When times are good, should you pay off debt? Or should you take on more debt to add productive assets, parlaying the strength of today’s commodity prices into growth?
Rémi Lemoine: I think one of the most important things it tells us is that the issue of farm debt is very complex and can’t be boiled down to simple, almost philosophical, statements like “Pay off debt during good times.” You also can’t read too much into numbers that cover the entire industry or entire sectors of the industry, because every farm operation has its own unique financial situation and the answer to the question of how much debt it can and should carry will also be unique.
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It’s a question of balance. You can’t afford to scrimp too much and miss making key productive investments — new technology that makes your farm more efficient, for example — or not replacing equipment so that it’s breaking down during harvest and you’ve now got a production risk, which really doesn’t strike me as good risk management. On the other hand, you also can’t afford to be so heavily indebted that the slightest hiccup or change in conditions causes you to run off the road.
It is true that total farm debt has gone up significantly in recent years, but I’m not sure that this one number tells the whole story. We also have to look at the debt-to-net-income ratio, and that paints a different picture — though I do want to add a word of caution that you can’t just apply it across the board either, for many of the same reasons. But when we look at it, it has actually been remarkably stable over the past decade. Yes, debt has risen, but so has income, and therefore the price that farmers must pay for productive assets. The one exception is in the supply-managed sector, where we saw it climbing quite significantly, to the point that the various boards began taking steps like setting maximum quota exchange values. It’s now in the process of dropping and will likely revert to close to the long-term average.
RL: Yes, that’s exactly right. As for finding the sweet spot, I think it all starts with the information about a farm’s individual financial health. It’s important to understand and analyse that information very carefully and that’s where having a good accountant or financial adviser is very important. A good accountant or adviser can really help you understand your farm’s financial position and sketch out scenarios and options that take into account the risks and the potential rewards. I think that this is actually one of the most important and cost-effective things a farmer can invest in when working on debt management and overall financial planning. It lets you both build a plan and stress test it. It lets you explore issues like what your business plan would look like with a three per cent rise in interest rates — or a drop in prices, or perhaps a sharp increase in the cost of inputs. It also allows you to build a “Plan B” that you can implement when something like this happens, so you can get back on track as quickly as possible.
Our ability to put financial information in electronic spreadsheet format has made this far easier than it has ever been before, and many if not most of the farmers we deal with are doing this.
RL: I don’t want to be waving my finger and scolding anyone here, but there is a very real difference in the way younger and older farmers approach debt. Older farmers have had the mindset that you borrow as little as possible and pay it off as quickly as possible. Younger farmers ask different questions — for example they want to know what the income-generating potential of an investment is, and if the numbers are there, they’re willing to take on debt to make that investment.
Again, however, I don’t want to draw too many generalities because these decisions really do have to be made taking an individual approach, based on that farm and that farmer’s unique financial information.
I suppose if I worry about anything when talking about farm debt, this is one of my bigger concerns — that farmers tend to talk amongst themselves about these things, and there’s the natural tendency to want to do what the other person is doing. But if the other producer is in their 50s, has been farming for more than 30 years and is in a comfortable financial situation, they have a very different ability to take on and carry debt and risk than a neighbour who’s in their 20s and is only five years into paying off their land.
RL: Well, I should say that I don’t do interest rate forecasts. (chuckles) I’m afraid everyone is on their own there. But you can analyse the situation a bit and make your own decision.
If you look at historic interest rates, say over the past 30 years or so, we’re clearly at a low. Long-term money is cheaper than ever, so it might make sense, given the right individual circumstances, to consider locking in these rates — especially if you can get a loan with a decent prepayment option. Maybe something on the order of the ability to pay 10 or 20 per cent back early without penalty.
On the other side of the equation, however, if you kept a variable-rate loan, and look at the past 50 years, there’s a very good chance you would have won. There are potential benefits to that strategy too. The key thing to remember is that when rates move, they can move fairly quickly. And recent history might not be a particularly good guide. The last time we saw a rate increase, the yield curve was quite gentle — maybe something like moving a variable-rate loan that was three per cent to a five-year term at four per cent. There’s no guarantee that will be the case. It’s entirely possible that in a couple years’ time you could see that three per cent variable-rate loan jump to six per cent for a five-year term.
I can tell you what our customers are doing. Right now about 65 per cent of them choose variable rate and about 35 per cent of them choose fixed terms. Again though, I stress that you can’t take the general trend and apply it to your specific farm. CG
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