Good Morning. In this newsletter, we will explore the latest updates from the U.S. Federal Reserve's recent interest rate cut in September, and signals the start of a new easing cycle. Next, we’ll dive into the Canadian perspective, where the Bank of Canada made a significant 50 bp rate cut, providing immediate relief to mortgage holders with variable rates. Shifting gears, we'll examine a growing market trend where institutional investors are increasingly viewing American farmland as a stable asset class. This has doubled investments in farmland since 2020 and led to rising land prices. Lastly, we will explore the world of convenants.
ECONOMIC UPDATE
THE INTEREST RATE ENVIRONMENT IS STILL MOVING
The Federal Open Market Committee (FOMC) made a significant move last September by implementing its first interest rate cut in four years, lowering the Fed funds target by 50 basis points (bp) to a range of 4.75–5.0%. This dovish action marks the end of the "higher-for-longer" period of interest rates and signals the start of a new monetary easing cycle, which could extend beyond 2025.
Michael Feroli, chief U.S. economist at J.P. Morgan, described the half-point cut as "an appropriate recalibration" in response to the current disinflationary environment. Core inflation was recently revised down by 0.2 percentage points to 2.6% this year, with projections for it to fall to 2.0% by 2026.
"While most expected a smaller 25 bp cut, we had predicted a 50 bp cut since early August, partly due to the view that the Fed should have acted in late July. This larger cut helps realign their policy," Feroli explained.
What’s Next?
Analysts anticipate the Federal Reserve will cut rates by another 50 basis points (bp) at its next meeting in early November. This prediction contrasts with the Fed’s "dot plot"—a chart showing each official's forecast for short-term interest rates—which indicates two additional 25 bp cuts for this year.
Looking ahead, the Fed’s dot plot projects four more 25 bp cuts, totaling 100 bp, in 2025. Additionally, the Fed has raised its projection for the neutral funds rate by another one-eighth of a percentage point, now expecting to reach 2.875% by 2026.
While rate cuts often point to slowing growth, the Fed is generally upbeat about the wider economy, especially in light of a strong — albeit gradually cooling — labor market. Nonfarm payrolls increased by 142,000 in August, while the unemployment rate ticked down from 4.3% to 4.2%.
Canadian Implications
The Bank of Canada delivered an oversized rate cute of 50 bp on Wednesday, once again picking up the pace of easing borrowing costs. The cut marks the fourth consecutive for the bank and the largest outside of the Covid-19 pandemic since the financial crisis in 2009.
Although we are still seeing cracks in the labour market from a sluggish economy, the bank has made it known that they are continuing their push for demand while keeping inflation on target. However, on a micro level, with renewal season for mortgages around the corner, this rate cut provides immediate relief for Canadians with variable rates or upcoming renewals.
Focusing on Canadian Real Estate, lower future interest expenses will help increase industrial and agricultural real estate value because cheaper credit facilitation will incentivize external investments and thus expansive growth and favourable land purchasing sentiment.
MARKET TREND
INSTITUTIONAL INVESTORS INTEREST IN FARMLAND
Farms in America have traditionally been owner-operated with many of those farms consisting of family businesses. Today farmland is increasingly being looked at as an attractive asset class for institutional investors instead of a necessary part of the farming business that supports so many communities and feeds the country.
Since 2020 the value of investments in Farmland has doubled. Today 40% of farmland is not owner operated and almost 13% of food output in America comes from farms that are owned by institutional investors. These may not seem like overwhelming numbers; however, they have been partly responsible for the propping up of farmland prices to levels that are double what were seen during the farmland bubble of the 1980’s, adjusted for inflation. With these growth rates and runways, this trend could have a serious impact on the American economy sooner than later.
Why the Interest?
Farmland as a Hedging Option
One of the biggest reasons that farmland has become so popular as an arbitrage asset class over the past few years is its stability. America has seen large inflation numbers and significant speculation of recessions. Farmland is a near perfect hedge against both issues.
Inflation leads to rising commodities prices including food, which inherently pushes up the prices of the land that is used to create it. In the past, as inflation has risen, the value of farmland has risen at and almost directly correlated rate.
Farmland has shown that it has almost no correlation to the equities markets, if anything a slightly negative one. During the 2008 financial crisis when equities were recording huge declines, the value of farmland increased by 6% during 2008, and 2% in 2009. This mostly comes down to the fact that despite the state of the economy, the one thing that everyone needs is food. The recession resistant nature of this asset class has added to its popularity during the economically uncertain times that America has faced over the past several years.
The Private Equity Treatment
The second reason farmland has become popular with institutional investors is the growing opportunity to do what private equity firms have been doing with so many other small American businesses for the past decade. Essentially the strategies include buying farmland utilizing large amounts of debt, and the consolidation of individual plots of farmland into a single plot for a single operator – essentially a leveraged buyout.
