Growers advised to lock in lower rates before increase
By MATEUSZ PERKOWSKI
Interest rates are expected to climb in coming years, which means farmers should act now to ease future financial burdens, according to credit experts.
"We know this input cost is going to go up, and fairly quickly," said Steve Blank, an agricultural economist specializing in financial management at the University of California-Davis.
Farmers should evaluate different cash flow scenarios to see how rate hikes will impact their bottom lines, said Dave Kohl, retired economist from Virginia Tech University.
The idea is to "see how sensitive their business is to an interest rate increase," Kohl said.
Growers who are highly leveraged with debt need to meet with lenders and determine how to limit their exposure, he said.
It's often wise to convert short-term debt into long-term debt, such as refinancing a credit line into a second mortgage to save on interest costs, Blank said.
"Look to see that you have your existing debt refinanced at the lowest possible rate," he said.
Such restructuring generally involves transaction fees, so farmers need to weigh the current costs against long-term savings, Kohl said.
The impact of rising interest rates will be felt unevenly across the agricultural industry, but younger farmers trying to expand will probably face the strongest headwind, Blank said.
"It really is an individual situation, because different people have different debt levels," he said.
Short-term interest rates are expected to rise most dramatically, according to economic projections commissioned by CoBank, a lender within the federal Farm Credit System of banks.
In the next five years, the three-month London Interbank Offered Rate, or LIBOR -- a benchmark rate for lending in the U.S. and Europe -- is expected to rise from about 0.35 percent to more than 4 percent.
The three-year swap rate, a type of interest rate commonly used among lenders, is expected to increase from about 2 percent to more than 4.5 percent in the next five years.
The actual interest rates to farmers and other borrowers would likely be higher, but LIBOR and swap rates are indicative of movement in the credit market, Blank said.
There are numerous reasons interest rates are expected to rise.
Massive government spending and the expanding federal deficit are likely to play a role, said Jay Penick, CEO of Northwest Farm Credit Services, an affiliate bank of the Farm Credit System.
As the economy improves, the federal government will have two primary motivations to raise interest rates, he said.
First of all, higher interest rates are associated with better returns on government bonds, Penick said.
The federal government will want to make bonds more attractive to investors because they're needed to fund the growing deficit, he said.
Secondly, the government will probably need to slow down liquidity -- the flow of money -- to prevent the inflation of U.S. currency, Penick said.
"That would be historically normal," he said.
Market forces also affect interest rates.
In the past year, economic fears have depressed the global appetite for debt, Blank said.
Interest rates represent the cost of borrowed money, he said. As the demand for debt has fallen, so have rates.
That's likely to change as investors and consumers become more confident, Blank said.
"As more people look to use borrowed money, the price is going to be bid up," he said.
In that sense, projections of higher interest rates are a sign that things are getting better.
"It's a derivative of the improving economy. It's probably more good news than bad news," Blank said. "This is one of the slightly negative aspects of a positive turn in the economy."
However, higher interest rates -- just like higher oil prices -- would also be a drag on the economic recovery, said Thorsten Egelkraut, an agricultural economist at Oregon State University.
The government spending that's currently supporting the economy can also be expected to hinder it to some degree, he said.
That's because it will result in higher taxes or reduced liquidity through spending cuts, Egelkraut said.
"Either way, we get a dampening effect," he said.
Staff writer Mateusz Perkowski is based in Salem, Ore. E-mail: firstname.lastname@example.org.