Are you ready for higher interest rates?
May 03, 2013
No business owner likes the thought of higher interest rates. But rate hikes and inflation are not something to be ignored – and both are a very real threat that I see looming on the horizon for dairy operations and all businesses.
At the pace that the Federal Reserve is printing money – more so than at any other time in history, the likelihood of having higher interest rates down the road is really high.
Surprisingly, in my conversations with dairy producers who have expansion plans, many have not really thought about the impact or risk of higher rates that are likely to be present 10 years from now when those loans come up for renewal. This is something to pay close attention to and plan for, especially if you’re considering expansion plans any time in the next 10 years.
During my visits with dairy producers at the beginning of the year, I noted that about a quarter of them had no expansion plans; a quarter of them planned to update facilities but not expand; a quarter of them planned to expand moderately by adding a few hundred cows; and the rest of them had significant expansion plans.
This is drastically different from five years ago when 80% of the dairy operations I visited had plans to double or triple their herd sizes within a couple of years.
Whatever stage you are in with regard to expansion, just be very cognizant that rates are low now and are likely going up.
Consider this scenario: A dairy producer takes out a 10-year, $3 million expansion loan with a 20-year amortization. It has a fixed rate and a balloon after 10 years.
What happens when the loan comes due 10 years from now if there’s still $1-2 million in principle due on the loan and interest rates are at 8% instead of 3%?
Well, all of a sudden the dairy operation that’s been doing well the last 10 years and looked like it was totally profitable finds itself completely incapable of servicing its debt and could be out of business in a blink.
That said, you would be wise to analyze your expansion plans for the next 10 to 20 years. You might consider coming up with several different "what if" scenarios; at Stewart-Peterson we call this Market Scenario Planningsm. Brainstorming in this manner gives you a chance to evaluate and strategize how your operation might prepare for the future – especially if interest rates start to climb.
Plan ahead and make sure you are not in a position where you need to borrow money when the rates are high – because if you have to borrow expensive money, you may end up out of business. My advice is to borrow all the money you want at cheap rates and absolutely have that money paid off at the end of the fixed term.
Scott Stewart is CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at email@example.com
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