Brace for rising interest rates in agribusiness
For farmers and producers planning their production and financial futures, there is no shortage of variables to consider in today’s market. First, weather patterns continue to confound producers on both sides of the too wet/too dry continuum. Second, grain and commodity prices have started to regain some support, both of which are up from recent levels but are still well below the highs of the past several years. Furthermore, land prices continue to hold (for now) at extraordinarily and historically high levels in many areas of the country.
However, with all of these variables to consider, there is one other factor that may be the most important to consider when planning for the future—interest rates. With historically low interest rates currently being offered for operating lines as well as some floating rate term debt financing that has been put in place during the last four to five years, many ag producers have been lulled into forgetting that interest rates can change as fast and dramatically as corn prices.
As the American economy improves and the Federal Reserve Bank looks at beginning to ease its security purchasing, the stage is set for a return to “normal” interest scenario during the next couple of years. As that happens, producers with large floating rate exposure can expect to see their interest expense double or even triple during that time frame. The spread between fixed and floating rates will also expand, regaining its historical gap. When that happens, borrowers with purely floating rates will be at the mercy of the financial markets in terms of controlling their interest expense.
Reviewing balance sheets and future cash flows now – with an eye toward the next several years – can both yield large potential interest expense savings and protect against possible loan repayment problems.
As farmers and producers look ahead, here are four steps to better financial planning:
- Review all current debt and forecast projected debt levels for the next four years. Include amounts, repayments required, current rates, and most importantly, whether the rates are fixed or floating.
- Optimize utilization of fixed assets (land or equipment) for securing the minimum level of total debt anticipated each year. This should be done regardless of whether it is presently for revolving/working capital lines or fixed assets.
- Determine available cash flow for debt service during the next four years.
- Structure new fixed-rate debt now by using a conservative debt service coverage ratio (1.3 to 1 or greater).
By fixing rates now, with proper use of fixed assets as collateral, and carefully forecasting future operational cash flows, producers can effectively lock in today’s historically low rates, save themselves tens of thousands of dollars or more in interest expense, and be far better prepared to effectively manage other variables that may come into play.