Historically low interest rates could be poised to climb. Should you consider a lower variable rate that can change monthly or a longer-term fixed rate?
By Gary Sipiorski, Vita Plus Corporation
Unbelievable, historically low interest rates have now been with us for four years. Many dairy producers have continued to ride the variable rate because those rates are rock-bottom low. Variable rates generally change monthly, but no one has noticed because, in the last four years, rates have gone no place.
Variable interest rates are mostly based on the Prime Rate, which, by definition, is supposed to be the best rate to the best customers. To a large degree, that definition has been lost. Prime is the Over Night Fed Funds rate that banks charge one another to borrow money back and forth overnight, which today is 0.25% plus 3.00%, giving us a Prime Rate of 3.25%.
The second rate used for variable rates is called LIBOR (London Interbank Offered Rate), which is a composite of bank rates across the globe. That rate is running around 3.60% at the writing of this article.
Sometimes lenders will have an inter-bank rate of their own based on their cost of funds and internal factors.
Regardless of how the variable rate is derived, it will be a lower interest rate than a fixed or locked-in interest rate. The real question is what is right for your dairy? A lower variable rate that can change monthly or a longer-term fixed rate?
A lender will normally offer you borrowed rates that are tied to their cost of funds or deposit or bonds that fund those loans. Remember, all a lender does is take money with one hand, pay the depositors an interest rate for the use of the money and loan that money back out at a higher rate, then use the difference to pay staff and show a return. The lender will match the deposited money to the borrowed money for a specific amount of time. So, when the depositor’s certificate of deposit or bonds matures, the loan comes due for a renewal.
So we do not forget, the overall U.S. interest rates are watched and moved by the Federal Reserve, which is totally separated from the government. They have a two-part mandate from Congress to keep people employed and keep inflation under control. The Fed, as it is commonly known, controls the money supply, which, in turn, moves interest rates up or down. It is the overnight Fed Fund rate that people focus on, which will move the U.S. bond market all the way to the 30-year U.S. Treasury Bond. All other borrowing rates in the U.S. are based on the U.S. bond market, considered to be the safest place to invest money.
Over last four years, since the "Great Recession," the Fed has been trying to stimulate the U.S. economy with low interest rates. This is in hopes of getting businesses to employ more people and get the general public spending more money. The U.S. economy, or GDP (Gross Domestic Product) of all goods and services, is driven 70% by consumer spending. The Fed has even been buying U.S. Treasury debt or bonds to keep interest rates low. So far, economic recovery has been slow. The Fed has gone so far as to say it plans to keep interest rates low until the end of 2014. Recently, some of the Fed Governors who vote every six weeks on interest rates are thinking the Fed has done enough and rates should start moving up.
So what does all of this mean for your dairy? There are a lot of moving parts to the Fed’s decisions. Interest rates cannot stay low forever. Once interest rates start to move, "all" longer-term fixed rates will begin to move up. It is possible they could move fast. Those producers who lived through the 1980s remember all too well 16% and even 18% interest rates. Today’s general economy could not stand for anything near those rates. A movement of a few percentages would get the public’s attention.
To take out whatever risk you can in this high expense rate environment of operating a dairy would be responsible. Talk to your lender about a longer-term interest-rate fix. You still have to make the final decision. It certainly is time to give it some serious consideration.
Gary Sipiorski has a long career in the banking industry, doing business primarily with dairy producers. He has been associated with the Citizens State Bank of Loyal, the Graduate School of Banking in Austin, Texas, the Independent Community Bankers of America, the Governor’s Task Force on Growing Agriculture in Wisconsin, and the Advisory Council on Agriculture, Industry and Labor for the Federal Reserve Bank of Chicago. In 2008, he joined the Wisconsin-based nutrition firm, Vita Plus Corporation, where he is dairy development manager. Contact him at 608-250-4267 or GSipiorski@vitaplus.com.