Tip #1
Cap Your Floating-Rate Exposure To Your Level Of Equity
Perhaps the central issue when pondering interest rates is the eternal question: fixed or floating? Floating rates can be very attractive, of course, but if an operation is carrying a significant amount of debt, floating rates pose a big risk that’s out of the farm manager’s control.
Young farmers and mid-career farmers with significant debt are most at risk. “Young farmers and indebted mid-career farmers will generally have narrower margins, as they’re more highly leveraged,” Betker says. “Balancing the amount of loans with floating and fixed interest rates is key.”
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A rough rule of thumb is to try to match the fixed and floating portions to your balance sheet equity. If your operation enjoys a 70 per cent equity position, for example, it’s likely safe to keep about 70 per cent of your loans on floating interest rates, with the balance on fixed rates. For more indebted operations with lower equity status, the safest route is to keep more of your loan portfolio on fixed interest rates.
“If you’re on the low (equity) end, you want to keep more than half of your loans locked in,” Betker advises.
Tip #2
Separate the risk to your retirement equity
“Determining the risk to retirement equity is important,” Betker says. “Length of time until you reach retirement is also important. With careful management, the onset of higher rates might be delayed to when retirement occurs.”
For older operators, or those fortunate enough to be less leveraged, it’s a different situation. Their operations are less likely to lose liquidity due to a rate spike, so floating interest rates are less dangerous. But they can still take a bit, and farmers who are nearing retirement have a few special considerations that Betker says can be expressed in just one word, “stability.”
Tip #3
Perform this sensitivity analysis
Regardless of age or experience, any farmer can benefit from performing a sensitivity analysis on their operation, Betker says. That means looking at the farm’s sensitivity to higher rates from a liquidity perspective. How will interest rates affect your farm’s ability to generate cash flow, and what impact will that have on your working capital?
For young farmers and mid-career farmers, Betker says, it boils down to answering two further questions about their exposure to interest rates. “How much can interest rates increase before you lose liquidity and have to restructure debt?” he asks. “And how much available equity is there to support a restructuring exercise?”
Tip #4
Calculate impact on next generation
For a farmer nearing retirement, there’s a crucial extra consideration. If you’ve got a family member interested in taking over the operation, you’ll need to analyze how higher interest rates may alter your succession plans.
“How much will rates need to increase before they threaten the transfer?” Betker asks.
There can be a bright side to a generational transfer, however. If interest rates rise, and if the retiring farmer hasn’t much debt, they may be able to secure higher rates on GICs and other deposits. This income can then decrease the cash flow needed from the farm to support the retirement.
Tip #5
Hedge by “laddering” your rates
Both Betker and FCC’s Hoffort say all farmers at all career stages should be aware of hedging strategies that can protect them from major interest-rate swings. The most common strategy has two different names, “multiple tracks” or “laddering.”
Let’s say your operation is carrying a $500,000 loan. The entire value of the loan doesn’t need to come up for renewal all at once. Instead, you can break it into multiple tracks — say five tracks of $100,000 each. You can set up each of these $100,000 tracks so they all have different terms and maturity dates, most commonly running from one to five years.
“That way you’re not going to have to refinance your entire loan portfolio at one time,” Betker says.
Younger farmers may also qualify for an interest rate rebate program that returns a portion of the interest rates to their operation. Such programs are pretty much exclusively targeted to young beginner farmers, and if properly managed they can help shield an operation from rising rates — but that means not treating them like general revenue.
“They may want to consider depositing any interest rebate into their savings so it can be used to offset higher interest rates when they materialize,” Betker says.
Tip #6
Make principal payments that improve liquidity
Paying off debt can also be a powerful tool. After all, you don’t pay interest on the loan you no longer carry. But be cautious. In some cases, it makes sense to follow the consumer model, which is paying off the highest-interest rate debt first. But for a business like farming, where liquidity is the key, sometimes it makes sense to pay off the largest loan first since it’s also the loan that will make the largest and most regular cash demands on the operation.
“A farmer wants to maintain as positive a debt servicing ability as possible,” Betker says. “Debt servicing is about principal and interest, not just higher or lower interest rates.”
Farmers closer to retirement, on the other hand, will generally have lower debt levels to start with, and therefore paying down the loans with the highest rates first makes more sense.
Tip #7
Keep manoeuverable
As business conditions continue to evolve, our experts say, the single best piece of advice for any farmer is to keep your options open.
Make sure that an increase in interest rates won’t sink you, or mean that all you’re able to do is tread water.
To the best of your ability, you should try to maintain some room to manoeuver, since there could be opportunities in the midst of the mayhem.
To illustrate this point, Betker tells the story of a U.S. farmer who locked in his interest rates towards the end of the last grain boom in the 1970s, and then used that capital to buy land during the subsequent crash of the 1980s.
At a recent meeting that farmer told attendees he was already pondering a repeat of that strategy, Betker says.
“It worked so well for him last time he was thinking of doing it again,” Betker says.
This might involve a bit of self-denial, however, and it may mean deferring the purchases that you’d like to make in favour of investments that will pay for themselves in this climate.
“A new combine won’t necessarily make you more productive,” Betker says. “But more land or quota will.”
