Posted March 2, 2023 | By: John Maman
Managing Risk in a Rising Interest Rate Environment
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, many growers are 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 too are the costs associated with borrowing, especially for growers who have higher debt loads and may not have stellar credit scores. Some lenders might offer better deals than others, simply to attract more customers in a competitive market. 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 Federal Open Market Committee (FOMC) adjusts the federal funds rate based on its mandate to manage inflation and employment. In February 2021, for example, the prime rate was 3.25%, and as of February 2023 it sits at 7.75%. On February 2, 2023, the prime rate increased for the eighth time in 11 months, driving up the cost of borrowing, even for those with exceptional credit.
Debt loads are heavier, 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 equity lines, adjustable-rate mortgages, credit cards or any other debt that is variable. The rising costs become a little more evident with an example. Let’s assume a grower is managing a 5,000-acre corn operation with a budget of $335 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 be 4.25%. Assuming the purchases are financed from May until crop proceeds are received in Q4, the interest expense on crop input spending of $1,675,000 comes in around $46,418 to finance that purchase. In the same scenario this year, the grower’s rate would be around 8.75%. The grower would pay $95,567, that’s more than double in interest on the same purchases from just two years. This is a perfect example of how dramatically rising interest rates can impact borrowing costs, and precisely why it’s important to research and evaluate different lending options to make sure your cost to borrow is as low as possible.
Current interest rates may seem high, but as many growers know, they have been much worse. For growers who experienced the record-setting interest rates of the 1980s, when the prime interest rate hovered at 21.5%, the cost to borrow in today’s market may not seem all that bad. Nevertheless, we can speculate that interest rates will continue to rise into 2023 as the Fed continues to grapple with elevated inflation and tight employment conditions, putting more pressure on all modes of financing.
The cost to borrow is just one factor growers need to consider in terms of impacting 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. 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 expect to have in the near future, and research opportunities for fixed-rate financing. Variable rates are exposed to interest rate fluctuations and offer less stability to predict expenses. You can and should know all your options and consider tactics like a blended rate, or financing options to lock in a fixed rate, which offers some protection against rising interest costs. This is a smart way to create more stability in your financial plan.
3. Complement your bank operating line of credit with a fixed-rate financing offer. This affords you flexibility to take advantage of the best rate that meets your operation’s needs.
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 see all your options when interest rates go up.
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.
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. Rest assured, Nutrien Financial’s programs are designed with your operation in mind. We take a personalized approach, with experts who know your crop, geography, and harvest timelines, which results in the most comprehensive financing solutions on the market.
Interested in more articles from Nutrien Financial? Go to Blog (nutrienagsolutions.com) or complete your credit application and lock in your interest rate today at nutrienfinancial.com.
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