Interest Rates and Market Volatility on the Upswing… Fast

April 12, 2022

The Takeaway is a new CoBank publication that provides practical commentary on interest rates and capital markets activities. These insights come from the professionals in CoBank’s Treasury and Capital Markets groups—people who are in the market interacting with customers, investors and other lenders seeking to understand what is driving activity.

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Fed Battles Raging Inflation with Interest Rate Fire Hose; Volatility on the Rise

What the Fed thought in mid-2021 was an isolated inflation dumpster fire has grown into a raging inferno fueled by continuing global supply chain issues, the tragic war in Ukraine and spiking commodity prices.

Responding in its economic smokejumper role, the Fed has dramatically changed its outlook on using interest rate increases as its preferred tool to douse inflation, according to Kiran Kini, CoBank senior vice president and treasurer.

“At the end of last year, the Fed indicated they would raise rates two or maybe three times in 2022,” said Kini. “Now, they’re guiding us to at least seven rate increases this year as a base case, with the first increase—25 basis points—having already occurred on March 16.

“The Fed also is indicating that it will front-load its rate increases, which means there is a high likelihood of back-to-back 50-basis-point increases in May and June (the Federal Open Market Committee, which sets rates, does not meet in April). Again, that appears to be the base case. And the Fed seems to be guiding toward announcing a balance sheet runoff in May, as well. That would remove a significant buyer from the market as they reduce the pace of reinvestments and let their balance sheet begin to run off.”

Kini says the war in Ukraine has caused commodity and food prices to increase, which has further exaggerated inflationary pressures. He added that the uncertainty around a resolution in Ukraine and the ability of rate increases to actually tame inflation are likely to create significant market volatility.

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Rate Volatility Picks Up

CoBank customers took notice of an uptick in interest rate volatility in the waning weeks of 2021 and entered into an increasing number of hedging transactions, said Eric Nickerson, CoBank’s sector vice president of customer derivatives.

“Since the beginning of the year, there has been growing awareness that the Fed is embarking on a period of tightening, which started with their 25-basis-point increase in March,” said Nickerson. “While experiencing some recent sticker shock, borrowers are realizing that rates are now likely to increase much higher and much faster than previously expected.

“We’re seeing the changing expectations manifested in the interest rate market, which is leading to increased dialogue with our customers as they think about what the interest rate future might look like, mainly higher short-term interest rates.”

Nickerson also said the move away from LIBOR toward SOFR or one of the other alternative rates is a subject of many customer discussions.

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Bye-Bye, LIBOR … Hello, SOFR!

A leader in the horse race to replace LIBOR (London Interbank Offer Rate), the former global standard benchmark interest rate that officially stopped being used on December 31, 2021, seems to be emerging.

The race has been among three odds-on favorites—SOFR (Secured Overnight Financing Rate), which was the rate selected by the Alternative Reference Rates Committee (ARRC) convened by the Federal Reserve Board and the New York Federal Reserve in 2017; AMERIBOR (American Interbank Offered Rate); and BSBY (Bloomberg Short-Term Bank Yield, pronounced bisby)—with the winner likely becoming LIBOR’s replacement as the new U.S. dollar standard.

The primary issue has been that lenders were pushing the rate that best meets their needs in what Clarence Plummer, CoBank senior vice president of capital markets, calls a follow the money scenario.

“The U.S. regulators are pushing for SOFR as the new standard,” said Plummer. “Some large institutions like Bank of America are pushing BSBY. Others—mid-sized regional banking institutions like Zions—are pushing AMERIBOR. It’s all about using the rate that best reflects your cost of funds in good times and bad.

“Now, it appears that some direct pressure from bank regulators is resulting in more banks using SOFR as an alternative to LIBOR than AMERIBOR or BSBY. There are still pockets of the industry that are pushing those other alternative rates, but the momentum has swung toward SOFR. By mid- to late year, I think SOFR will be the dominant benchmark rate.”

Plummer added that SOFR is the benchmark rate that generally benefits many of CoBank’s customers because of the low funding costs. It also is less volatile, or less susceptible to the types of events—such as debt ceiling debates—that tend to raise rates.

Market Focus

Agribusiness

“Bulging” Demand for Working Capital Loans

Rising prices for input commodities—particularly grains—are driving significant demand for short-term working capital loans, or bulge facilities. CoBank is funding an increasing number of bulge facilities and participating in these types of loans generated by other Farm Credit System members and large banks.

