The fledgling recovery has a long way to go before the economy achieves stability, and the key word moving forward is "uncertainty." Many worry that when the unprecedented government spending collides with a return to growth and confidence in the consumer economy, the outcome will be a hike in interest rates. Farmers who rely on variable loans could face suddenly higher costs.
Price of Money. Chicago Mercantile Exchange interest rate futures imply rates at recent lows until mid-2010, after which they climb a quarter of a percent per month for the next 24 months.
Rather than try to predict the future, look at what is available and whether rates 400 or 500 basis points higher would cause financial strain for your operation, advises Michael Swanson of Wells Fargo. "Low-debt, low-leverage operators would find it annoying but not critical," he says. "Younger, more leveraged operators might want to convert to fixed rates now."
That might mean that instead of today's ultralow rate of 3¼%, you pay 5% today, Swanson says.
"Ideally, we'd want to go to a fixed rate on all our loans just at the start of an increase," he says. "But that's like jumping on the train as the caboose goes by."
Although it is not simple, it also is possible to hedge interest via Eurodollar futures, which are tied to the three-month LIBOR contract. (See "Head Off Interest Rate Risk," October 2009 issue.)
Short versus Long. Interest rates and debt structure can be as important as debt levels in terms of their impact on your financial performance. Today, you may find it more difficult to actually fix a rate for 15 or 20 years, says Dan Clevidence, manager of credit administration at John Deere Credit. "Lenders are looking at more frequent pricing opportunities—a loan amortized for 15 or 20 years may have a five-year balloon when rates can change."
As a captive lender, Clevidence says, John Deere Credit continues to provide needed access for purchases at a time when some lenders may be pulling back. However, some producers find it more advantageous to lease machinery, he says. "Some larger operations watch interest cost/acre, and leasing may keep that lower. You have to consider your operation's financial structure and the tax implications."
Proving Worthiness. Don't be surprised if your lender requires more documentation. A balance sheet and past payment history may have been enough to secure a loan until recently, but that no longer is the case, Clevidence says. "While our requirements are much the same as they were during the past few years, which have been very good for many farmers, we are taking a closer look at them. We also are paying closer attention to farmers' marketing plans and putting more emphasis on accrual-based accounting."
Farmers should not look at this as a penalty—rather, lenders are seeking to minimize problems so they can keep costs lower, he adds.
Watch the Rocks. After 15 years of pretty stable prices, the volatility of inputs and output has risen, and the reliability of predictions of your operation's profit has dropped. In such cases, you need to run your business with less leverage, Swanson says. "Debt is like rocks in a river. You need enough liquidity to float over them, or you could hit them and sink. These days, you need to float a little higher."
Top Producer, December 2009