Agriculture lending outlook remains grim due to high rates, inflation

Fallout from festering inflation and rapidly rising interest rates are leading concerns for agriculture lenders heading into 2023, given that both threaten to pinch borrowers, crimp loan demand and weaken rural economies.

Such are the key takeaways from a series of survey results released this month aimed at sizing up sentiment of bankers who lend to farmers and the ag-related businesses that work with them, including fertilizer suppliers and equipment manufacturers.

The Federal Reserve has aggressively pursued rate hikes to slow spending and tamp down inflation that reached a 40-year high in 2022. The Fed has increased its benchmark rate this year from just above zero to nearly 4%, the highest level since the 2008 financial crisis. Policymakers are widely expected to boost rates even further as inflation remains elevated. Historically, aggressive rate hikes have gradually curbed high consumer prices, but they also have stunted spending enough to tilt the economy into recession.

The American Bankers Association's annual ag lender survey found 49% of respondents ranked interest rate shifts among their top two concerns, up 35.5 percentage points from last year. While rising rates have helped bolster banks' net interest margins, they are also driving up deposit costs and sparking fears of weakening loan demand that would cut into profitability.

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"Given the Fed's clear signal that it expects to continue raising rates until inflation is contained, it's fitting that ag lenders cited interest rate volatility as their number one concern," said ABA Chief Economist Sayee Srinivasan. "Lenders expect that both short-term and long-term rates will continue to rise in the coming year, reflecting market expectations that rates could rise by another 100-150 basis points by the end of the first quarter of 2023."

Other than interest rates, ag lenders' top concerns are weaker loan demand, intensifying competition, and the potential for credit quality deterioration, according to the ABA's report, which was produced jointly with the Federal Agricultural Mortgage Corp.

More than 35% of bankers rated fading loan demand as a top concern, while 33% ranked competition as a leading worry. Credit quality was ranked among the top two concerns for 21% of respondents.

Though credit quality remained excellent across the banking industry this year, "it is to be expected that lenders would anticipate some deterioration in the coming year as the potential for a downturn grows," Srinivasan said.

Rural economies are particularly vulnerable to an inflation-induced recession, according to Ernest Goss, an economist at Creighton University in Omaha, Nebraska, who surveys bankers each month. In the results of his October poll covering the 10-state central U.S. region that encompasses the Midwest farm belt, Goss found that bankers predicted flagging economic conditions for the sixth time in the past seven months.

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Creighton's Rural Mainstreet Index produced a reading of 44.2 for last month. Anything below 50 indicates contraction. It was the fifth consecutive month the reading came in below 50.

Bankers cited higher borrowing costs and elevated agriculture input expenses — such as seed and fertilizer — as key stresses.

Purdue University's Ag Economy Barometer found farmer sentiment further weakened last month as well. It dropped 10 points to a reading of 102, and this followed a decrease the month before. A reading below 100 indicates expectations for recession. It has not dropped notably below that level since 2016.

"Concern over rising interest rates grew once again in October and is adding to the unease among producers who are worried about its impact on their farm operations," said James Mintert, head of Purdue's Center for Commercial Agriculture.

Commodity prices also have also been volatile even as overall inflation persists, driving up costs and threatening to curtail profits. 

"Many of America's farmers and ranchers experienced a strong recovery in 2021 and 2022" from the depths of the pandemic, "driven by higher commodity prices and robust sales," said Jackson Takach, chief economist at Farmer Mac. 

With those tailwinds receding, "ag lenders are keeping a close eye on expenses, as feed, fertilizer, fuel and other input costs remain elevated," Takach said.