Spurred by higher input costs, ag lending activity increased in the second quarter as farmers and feedlot operators borrowed to pay for higher priced fuel, fertilizer, feed and livestock, according to survey data of commercial and ag bankers by the Federal Reserve.

Non real-estate farm loan volumes at commercial banks increased in the second quarter as crop and livestock producers paid higher input costs, says Jason Henderson, Omaha branch executive with the Federal Reserve Bank of Kansas City. “In the second quarter, non real-estate farm loan volumes exceeded year-ago levels by 14%,” he says. “The average size of short-term operating loans jumped 36% above year-ago levels due to higher costs for fuel, fertilizer and feed.” The cost of borrowing fell, however, as the average interest rate charged for operation loans dropped from 5.3% to 4.7%.

Cattlemen particularly felt the pinch of higher input costs. The average loan amount for feeder livestock almost doubled, Henderson says, pushing the volume of livestock loans more than 25% higher.

However, feedyard operators got a small break on interest rates, as the average rate for livestock feeder loans fell to 4.8%. What’s more, loan portfolios at larger ag banks rose as the number of large feeder livestock and operation loans of more than $100,000 increased.

Most banks report ample funds, meaning lenders are able to satisfy the higher levels of cash that cattlemen need to operate in the current ag economy. Grain farmers, flush with cash, paid for expenses out-of-pocket during the first quarter, Henderson says. However, rising costs for fuel, fertilizer, seed and feed may strain that cash position and prompt increased borrowing, he says.

District surveys also reported strong demand for farm machinery and equipment in the first quarter, but noted that capital spending may wane through the rest of 2011 as most large equipment purchases are completed.

Among the higher input costs that producers are facing are rising land values. Most states in the Chicago, Minneapolis and Kansas City Fed districts posted double-digit gains in cropland value from the prior year, Henderson says, with gains approaching 25% in Kansas, Nebraska and Minnesota. That exuberance spilled into land lease rates as well.

“With the positive outlook for farm incomes, bankers in the Chicago, Dallas and Kansas City districts noted that many farmland owners negotiated a substantial increase in cash rental rates for the coming year,” Henderson says. “Many survey respondents felt that farmland values had yet to peak as demand from farm and non-farm investors continued unabated.”

While the unrelenting increase in land values has caused some to wonder if the ag economy isn’t seeing a bubble in land values, one farm real estate broker doesn’t think so.

“We’re entering the third decade of a bull market in farmland,” says Murray Wise with Murray Wise Associates in Champaign, IL. “Over that time, the general rise has been consistent and moderate. The past year has seen acceleration and some level of correction is possible, but I simply don’t see a bubble bursting.”

The reason, he says, is somewhere between 70% and 90% of the buyers of Midwestern farmland are farmers who intend to use the land in their business, not speculators betting on further growth.

“Ultimately, the value of the land is a function of its ability to produce a profit for the operator. That, too, seems to lend to the substance and permanence of higher land values. The growth of the middle class demanding protein in their diets in many areas of the globe is well documented and, in my judgment, irreversible,” he says. “That means increasing demand for animal feed and no one is better at growing that sort of grain than American farmers.”

To read the complete Kansas City Fed ag finance report, go to www.kansascityfed.org.