There are a number of ways that rising interest rates affect farm balance sheets. They can negatively affect cash flow, can create a need to adjust short-term and long-term liabilities and affect the value of farmland that in turn can impact the farm’s asset values.
“Higher interest rates will impact operations differently based on how the debt is structured,” says Farm Credit Canada (FCC) chief agricultural economist, J.P. Gervais. “Is all of a producer’s debt priced under a variable rate or do they have a combination of variable and fixed rate loans? Changes in interest rate will not impact fixed rate loans until they come due for renewal.”
Ag balance sheets strong
Since June 2017, the Bank of Canada has increased interest rates four times, but agricultural economist Amy Carduner with FCC believes the industry will finish 2018 financially strong and head into 2019 on a good note.
In a recent blog post Carduner says “I might be forced to change my mind, but the fact is that the starting point — the relatively low level at which the recent rate hikes kicked in — will influence the degree of its impact on overall farm financial health.”
More good news, she adds, is that the recent strong net income will take the sting out of interest rate hikes, and that the net worth (equity) of Canadian agriculture continues to grow at record levels, as does net cash income for Canadian farms. Net cash income has more than doubled and strengthened demand for farm assets, the value of which has also increased.
This strong balance sheet will allow Canadian agriculture to weather future rate hikes. “Even though financial markets are currently estimating an almost-certain probability of an increase in the overnight rate on October 23, with a 66 per cent chance of another hike in January, I don’t think any serious threat posed by higher rates will materialize,” says Carduner.
There are several reasons for her optimism. Current interest rates, while on the rise, are still low enough to have a relatively weak impact on agriculture’s overall financial health or to reduce demand for land and other assets. She is confident that net farm incomes in 2018 will remain strong, but also recognizes that weather and weaker prices could lead to a small decline in gross income.
Assessing your farm’s tolerance
One tool producers can use to evaluate how different interest rate scenarios could affect their farm’s financial health is the Interest Coverage Ratio. This is calculated by dividing earnings before interest, taxes and depreciation by the interest expense. If the ratio comes out below 1.5 it could expose operations to difficulties in servicing existing debt if net operating income fluctuates. The higher the ratio, the stronger the financial health of the farm business and the more resilient it will be to increased interest rates at current debt levels.
Shopping for lower rates?
Some producers shop around for a lower interest rate in some instances says Gervais, although interest rates are only one component of a relationship with a financial institution. “How well lenders know your operation, their ability to find solutions, commitment to the farms’ success and being a trusted partner are all part of a successful formula,” he says.
Although producers can’t control where interest rates may go, it’s important to focus on management decisions that can help them control costs, raise revenues and productivity, and prepare them to face unfavourable movements in rates or income, says Carduner.