With margins for farmers becoming increasingly thin recently with only 10% of family-owned farms having a greater than 25% operating margin, and the prices of farmland being at all time highs, many family-owned farms feel like they have no choice but to sell their land. Institutional investors have seen this, as well as the decreasing government financial support for family-owned farms, as an opportunity. The advent of farming technologies that small farms don’t have the economies of scale to afford, mean that investors can use leverage to buy multiple plots of land and consolidate them into a single farm with similar fixed costs to the smaller one but the ability to produce much larger margins with these new technologies. It is also easy for these investors to get these loans as the farmland itself is a hard asset that can be used to secure the loan. The plan is that the cash flow from these now efficient farms is enough to pay the interest on the debt while the land appreciates in value to later be sold.
Implications
All these factors may mean that the traditional American family-owned farm may no longer be a viable business model. The institutional ownership of farmland and shift towards automation mean that many livelihoods of families that have been in the farming business for decades will be severely impacted while many jobs are lost.
On the positive side, farming is becoming more efficient due to this investment into technology and increased economies of scale. Despite this, it is unclear if these savings will be passed on the consumers or used to boost the margins of investors. The benefit of economies of scale also poses a monopolization risk in which food prices could be manipulated.
Lastly the institutional investment into farmland will, and almost certainly already has, somewhat disconnected the value of the land from the value it produces in terms of food. The focus of farmland is shifting from a focus on the business of farming to a focus on “will this land appreciate in the future?” This speculatory investing can create bubbles and it is possible that farmland could or already may fall under this category. If a bubble were to exist and burst, this could cause a ripple effect through the economy. People who borrowed against the inflated value of their farmland may find that it is now worth less than what they owe on it. This could lead to issues like bankruptcies and defaults. The entire supply chain would be hit including agricultural suppliers and agricultural lenders. Farming activity could be impacted and in turn food prices, impacting the entire American economy.
MERGER AND ACQUISITION
RIO TINTO - EXPANDING ITS LITHIUM OPERATIONS
Buyer Summary: Rio Tinto
Rio Tinto is a leading global mining company with a primary focus on the extraction and production of minerals and metals. They operate offices in over 35 countries specializing in commodities such as iron ore, aluminium, copper, diamonds, gold and industrial minerals. As one of the largest producers of iron ore and aluminium globally, they are a mission critical supplier for raw materials in construction, transportation and technology. With new initiative is sustainability, it has committed to continued investment into renewable and low-carbon technologies.
Target Summary: Arcadium Lithium
Arcadium Lithium is a leading global lithium chemicals producer playing a key role in the transition to a clean energy future. They are a vertically integrated lithium provider with industry-leading capabilities in lithium extraction processes including hard-rock mining, conventional brine extraction and direct lithium extraction. They are leading innovative break throughs from lithium-ion batteries for electric vehicles to modern-life sustainability across facilities in over 20+ cities globally.
Acquisition Details
The acquisition of Arcadium Lithium is a pivotal strategic move for Rio Tinto, significantly enhancing its position in the growing energy transition sector. Rio Tinto purchased Arcadium for $6.7 billion, which includes a substantial 90% premium on Arcadium's share price. As demand for lithium is projected to more than double by 2030—from 1.2 million tonnes in 2023 to an estimated 2.7 million tonnes—driven by the increasing adoption of electric vehicles (EVs) and energy storage technologies, this acquisition will enable Rio Tinto to secure a crucial supply chain component for lithium-ion batteries. By acquiring Arcadium's high-quality assets in Argentina and Australia, Rio Tinto is not only positioned to capitalize on anticipated future supply shortages but also illustrates a broader trend within the industry, where cash-rich firms are actively pursuing mergers and acquisitions to bolster their production capabilities.
Long-Term Implications
This deal could potentially ignite a wave of consolidation in the lithium market, as other companies recognize the strategic advantages of acquiring established producers rather than undertaking the lengthy process of developing new projects from the ground up. Analysts predict that the current downturn in lithium prices creates an environment ripe for mergers and acquisitions, offering attractive opportunities for companies looking to strengthen their market positions. Firms such as Fortescue and SQM are already exploring various potential projects, indicating a robust interest in securing critical lithium resources amid rising long-term demand forecasts. The dynamic fosters optimism about the future of the lithium sector, with established players seeking to diversify their portfolios and play integral roles in the transition toward greener energy solutions.
QUFN FINANCE CONCEPT SPOTLIGHT
CONVENANTS
Covenants are an important component of many financial agreements, especially in lending and corporate finance. In simple terms, a covenant is a clause within a loan or bond contract that places certain conditions or restrictions on the borrower. These conditions are intended to protect the interests of the lender and ensure that the borrower maintains a sufficient level of financial health throughout the life of the loan.
