Interest rate hike protection advised

Farmers should start thinking about protecting themselves from potential interest rate hikes, agricultural debt financing experts say.

“If you … have borrowings of $2 million or greater that do have long-term amortizations that are associated with them, you should be exploring ways for you to mitigate your interest rate risk over a longer period of time,” Quinn Durrant of RBC Capital Markets said during a recent Ag in Motion event.

Long-term rates plunged when the world’s economies slumped in the first flush of the pandemic, were suppressed by central bank “quantitative easing,” and have remained low as the world’s economies and consumers limp along.

However, reopenings and expectations of reopenings by major economies, the tapering off of quantitative easing in some places and higher interest rates from some central banks have led to interest rates beginning to crawl back toward more normal levels.

RBC is forecasting two quarter-point interest rate increases in the second half of 2022, which Durrant and Jon Jonsson, also of RBC, said makes now a good time to be looking at interest rate risk hedging.

They are promoting a swap-based mechanism that allows farmers to lock in for much longer-than-usual debt maturities and can match a fixed borrowing rate to the amortization period for an asset.

“We can fix your underlying cost of borrowing for the full term of your amortization,” said Jonsson.

That means having to renew every few years, and facing the risk of renewing at substantially higher rates, the swap-based approach can provide interest rate certainty for as long as the asset is being paid off, such as 20 years.

“This might be a really useful solution,” said Jonsson.

It is also possible to customize the payments schedule to fit a farm’s cash flow pattern. Instead of dealing with regular monthly payments, a farm could arrange to make payments that match the time of year when a farm’s cash usually rolls in.

“One of the most interesting things about the ag sector is cash flow and management of cash flow,” said Jonsson.

For some farms, “you just can’t go the traditional principal and interest repayment every month or every quarter because that doesn’t always necessarily fit with the way you want to repay your loan.”

Customized debt financing deals can make it possible to arrange once-a-year or twice-a-year payments.

However, Jonsson urged farmers not to do their debt financing at the last minute. Customized deals take time to think up, formulate and approve.

“Make sure you’re engaging with your banker and giving them enough time so that we together can scope out a solution that’s also really going to work out for you,” said Jonsson.