Eric Itambo, CoBank’s chief banking officer, recently told Reuters that the bank extended more than $4.5 billion in bulge facilities to customers dealing with margin calls and grain purchases in January and February alone.

The higher input commodity prices—as well as supply-side issues prompted by the COVID-19 pandemic and the Ukraine crisis—have also resulted in higher output commodity prices, which are reflected in higher beef, poultry and pork prices at the supermarket.

Recent CoBank Capital Markets Activity

Growmark

Growmark

$800M Credit Facilities
Administrative Agent

Darling Ingredients

Darling Ingredients

$400M Credit Facility
Lead Arranger

Communications

Bigger, Better, Faster!

Communications companies are ramping up capital spending over the next several years because of growing internet and wireless telephone and data usage, as well as the conversion to 5G. Internet and wireless usage has been spurred significantly by company work-from-home protocols, which resulted in 42 percent of the U.S. labor force working from home in the spring/summer of 2020, according to research conducted by the Stanford Institute for Economic Policy Research. And the recent surge of the omicron sub-variant BA.2 in the UK, and a corresponding rise in U.S. cases, is raising some new concerns.

Based on the evolving work-from-home economy, which is expected to outlast COVID-19, and user demand for faster service, companies will make large investments in new cell towers, fiber-optic broadband networks and generally denser networks.

CoBank, with the support of System partners, are funding term loans for capital expenditures and providing project financings to the full array of communication providers, including local exchange carriers, competitive local exchange carriers, wireless and cable companies, data centers, and tower and fiber companies.

Recent CoBank Capital Markets Activity

Cincinnati Bell

Cincinnati Bell

$500M Credit Facilities
Lead Arranger

GCI

GCI

$250M Credit Facilities
Lead Arranger

C Spire Wireless

C Spire

$300M Credit Facility
Lead Arranger

Power & Energy

Delayed Draw Loans Expand Investor Interest

Power and energy companies are making increased use of delayed draw facilities—loans that allow borrowers to draw down full proceeds at one time within a set draw period, e.g., 18 months, rather drawing funds immediately. The trend is expanding the pool of potential investors and allowing CoBank to make larger and longer-term loans.

Delayed draw facilities provide institutional investors—such as collateralized loan obligation funds and insurance companies—with a viable investment alternative to bonds, which decrease in value as interest rates rise. The facilities provide investors with a commitment fee, usually 25 to 50 basis points, and assurance that their funds will be invested for the full term of the loan rather than repaid and redrawn, as is the case with administratively intensive credit revolvers.

Loans are an attractive asset class for relative value investors in a rising rate environment because their return increases as interest rates rise, thereby serving as a natural hedge against inflation.

Delayed draw facilities benefit borrowers by reducing their interest expense. Borrowers can lock in a loan commitment but avoid paying interest on a lump sum they may not need to use for several months. The facilities are being used to fund many renewable energy projects—wind and solar—and for municipal water projects.

Recent CoBank Capital Markets Activity

Basin Electric Power Cooperative

Basin Electric Power Cooperative

$500M Credit Facility
Joint Lead Arranger

Georgia Transmission

Georgia Transmission

$425M Credit Facility
Administrative Agent

Pattern

Pattern–Western Spirit Finco

$1,757M Credit Facility
Lead Arranger, Term Loan Administrative Agent

DISCLAIMER: The information provided in this publication is for informational purposes only and is not to be used or considered as investment research, a proposal, or the solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. Companies and transactions referenced in this publication are shown for illustrative purposes only, and the provision of such information is not a recommendation or endorsement in this context. Certain information contained in this publication has been obtained or derived from third-party sources, and such information is believed to be correct and reliable but has not been independently verified. While CoBank believes that factual statements in this publication, and any assumptions on which information in this publication is based, are in each case accurate, CoBank makes no representation or warranty regarding such accuracy and shall not be responsible for any inaccuracy in such statements or assumptions. Note that CoBank may have issued, and may in the future issue, other reports that are inconsistent with or that reach conclusions different from the information set forth in this publication. CoBank is under no obligation to ensure that such other reports are brought to your attention. Furthermore, the information may not be current due to, among other things, changes in the financial markets or economic environment, and CoBank has no obligation to update any such information contained in this publication. This publication is not intended to forecast or predict future events.

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