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Managing Risk in a Rising Interest Rate Environment
Posted September 11, 2023 | By: Carrie Cholak
Being proactive can save you in interest costs in 2023
There’s a lot of talk about rising interest rates these days. Driven by speculation about the pace and magnitude of rising interest rates and apprehension around the timing of these increases, growers should be concerned how their profitability will be impacted. Now, more than ever, growers need support and resources to help navigate these economic factors to manage their risk and protect themselves against market uncertainty. Taking a proactive approach and working to control the variables that impact your financial position can minimize anxiety and save you money. Here are a few things to consider:
Understand the rising costs of interest
When interest rates are higher, so are the costs associated with borrowing. This is why it is so important to review an agronomic and economic plan for your input purchases, especially in the current interest rate environment.
Anyone watching the economy has seen the steady increase in interest rates over the last two years. While it’s well known that interest rates fluctuate over time, there’s no set rhythm as to when or if they will change. The Bank of Canada (BoC) adjusts their overnight target rate based on its mandate to manage inflation. In July 2023, the BoC’s overnight target rate reached 5%, a rate that hasn’t been seen in Canada since 2001. In the last 12 months, the target rate has doubled, driving up the cost of credit and directly impacting the profitability of growers.
Cash flow for immediate budgets is impacted and depending on how leveraged you are, your credit score may be impacted as well. Interest rate increases can also affect other modes of borrowing, such as variable-rate operating lines, home mortgages and equity lines, personal credit lines, credit cards or any other debt that is based on variable interest rate terms. The rising costs become a little more evident with an example. Let’s assume a grower is managing a 5,000-acre grain farm with a budget of $300 per acre to purchase seed, fertilizer and crop protection products. If that grower had a borrowing rate of Prime + 1% back in February of 2021, their interest rate would have been 3.45%. Assuming the purchases are financed from May until crop proceeds are received in late fall, the monthly compounded interest expense on crop input spending of $1.5 million comes in around $35K to finance that purchase. In the same scenario this year, the grower’s interest rate would be 8.2%. The grower would pay $82K in interest, more than double on the same purchases compared to just two years ago. This is a perfect example of how dramatically rising interest rates can impact borrowing costs and why it’s important to research and evaluate different lending options to make sure your cost of borrowing is as “controlled” as possible.
Current interest rates may seem high, but as many growers know, they have been much worse. Growers experienced the record-setting interest rates of the 1980s, when the prime interest rate hovered over 20% (22.75% in August 1981!). While it could be worse, that doesn’t do much to alleviate the financial pressure growers are feeling today.
The cost to borrow is just one factor growers need to consider when assessing the impacts to profitability. In addition to rising interest rates, commodity prices and the cost of production and land are all tied to the market as well. Growers have a lot of variables to contend with, so having a plan with room to adjust as variables shift gives you more control over your financial success.
Be proactive in responding to market changes
There are a few things you can do to manage your risk and take some of the stress out of these market highs and lows:
1. Know your interest rate and explore your financing options. There are many types of financing and it’s important to understand the terms and products so you can have greater certainty around your budget. Fixed-rate loans can help control one more variable in your cost equation. This can also provide a bit more budget certainty.
2. Identify the type of financing you have in place or what you intend to incur in the near future and research opportunities for fixed or blended rate financing. Variable rates are subject to interest rate fluctuations and offer less stability to predict expenses. This is an effective way to create more stability in your financial plan.
3. Complement your bank operating line of credit with input financing offers. This affords you flexibility to take advantage of rates and terms that meet your operation’s needs. By refining your cash management strategies, you’ll be better positioned to preserve capital or leverage operating lines where needed for items such as making payroll, paying for maintenance or funding down payments for capital expansions.
4. Identify your debts and make a plan to control the things you can. Look at your complete financial picture and build a plan so you can evaluate all your options when interest rates go up. It is key to understand the impact of fluctuating interest rates on your operation’s profitability.
5. Continuously monitor the variables that can change throughout the year. Make time to understand your breakeven costs and your cash flow cycle and involve a trusted business partner to help if you need it. For example, conducting sensitivity analysis on the impact of a 1% increase in rate on all variable-rate priced debt that you are carrying or determining the impact of a 10-15% increase in the cost of your inputs will help mitigate the element of surprise should the event happen. No one likes surprises, especially when it impacts your bottom line.
How to build a financial plan
Farmers are experts when it comes to dealing with the unexpected. The best way to find yourself on solid financial footing, regardless of the market, is to make a plan and reevaluate that plan any time you experience a change in circumstances. Your plan should factor in things like rising costs and other inflationary pressures, along with a clear roadmap to your goals. This will help identify all the ways you might pivot should challenges arise. Find a partner to help (your account manager at your financial institution, accountant or consultant) if you are not comfortable assessing these factors on your own.
Though the market will always be unpredictable, there’s still good news. We are seeing positive signs that we’ve weathered the worst of the market volatility; inflation is tempering and supply chain issues are improving. While no one can predict with total certainty what's to come, there's reason to feel optimistic that we're closer to the end of this turbulent market than the beginning. Nutrien Financial’s programs are designed to help you control the interest rate volatility that could impact your operation’s profitability. We take a personalized approach in helping you attain your crop inputs and aligning repayment with your crop revenue cycle which is another key factor to consider when planning your cash flow for the year.
Interested in learning more about Nutrien Financial? Go to NutrienFinancial.ca.