End of an Era for Cheapest Farm Mortgages

As seen on dtn.com

Like Rip Van Winkle, long-term interest rates are awaking from years of deep sleep. Panic over the Fed's eventual exit from mortgage markets sent rates on the benchmark 10-year Treasuries spiraling, up from 2.14% on June 14 to 2.62% a week later. Rates are now running the highest since August 2011.

Rates on 20-year fixed rate farm mortgages bounced to 5.55% this week, up from a low of 4.25% just a few months ago.

Farm mortgages at the nation's largest farm real estate lenders are responding in kind--and then some. As bond markets fell out of favor, the spread between Treasuries and Farm Credit System bonds widened, from 50-70 basis points to more than 100 basis points over comparable Treasuries.

Twenty-year, fixed rate mortgages for qualified borrowers at Louisville-based Farm Credit Mid-America (see Farm Finance page, under Farm Business) topped out at 5.55% today, up from all-time lows of 4.25% only a few months ago. For every $500,000 borrowed, that's an extra $4,400 payment annually. Popular 15-year mortgages bottomed at 3.9% in early December 2012, but have since risen to 5.2%. (Farm Credit rates in other regions may charge a bit more, as Mid-America pays no patronage dividend).

So far, short-term rates seem unaffected, in part because the Federal Reserve doesn't expect inflation or unemployment to reach trigger points until mid-2014. That's a rare situation, since short-term rates normally lead the charge when bond markets hit a turning point.

"These are very volatile times. We've got the Feds saying they will stop monetary infusions, but they haven't done anything yet," says Paul Bruce, Mid-America's chief financial officer.

Bruce isn't convinced this is the permanent turning point in rates. He characterizes the unusually large big bond moves the past few weeks as a possible over reaction, with the chance for some dips later should global imbalances in European or Asian countries send investors fleeing back to the safety of U.S. markets. Farmers could also capture some rate relief if the premiums Farm Credit bonds pay at auction later narrow back to normal. He recommends growers keep a close eye on credit markets.

Mid-America's customers converted much of their fixed-rate credit at historically low terms over the last 18 months, so they already may be immunized from some of the rate fallout. In 2012, the lender reset rates on 32,500 customer accounts saving $130 million in interest payments; another 11,200 customers refinanced through May.

Even with the rally, rates still appear low by historical standards, Bruce says. Normally, long-term fixed mortgage rates have run closer to 7% to 8%.

Several Federal Reserve economists believe the convulsion in long-term mortgage rates is worth monitoring, even if you pay cash for your farm purchases. History shows that for the past century, farm incomes and interest rates move in opposite directions, former Kansas City Federal Reserve Economist Jason Henderson points out. Rising rates and falling farm profits also curb enthusiasm for land purchases. Federal Reserve surveys already show farm real estate gains slowing in some regions in 2013.

It was easy for the Fed to create its $85 billion/mo. spending in mortgage markets as a way to jump start the economy, Henderson tells farm audiences, but the question now is how to retreat.