Rates Too Low Too Long
Elizabeth Williams DTN Special Correspondent
Mon Jul 21, 2014 01:28 PM CDT
(Page 1 of 2)

KANSAS CITY, Mo. (DTN) -- It seems almost sacrilegious to support higher interest rates in a capital-intensive industry such as agriculture. But attendees at the Kansas City Federal Reserve Bank's Agricultural symposium this week agreed with bank president Esther George's statement that "getting interest rates off zero relatively soon is appropriate in terms of current economic conditions." George noted as Federal Reserve asset purchases come to an end, "It will be important to lay the groundwork for a more-normal rate environment."

Kansas City Federal Reserve President Esther George advocates "getting interest rates off zero relatively soon" and warned farm borrowers and lenders to prepare for a more normal rate environment at this week's ag symposium. (Photo courtesy of Federal Reserve Bank of Kansas City)

"Zero interest rates are appropriate in a crisis. The crisis is over," said Max Wake, president of Jones National Bank in Seward, Neb.

"Interest rates have been low longer than needed," said Jim Farrell, president of Farmers National Company and chair of the Omaha branch board of directors of the Kansas City Fed. "The low rate doesn't seem to be stimulating anything now."

"Beware of unintended consequences," Farrell added. Discounted interest rates get factored into farmland values, which influence cash rents and that drives up the cost of production, Farrell noted.

Another consequence: "Some have called it a 'retirement tax,' because retirees are paying the price, [by not being compensated for their savings]," said Farrell.

In fact, George pointed out, "We've seen signs of 'reaching-for-yield' behavior in the leveraged loan market, subprime auto lending and corporate bonds."

The lack of alternative investments has been a factor in keeping farmland values high, noted Doug Stark, president of Farm Credit Services of America, based in Omaha.

"Lower interest rates have also pushed some savers, who traditionally relied on safer assets, into riskier securities," said George. And there is growing concern these savers, especially those retired or nearing retirement, may not understand those risks, George noted.

A return to more normal interest rates will help community banks. "Our business model is based on a 'happy medium,'" said Wake. How much a bank can lend out is based on the amount it holds in deposits. "We depend on savers," Wake said. "We need to compensate depositors with a fair return on their investment. Moving rates up slightly would help bring back a balance -- depositors earn a fair return above inflation and borrowers can get money. That's the ideal."

How would agriculture weather a bump up in interest rates? "About 75% of our real estate loan portfolio is locked into fixed rates (10-, 15-, 20-year term) at around 4%-5%, which is a historically low rate," reported Stark. "Also, the loan-to-value ratio on our real estate loans averages less than 50%. So, we could see a 30% to 35% drop in farmland values before we would be underwater on our loans."

Moe Russell, a farm business consultant in Panora, Iowa, thinks most farmers could handle an economic correction. "A lot of my clients have bulletproofed their balance sheet and have a healthy amount of working capital."

That's not to say there won't be problems. "We've identified some working capital concerns among our borrowers that we are watching," said Wake. "But some of our borrowers have paid ahead on term debt and have pre-paid equipment. That will take some pressure off their credit needs."

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