How dairy farmers can stay ahead of rising interest rates

While the expectation is that rates will continue to rise, we’re not expecting to get anywhere near those heights.

National Manager of Agriculture / BMO Bank of Montreal

The Bank of Canada’ts current rate is 1.75 percent. We expect the Bank of Canada to tread cautiously as it continues to tighten policy, as raising rates abruptly would risk derailing the economy. Canadian household credit burdens crept higher in the third quarter, and the key debt-to-disposable-income ratio climbed to a near-record high of 173.8 percent.

All told, we believe the Bank of Canada is likely to reach neutral territory in the first half of 2020, and the five-year Government of Canada yield will level off near 3 percent around the same time. That said, rates could rise further and faster if the economy were to begin to show signs of overheating.

Canadian farm debt is also on the rise, with farm debt rising 14 percent since 2015. The dairy sector, as well, has above-average debt loads and, for every $1 million in debt, a rate increase of 1 percent means an additional $10,000 in just interest payments each year. Rising interest rates and higher farm debt are poised to weigh more heavily on farm finances than in the past.

However, dairy farmers can take action to protect themselves against rising rates using four key strategies.

Fixed versus variable loans

The two biggest forces putting pressure on farmers right now are weather conditions and interest rates. Hot, dry weather was a staple in Canada this year, which dampened crop production; Canadian farmers in the country’s largest agricultural regions saw composite crop yields – consisting of corn, soybeans, wheat and canola – come in below trend for a second straight season.

For dairy farmers, hotter weather can cause heat stress for cows and can also negatively impact forage quality, and both can affect production. Rising interest rates create another element of uncertainty.

This is where the importance of evaluating loan options comes in. With a fixed rate, interest rates are locked in for the term of the loan. A variable rate loan will move up and down, as the Bank of Canada moves its own rate. As variable interest rates are expected to get more costly over the next couple of years, a fixed rate may be preferable, as it will bring predictability to cash flow.

But one size doesn’t fit all. Farmers should evaluate the merits of locking in rates for their particular operations. Taking the fixed route for a portion of the loan – one, three or five years – may help them hurdle the current external pressures.

Milking it

Technology is providing farm operators a significant opportunity to drive greater efficiency in their operations. Even with moderately climbing interest rates, improved efficiencies in farm operations should help improve profitability and cash flows – leaving farmers better positioned to handle interest rate bumps.

An extra farm hand

When interest rates are on the rise, farmers should speak to their financial advisers – such as their bank relationship managers. Depending on how high rates rise, it might still be an attractive time for them to invest in their operations if the investment results in improved profitability and cash flow. Farmers need strong relationships with their advisers; this helps advisers find solutions most likely to fit particular circumstances.

Look to the amortization period

Loan amortization can be another option to head off potential headwinds. Make sure the amortization period is aligned with the appropriate life of the asset. As a guideline, for real estate loans on dairy farms, look at 25 years. For quota, look to 15 years; equipment should be between five and 10 years.

While we know there are external factors putting pressure on dairy farmers, there are still opportunities to ensure stability and growth.