All Things Considered: August 2010
Interest Rate Vulnerability
By Jim Knisley
A couple of years ago my bank had a sale. They were offering deep discount prices on money. The variable rate mortgage offer was 0.85 of a percentage point below
prime, which put the interest rate under two per cent per year. It was
too good to pass up.
A couple of years ago my bank had a sale. They were offering deep discount prices on money.
The variable rate mortgage offer was 0.85 of a percentage point below prime, which put the interest rate under two per cent per year. It was too good to pass up.
Recently, the interest rate rose half a percentage point and now sits at just over two per cent per year. For the next several years the expectation is that the variable rate will continue to rise. This will leave interest rates low by historical measures. But rising interest charges will still cost a lot of money and could blindside the unprepared.
George Brinkman, professor emeritus and former Chair of the Department of Food, Agricultural and Resource Economics at the University of Guelph, is concerned about how this will affect farmers. Brinkman, who has focused on farm debt analysis and farm viability for decades, is urging Canadian farm businesses to shed unproductive assets and to develop a business strategy to manage the impact of interest rates that are expected to rise by as much as three to five percentage points by 2015.
“Rising interest rates are the real vulnerability that Canadian farm businesses face today,” said Brinkman, who teamed up with the Bank of Montreal (BMO), to issue the warning.
“Many Canadian farmers are carrying an inordinate level of debt vis-à-vis comparable markets in the world. Consequently, the impending rise in interest rates, expected over the balance of 2010 and throughout 2011, poses an issue for Canadian farms. “It’s important that Canada’s agriculture industry takes steps now in planning for higher rate scenarios in three to five years just when the rest of the global economy is picking up and governments may not have an appetite for another bailout,” he said.
Brinkman has recently said that in 2007 the average debt to income ratio for Canadian farmers was 40 to one. In the 1980s, when the farm debt crisis was making headlines, the ratio was seven to one.
Farm debt today is $63 billion, 3.5 times its 1981 level. By comparison farm debt in the U.S. has grown just 20 per cent since 1980.
Brinkman’s numbers present the big picture. A tighter focus shows that many farmers do not have debt problems. But for many others the potential problems may be worse than they believe.
For example, back in the 1980s I interviewed a farmer who appeared to be a portrait of success. He had more than 15,000 acres and a reputation for producing high-yield, high-quality crops. He was considered a good marketer and hard worker. But he was going broke in a hurry. Interest rates had risen, land values had dropped and crop prices in the coming year were forecast to fall. He was done and he knew it. He had bought too much land, was carrying too much debt and the rise in interest costs had pushed him into the red.
The BMO’s Economics Department isn’t forecasting interest rates rising anywhere near 1980s levels. But they are going to rise. They say the Bank of Canada will likely raise overnight lending rates steadily but gradually to 3.25 per cent by the end of 2011 and to 4.25 per cent by the end of 2012.
Sal Guatieri, senior economist, BMO Capital Markets, says, “Agri-businesses are advised to consider their financing and interest rate options sooner rather than later in order to take advantage of current historically low long-term borrowing costs.”
David Rinneard, National Manager, Agriculture, BMO Bank of Montreal, said farmers need to adopt strategies to cope with looming interest rate increases, and to review their longer-term interest rate strategies to avoid risks and leverage opportunities.
“We’re at the beginning of a long-awaited growth cycle in the economy so it’s imperative your business is fit and tuned to leverage the opportunities that a healthy market presents,” said Rinneard. “But there are risks as well, especially if your capital is supported by high-cost debt. You have to get it right.”
Poultry farmers are traditionally among the most financially stable groups in agriculture. The cost of production formula has guaranteed a positive return and should continue to do so. This reliable cash flow makes them attractive to lenders. But no one, except those who are debt free, is immune to the costs imposed by higher interest rates.
This may be a good time to run some “what if” scenarios and check out the available options just to ensure you are prepared.