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Amortizing Farm Loans Just As Important As Interest Rate Considerations
Expect the Federal Reserve to continue to tighten down the U.S. money supply growth in 2017 and as a result short-term interest rates will rise.
Very few economists are predicting a farming free-fall comparable to the 1930s or 1980s. However, most farmers should expect some tough sledding ahead, especially those operations that are undercapitalized. The outlook appears not to be a full-blown “farm crisis” impacting all farms but more of a “liquidity crisis” effecting a small but growing percentage of farms.
Currently the U.S. economy and expansion of global trade face a lot of uncertainty. Profit margins are tight, especially for row crop farming operations. Interest rates are expected to rise slowly over the next few years. Higher rates will increase a farm operation’s cost of production.
Farm operating loans that are currently around 4% will likely increase to around 7% by 2020. Just as the low interest rates and weather concerns helped fuel the agricultural boom a few years ago, expect higher rates to be a part of the farm cash flow challenges ahead.
These higher interest rates are hitting farmers just when they are seeing lower corn and soybean cash prices. Farm operations should prepare to pay more money to finance debt.
Expect this ag economic downturn and higher interest rates to be much harder on farmers that might not have large amounts of equity in fixed assets. Also, farming operations that expanded rapidly using borrowed funds and cash rent the majority of their land without the support from livestock or other sources of non-farm income.
Fortunately, farmers and their lenders had a couple years to prepare for higher short-term interest rates. Most farming operations are well positioned to weather this period of tighter profit margins. Record corn and soybean yields in both 2015 and 2016 along with much improved livestock prices in 2017 have helped.
Working capital constraints for some operations already meant their lenders worked with them to reamortize loans. This likely included fixing longer-term interest rates on debt before the recent rise.
For farms that still have working capital or liquidity problems, expect more scrutiny on additional loan requests. This might mean providing updated cash flow information, mid-year inventory inspections, required crop marketing plans (both old and new crop) and credit monitoring for use of other credit sources including retail suppliers and credit cards.
Managing short term interest rates only provides a short term win for most farm borrowers. However, managing long-term interest rates will likely provide for a meaningful long-term win. Remember, the current farm financial situation is mostly about cash flow and liquidity, not solvency.
Farmers should review their balance sheet structure with a lender who understands how to assess their working capital needs and the proper structure of their intermediate and long-term debt.
Be proactive in rebalancing debt to provide adequate working capital and viable long-term debt structure to match fixed assets. This should allow farmers to use longer-term fixed interest rates for term debt without overextending themselves and limit the use of short-term debt at higher interest rates.
Steve Johnson is an Iowa State University Extension and Outreach Farm Management Specialist and can be reached at firstname.lastname@example.org.