My last column discussed how to use key employment and inflation data to anticipate how the Federal Reserve may change the level or direction of interest rates. Now, let’s zero in on how interest rates impact producers.
Why would any producer want to lock in on interest rates at a higher level costing extra money? It is all about margin management and carrying through on a total risk-management program.
First, a producer must determine how sensitive their profit margin is to a 2-4% increase in interest rates. How would margins be impacted if the interest rates increased to 10%? Some producers will assign probabilities to each of these scenarios in conducting cash flow forecasts.
Second, one has to ascertain the actual fixed rate. In today’s marketplace, fixed interest rates come with a premium, particularly for 10- and 20-year-term financing. One suggestion is to stagger debt maturity dates or do a blended rate program. That is, fix the term of some of the debt at three, five, seven, 10 and 20 years maturity. If you are a young producer early in the business lifecycle or have an aggressive growth-oriented business, this may be the best option.
Also determine the amount of working capital and cash reserves you have that could be used to supplement cash flow and debt service commitments should adverse circumstances arise.
Finally, can you and your business partner sleep at night? Often if you toss and turn worrying about whether your variable rate will increase, maybe it is time to lock and load.
P.S.: Be careful when examining interest rate strategy because of the speed of change. Remember how quick rates increased in Greece as well as in the U.S. in the 1980s.
Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at [email protected]