On April 11, the Commodity Futures Trading Commission (CFTC) Agricultural Advisory Committee (AAC) held a public meeting. The meeting covered topics related to the agricultural economy and recent developments in the agricultural derivatives markets.
Below is a summary of the meeting prepared by Delta Strategy Group.
PANEL: AGRICULTURAL LENDING
- Ty Kreitman, Federal Reserve Bank of Kansas City
o Economic conditions in U.S. agriculture have moderated from a period of exceptional strength. Farm income has decreased due to lower commodity prices and increased input costs. The trend is expected to continue without significant changes. Financing costs have risen over the past two years, posing challenges for borrowers, particularly those with high debt levels. Profit margins are expected to be narrower in 2024 due to lower income and higher expenses, leading to some initial signs of tightening financial conditions, but financial stress should remain limited in the near term.
- Joe Koenigsman, Federal Deposit Insurance Corporation (FDIC)
o Agricultural credit quality indicators are strong. Full-year net interest margin rose at more than half of farm banks while deposit growth was flat between year-end 2022 and year-end 2023. The Federal Deposit Insurance Corporation found that loan growth was concentrated in the agricultural production loan portfolio. Farm bank delinquency ratios continue to decline and are near their lowest level reported in over a decade. However, signs are emerging that credit quality may begin to weaken. Despite rising interest rates and falling incomes, land values continued to rise throughout the region in 2024. Land values will provide support against any credit quality deterioration, but land values may be getting a bit stretched.
- Scott Donnelly, Farm Credit Administration
o The Farm Credit System experienced significant growth during the COVID era, driven partly by remote work opportunities and low-interest rates. Growth continued into 2021 and 2022, particularly in agri-business loans due to factors like the Russia-Ukraine war affecting commodity prices. Growth normalized in 2023 with a 6.7 percent increase, possibly influenced by increased interest rates. Despite the growth, credit risk remains historically low. Stress testing for lenders is critical to ensure proper risk management in periods of heightened volatility and uncertainty. The Farm Credit Administration is focused on risk management practices and providing certainty in an uncertain environment.
Discussion:
Buddy Allen, ACSA: Approximately two-thirds of agricultural real estate loans have a long-term fixed rate, providing insulation from interest rate risk. However, the remaining one-third of loans are variable rate loans, which will experience significant repricing in the next 12 to 18 months, potentially causing liquidity challenges and increasing the need for operating capital. Donnelly: Interest rates are a major concern and will increase the cost of operating credit and adopting technology. However, some borrowers still have strong balance sheets, which may help withstand the impact of higher interest rates. The key question remains about the duration of the higher interest rates and whether commodity prices will adjust to mitigate the effects on borrowers; Koenigsman: I agree that interest rates are one of the more significant headwinds the industry faces; Kreitman: There may be variance in the number of borrowers who have variable rates depending on the lending model of the institution.
Commissioner Goldsmith Romero: What percentages of small farmers use derivatives products? Donnelly: It is a very small percentage.
Commissioner Johnson: Are there ways we can mitigate the shock of the loan repricing? Kreitman: Adequate capital and collateral can be helpful; Koenigsman: Capital and collateral is a short-term solution, but it may not be a healthy trend in the long run.
Commissioner Pham: Has the market experienced an increase in non-bank sources of credit? Donnelly: Yes, that is a concern; Kreitman: Yes, but the vast majority of lending happens from traditional institutions.
Commissioner Mersinger: Considering the record cancellations of contracts for grains by China, how are contract cancellations being monitored, and what is their potential impact on agriculture? Kreitman: Any hesitation from such a significant trading partner poses a risk to the stability of product demand; Donnelly: The Farm Credit Administration is monitoring this situation.
PRESENTATION: OPTIONS GROWTH IN AGRICULTURAL MARKETS
- Derek Sammann, CME Group
o The agricultural options market is witnessing increased activity, greater participation, and the adoption of more advanced trading strategies and technologies. Options are a robust risk management tool, especially in times of high volatility, and CME has an option product suite that fits commercial hedging needs. There is a focus on the development of short-dated options, which are used to manage discrete event risks effectively. Customers are increasingly trading options against options or options against futures, to manage risk profiles effectively.
Ed Prosser, Scoular: How might the convergence of agricultural markets and the energy sector affect price discovery mechanisms and liquidity? Sammann: It is important to ensure that all participants understand the rules and regulations. The convergence of the energy and ag sectors is positive, but it is critical to maintain market integrity.
Liam Smith, Optiver: Why is block trading still relatively low in agricultural markets compared to other commodities? Sammann: Block business is still less than 2 percent of our total ag market turnover, but it is growing in line with overall turnover.
Liam Smith, Optiver: What is the growth potential for smaller agricultural products like oats and rough rice? Sammann: These products have low market uptake, but CME is committed to providing tools and resources to support their growth.