This post is part 2 of 2. Click here for part 1.
So what does all this have to do with the Farm Credit System and Yankee? The Farm Credit System is a U.S. government sponsored enterprise (GSE), what does it have to do with interbank lending in London?
It turns out that LIBOR interest rates are widely used, throughout the world, as a benchmark. When the Farm Credit System issues variable rate debt, it is often pegged to LIBOR. When the Farm Credit System issues long term fixed rate debt, it is often desirable for purposes of prudent asset-liability management to synthetically convert that debt to variable rate debt, pegged to LIBOR, using interest rate swaps.
It is true that the Farm Credit System can presently issue short term fixed rate debt at attractive rates. Not as attractive as the U.S. Treasury, but close. But what good does that do us? Short term debt must be refinanced frequently. One always runs the risk that a day will come when it cannot be refinanced, which is a sure bullet in the head.
It is essential for the Farm Credit System to issue a considerable amount of longer term debt to more closely match the term of our loans. And since the majority of our borrowers choose variable rate loans, the debt should also be variable rate—either directly issued as variable rate debt or issued as fixed rate debt and then swapped to a variable rate. Either way will usually involve LIBOR.
As noted in the previous post, interest rates have gone crazy since mid-September. As a result, CoBank has changed the way it calculates the interest rate on the money it lends to associations such as Yankee. Effective November 1 a portion of our interest expense is now directly tied to LIBOR. Now even little ol’ Yankee is directly affected by interbank lending in London. This is new for us.
Yankee is now exposed to more interest rate volatility than it was before. It will take some getting used to. That is also part of the reason why we decreased rates only 0.25% on November 1, and why the other northeast Farm Credit associations did not decrease interest rates at all.
It’s a brave new world.