor’s will mean a rise in production costs for agriculture. Not only could interest rates increase on Farm Credit Loans, but commercial banks may also raise their rates, and input costs throughout agriculture will rise as a result. The rating agency indicated it believed the Farm Credit System would get government support if needed.
Posted by Stu Ellis on 08/09 at 12:00 AM | Permalink
Comments
Posted by: Jib at August 9, 2011 12:12AM
Truth Justice and the Japanese Way
S&P’s downgrade of the US Government as reported by S&P is all about the Government’s inability to handle future spending and inability to move to a more balanced budget. The strange thing is US bonds strengthened after the downgrade; not what would be expected when one’s debt quality is reduced. This could be more about politics and saving face. S&P is one of the rating agencies that “missed” the housing crisis that started the latest recession in the US and EU. S&P’s comments imply the “Tea Party’s” approach is “what is needed” to “Save” the country. Another reason for the market decline may have to do with the lack of World wide economic growth thus lower equities with higher bond prices (lower interest rates). Japan is used as one model for handling what has becomes to be known as a balance sheet recession. (A balance sheet recession is a “rare” event that occurs after the collapse of an asset bubble and corporations are more concerned about debt reduction than making profits. Japan’s asset bubble was in the end of the 1980’s, ours occurred with the current housing crisis.) The Japanese solution mandates Government spending to keep the economy moving with the lack of corporate spending. (So is QE3 coming?) This would point to more debt and a more unbalanced budget. The balanced budget approach of the Tea Party could/would make the cuts currently being felt in school districts, local and state government look mild. The carnage could be severe but a healthier economy could result quicker than the government supported recovery. As usually is the case, the best solution is probably somewhere in between.
If today’s decline in stock prices are more akin to a no confidence vote, the decline might be short lived. If the decline reflects concern for lower economic growth a recovery may be more problematic. S&P could be correct on their downgrade but wrong on their assessment of the problems. More political discussion might be needed to point the solution to a mutually agreeable direction. (That last sentence may of just confirmed S&P’s AA+.)
Jib aka Gibberish