Who Uses Covenants?
Lenders (such as banks, credit institutions, bondholders) are the primary users of covenants. They impose these conditions on borrowers (such as corporations, private equity firms, or individuals) to reduce their risk when providing financing. Covenants are common in various financial agreements, including:
Corporate loans – Often part of syndicated or bilateral loans to large companies
Bond agreements – When companies raise debt in capital markets
Private equity deals – In LBOs, covenants are placed on portfolio companies
Why Are Covenants Used?
Covenants are used to reduce the risk of a lender’s investment. They serve this purpose by:
Mitigating Credit Risk – covenants help lenders monitor the borrower’s financial health and identify early warning signs of potential default
Ensuring Financial Discipline – they limit risky activities, like taking on excessive debt or making large expenditures, to keep borrowers within safe financial boundaries
Providing Early Intervention – breaching a covenant allows lenders to renegotiate terms or take corrective actions before the situation worsens
Enhancing Transparency – regular financial reporting required by covenants ensures lenders stay informed about the borrower’s financial condition
What Kinds of Covenants Exist?
There are four main types of covenants, all of which be used in tandem to customize the risk level of an investment to a lender’s liking. These covenants include:
Positive/Affirmative Covenants: Ensure that the borrower continues to perform activities they should be doing. Breaking these conditions often results in a cancellation of the loan and immediate repayment of the principal and interest. Examples of this include paying regular corporate taxes, reporting their financial performance and statements on time, etc.
Negative Covenants: These include activities that the borrower is not allowed to do, and is usually implemented to ensure the borrower can repay their loan successfully. Examples include asking for authorization to sell capital assets, not issuing dividends to shareholders, or issuing additional debt.
Maintenance Covenants: Ensure that the borrower maintains certain operational metrics. For example, the company’s leverage and interest coverage ratio cannot be above a certain multiple, or the company must maintain a minimum credit rating.
Incurrence Covenants: These conditions are tested only if the borrower performs a specific action (aka “triggering” event). If the activity is performed, the lender will check for breaches with certain specified conditions. For example, the borrower cannot acquire another business if it causes the debt-to-EBITDA ratio to exceed a certain threshold.
RECRUITING QUESTIONS
CONVENANTS
Regarding a highly leveraged LBO, how would you structure covenants, and which covenants would you focus on most in trying to balance the protection of the lender's interests with minimal operational constraints on the portfolio company?
In the case of a highly leveraged LBO, I would structure covenants so that the risk from the lender is sufficiently offset without constricting the portfolio company's growth. An example of a Leverage Covenant is the debt-to-EBITDA ratio, which constrains how much debt the company can carry relative to its earnings. This protects against over-leveraging a company's balance sheet but still allows for operational flexibility. Another example is the interest coverage ratio, which ensures that there is enough operating cash flow to cover the interest due and payable. It also makes sure that the probability of default is low. Further, CapEx metrics assist in controlling and limiting capital spending to prevent over-investment that could otherwise impair the liquidity position of the company.
Can you give me some real-life scenario where a covenant breach may be prompted by the volatility of the market? And explain to me what the next steps the lender and the borrower would take to renegotiate terms or resolve the covenant breach.
One scenario might be linked to the company's EBITDA performance. For example, the borrower is in a cyclic industry and their EBITDA performance has decreased due to a general economic slowdown. This decrease in performance would result in a breach of the debt-to-EBITDA covenant. The first step would be that the lender declare the breach to the borrower. At that point, the borrower might seek a waiver or modification of the covenant by offering additional collateral, accepting higher interest rates, or agreeing to closer financial monitoring. The lender would analyze the company's revised financial forecasts to determine whether the violation had been temporary or reflective of issues more deeply ingrained. Most of the time, a lender would rather be pleased to renegotiate the terms-loosening the covenant in exchange for increased fees, or tightened restrictions on the borrower. This would force the borrower into default and would trigger larger losses for all parties involved.
A company has a debt agreement that includes a leverage covenant where the Debt-to-EBITDA is required to be less than 3.0. The company currently has $150 million of debt and $45 million of EBITDA. The company is contemplating taking on an additional $30 million of debt. Will they still be within the covenant after taking on this new debt?
Current Debt-to-EBITDA:
Debt-to-EBITDA = Debt/EBITDA = 150/45=3.33 (The company breached the covenant already)
Adding $30 million more in Debt:
Debt-to-EBITDA=(150+30)/45=4.0 (Adding new debt will worsen the breach)
WANT MORE? FIND US ON OUR SOCIALS BELOW.
