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VIDEO: Old foe, new focus: Interest rates begin to climb

Farmers and ranchers, who already had plenty of financial worries, face a new concern — or more accurately, the return of an old one.

Interest rates, which in recent years were at historically low levels, are rising. The increase so far is minor, and nobody thinks rates will skyrocket anytime soon. But even a small increase means additional expense at a time when the bottom lines of ag producers, especially crop farmers, are stressed already.

“It’s a small expense by itself. But it makes a difference in the big picture,” says Rob Davis, a Larslan, Mont., farmer and president of his state Grain Growers Association.

Ron Haugen, a North Dakota State University farm management specialist, makes the same point. “They (higher rates) aren’t a big worry right now, but there are so many (financial) concerns; producers don’t need another one,” he says.

John Weinand, a Hazen, N.D., farmer and president of the state Grain Growers Association says, “We’re sure aware of it (rising rates). We’re not too worried yet, but it’s another thing that we need to deal with.”

Ag businesses in general, not only farmers and ranchers, are paying attention.

“They haven’t risen enough to be a big worry. But it’s something our members are watching,” Nicholas Sinner, president and CEO of the Minnesota-South Dakota Equipment Dealers Association, says of rates.

Higher interest rates reduce ag producers’ ability to buy equipment and buildings. They increase the difficulty of repaying existing loans that carry variable rates. And they make it harder to borrow more money for the 2016 crop.

Farmers and others say poor crop prices and high expenses, including land values, are bigger concerns. The interest rate increase is so small, and rates still so low, that the increase isn’t particularly alarming.

The so-called prime rate, a widely followed rate determined by the rates charged by 30 big banks across the country, has increased to 3.5 percent from 3.25 percent. That quarter-percentage-point increase adds just $2,500 in interest expense on a $1 million annual operating loan.

Even a full 1-percentage-point increase on a $1 million annual operating loan would add only $10,000 in interest expense, says Nathan Franzen, president of the agribusiness division of First Dakota National Bank in Yankton, S.D.

Although an increase of that size hardly would be insignificant, it would be small compared with costs associated with land and chemicals, Franzen says.

Low rates were a boon

High crop prices from 2008 to 2012 led to record profits and prosperity for many U.S. farmers. Low interest rates were a factor in the good times, too. The Federal Reserve System, the nation’s central bank commonly known as the Fed, held down rates to stimulate economic growth. That benefitted many Americans, including homebuyers.

Low rates definitely help agriculture. Some farmers and ranchers have borrowed money for as little as 3 percent to 4 percent, about a third of what they paid a decade ago, area bankers and others say. Big-ticket items such as land, buildings and equipment are easier to buy when some or all of the money is borrowed. The balance sheets of farmers and farmers are strengthened by reducing the amount of interest they pay.

Lower rates also help U.S. ag exports: the rule of thumb is that low rates weaken the value of the U.S. dollar, making U.S. ag products more affordable to foreign customers.

Now, the Fed is inching rates higher. The thinking is, higher rates will slow growth and keep the economy from overheating. Higher rates also will help investors, who for years have received next to nothing on certificates of deposit and similar investments.

Unpleasant memories

Predicting the direction of interest rates in notoriously tricky. But the strong consensus of prognosticators is that the Fed will phase in further increases slowly and carefully. The increase so far has been measured, as the upturn in the prime rate from 3.25 percent to 3.5 percent indicates.

Even with the increase, the prime remains far lower than in 2000, when it stood at 9.23 percent, and in 1981, when it hit a record 18.87 percent. For a farmer who borrows $100,000 to be repaid over 20 years, that means:

  • A monthly payment of $1,620.99 at 19 percent.
  • A monthly payment of $899.73 at 9 percent.
  • A monthly payment of $579.96 at 3.5 percent.
  • A monthly payment of $567.20 at 3.25 percent.

The monthly payment at 3.50 percent is much lower than at 9 percent and vastly lower than at 19 percent, but only slightly higher than at 3.25 percent.

For younger agriculturalists, high interest rates may be an abstract threat. But older farmers and ranchers, who lived through the difficult 1980s, know firsthand how destructive high rates can be. Double-digit rates then were blamed, in part, for a wave of ag bankruptcies.

“It was not a pretty time,” says Franzen, who grew up on a family farm and has spent 25 years in ag banking. “It was a much different time. That’s not to say we don’t have our challenges now, but the environment, especially the interest rates, was much different.”

Still, as overall production costs increase — and farmers need to borrow more to put in their crop — higher interest rates become potentially more troublesome.

Small piece of the pie

For now, at least, farmers are mostly concerned with expenses such as seed, fertilizer and land costs, Haugen says.

Three examples:

  • University of Minnesota Extension projects the operating interest paid to produce an acre of corn in central Minnesota this year at $12, not much higher than the average of $11.17 per acre in 2005-2014. In contrast, the land cost associated with that acre of corn is estimated at $190, up sharply from the 2005-1014 average of $146.33 per acre.
  • The South Dakota State University Extension Crop Budgets peg the 2016 cost of raising an acre of corn on high-production land in the eastern and central part of the state at $484. Operating interest is estimated at $13 per acre, compared with $104 per acre for seed and $101 per acre for fertilizer.
  • The NDSU 2016 Projected Crop Budgets estimate the cost of raising an acre of spring wheat in north-central North Dakota at $245.51, with the cost of borrowing money to put in the crop pegged at $3.19 per acre, or about 1.3 percent of the total. In contrast, the per-acre cost of fertilizer is estimated at $56.60. Land costs are pegged at $50 per acre, and seed costs at $15.73 per acre.

To put that those final numbers in better perspective, consider this: the 2006 NDSU Projected Crop Budgets put the cost of raising an acre of spring wheat in north-central North Dakota at $131.70, with the cost of borrowing money to plant the crop estimated at $2.77 per acre, or about 2 percent of the total (compared with just 1.3 percent in 2016.)

In short, interest expense is a slightly smaller part of total costs than it was a decade ago. And it’s a far smaller slice of overall expenses than it was in the late ’70s and ’80s, when rates were at their peak.

Taking action

Working capital refers to liquid assets with which a business can meet short-term financial obligations. It’s calculated by subtracting current liabilities from current assets.

By all accounts, working capital is a concern as ag producers prepare to plant, nurture and harvest their 2016 crop.

“We’re working to be sure they’ll have enough working capital,” Franzen says.

As part of the process, ag producers are being encouraged to convert variable-rate loans to fixed-rate loans. By doing so, producers improve access to working capital and, additionally, “won’t be impacted no matter where rates go,” Franzen says.

He and other ag bankers encourage farmers and ranchers to talk with their lenders about higher rates and what might be done to limit the risk.

Davis, the Montana farmer, says some producers may need to reduce spending elsewhere in their operation to offset even slightly higher borrowing costs.

“No, these higher rates aren’t a huge deal in the grand scheme of things. But if your loans aren’t fixed or if you need to borrow more money, it’s going to affect you. It’s one more thing you have to deal with,” Davis says.