Streamline debt and grow your business for the future
Thanks to low interest rates for the next year or two, producers have an opportunity to restructure existing debt and use cheap money for capital purchases as they grow their businesses.
"Farming is strong today, but it won’t always be that way. Get your house in order," encourages Danny Klinefelter, an ag economist at Texas A&M University. "Make sure your working capital and capital debt coverage ratio are in good shape."
For highly leveraged producers, this is an opportunity to lock in long-term fixed rates at very low
levels, says Michael Boehlje, an ag economist at Purdue University. "Producers who are low leveraged might want to use this opportunity to grow their business. Be careful you don’t do so just because of cheap money. Have a good rational basis for buying land or machinery."
Number Outlook. The Federal Reserve Board of Governors has pledged to keep interest rates low through 2013. "The Open Market Committee has not said how low, though," says Paul Bruce, chief financial officer of Farm Credit Services of Mid-America.
Bruce sees a slight uptick in variable rates during 2012, from 25 to 50 basis points. That means variable rates for the best farm customers could increase from 3.6% today to 4.1% by the end of 2012. On 25-year fixed rates, he looks for an increase of 50 to 75 basis points, which would increase rates from 5.35% to 6.35% by the end of next year. "These rates are still incredibly low," Bruce says.
Global unrest could drive rates lower than what Bruce expects, creating a flow into U.S. treasuries and thus decreasing their yield. He also says that producers considering a capital purchase in 2013 or 2014 might want to fast-forward that decision into 2012 if it makes economic sense.
While there’s incentive to make purchases at today’s interest rates, particularly with the 100% depreciation available for 2012, this is not the time to get highly leveraged, cautions Matt Williams, chairman and president of Gothenburg State Bank, Gothenburg, Neb.
With interest rates at historic lows, producers should be prepared for an increase, he says. Consider exchanging short-term lows for three-, five- and seven-year term loans if you haven’t done so already, he suggests. Right now, long-term rates are not much higher than short-term rates. "We have a twisted yield curve," Williams adds.
Klinefelter agrees, noting there’s risk in financing purchases with short-term adjustable rates, as many farmers are doing. It’s not necessary to convert all short-term debt to longer-term fixed rates, but converting a percentage makes sense with attractive long-term rates, he says.
By mid-decade, rates will not be as high as predicted at the end of 2010, says Purdue ag economist Boehlje. Pessimism in regard to the country’s economic recovery and doubts that inflation will reappear have lowered expectations.
"Agriculture is cyclical," Klinefelter says. "Right now, a lot depends on the U.S. dollar and the Chinese economy. There is a lot of volatility on input costs, output prices and weather as well." n