Inflation, Fed Rate Hikes and Bank Failures. What’s next?
The American pig farmer has been incredibly resilient over the years. We have withstood packing plant shutdowns during COVID-19, feed costs doubling within a two-year period and labor availability challenges. Most recently, inflation has broadly impacted all aspects of production costs for farmers and consumers alike. The cost of borrowing money escalated dramatically as the Fed raised interest rates to combat run-away inflation. Last week, we added bank collapses to the list of events that are still rippling out of the once-in-a century pandemic.
On Friday, March 10, 2023 Silicon Valley Bank (SVB) collapsed after large tech company depositors clamored to withdraw funds in fear of the bank going under. This was the largest bank failure since 2008 when Washington Mutual failed on the heels of the Lehman Brothers collapse which nearly took down the global financial market.
SVB’s collapse was driven by a nearly $1.8 billion loss after it sold roughly $21 billion of treasury and mortgage backed securities. The bank’s significant deposits with tech companies that exceeded the protection of the Federal Deposit Insurance Corp (FDIC) insured deposit levels made it more vulnerable than most banks across the country. SVB’s inability to raise the capital sparked rapid deposit withdrawals, sealing the fate of SVB in the matter of only two short days. Signature Bank also subsequently failed over the weekend as depositors feared a similar outcome magnified by Signature’s ties to crypto markets. Time will tell if the FDIC’s efforts to insure deposits in excess of traditional levels will strengthen the confidence of depositors with hopes of avoiding the ripple effect of additional bank collapses.
What does this have to do with pig farming or agriculture? Farmers are business owners who rely heavily on Farm Credit System lenders and local banks for conducting their financial transactions. The good news is that credit quality across much of the agriculture sector is very strong with lenders holding robust capital positions. Furthermore, the majority of community banks across rural America have a larger portion of their deposit balances that fall within the FDIC insured limits as compared to SVB. This highly insured deposit base gives account holders confidence, reducing the potential of a run on local banks. The theme of counter party risk is naturally elevated in times like these.
Agriculture and the broader economy have been stable for a number of years, which has given us confidence in the system. During the peak of COVID-19, there was stress and anxiety, but financial relief packages helped ease concerns. With pieces of the financial system becoming fractured, there are certain to be ripple effects that reach into the pork sector. Global trade, freight and logistics, key input supply chains, pork market delivery channels and the broader commodity markets will all likely exhibit increased volatility. Volatility can be a good thing, but it takes management to capitalize on the unpredictability and to avoid distress. During the pandemic we saw how fragile our supply chain and marketing channels can be when one part of the process is interrupted. It is important that producers focus on managing factors that are inside their circle of influence.
One of the best ways to do that is through assessing counter party risks and financial exposures in your annual budgeting process. Stress testing key financial assumptions will help provide context to the magnitude of the primary risks identified. Unforeseen events like fires or natural disasters that impact pig flows, replacement cost of feed deliveries from regional feed mills where production is interrupted and long-term interruptions of harvesting activities at packing plants affected by fire like the Tyson Beef Plant in Holcomb, Kansas, are all examples of how farmers are economically impacted by unexpected events. If these issues aren’t enough, African Swine Fever and Foot-and-mouth disease are always knocking at the door looking for a way to turn our domestic farming operations upside down.
It is easy to get overwhelmed but focusing on ways to manage risk are key to surviving adversity. We are seeing more producers leverage LRP and LGM risk management tools to protect their bottom line and, ultimately, the equity on their balance sheets. Out-of-the-money option positions have also been a valuable tool for efficiently adding financial protection from significant market movements in core commodity prices. At publication, the average profitability over the next 12 months is roughly $12-14 per pig. The reality is that producers have been losing $30 or more per pig in recent months. Looking at ways to secure earnings and rebuild equity onto the balance sheet is an appropriate exercise to do regularly. As we experience economic influences from in and outside of our agricultural world, it is necessary to understand how your balance sheet is enhanced through securing profits that are available today.
Daryl is a senior swine lending specialist for Compeer Financial. For more insights from Daryl and the Compeer Swine Team, visit Compeer.com/swine.