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Steps for Minimizing Operational Risks of Rising Interest Rates

The general view following last week’s Federal Reserve meeting is that interest rates will hold until 2015 or early 2016 – in which case producers have time to understand and minimize the impact of rising interest rates on their operation. Most producers who borrow money for operating expenses have loans with variable interest rates. Two examples illustrate what rising interest rates would mean to these operators.

  • A farmer borrows 50 percent of his operating costs on 1,500 acres of irrigated corn for an estimated line of credit of $525,000. A 1 percent increase in the cost of credit would equate to $5,250, or about $3.50 per acre.
  • A producer who feeds cattle for 200 days would be impacted about $8 per head at the same 1 percent increase in the cost of credit.

As part of their total risk management plan, producers also need to consider the impact of rising long-term fixed rates. An example:

  • A producer has real estate debt of $3,000 per acre and a 20-year loan. If the loan doesn’t have a fixed rate and the producer doesn’t pay off the loan early, he or she faces interest rate risks. A 1 percent hike in interest would cost the producer an additional $30 per acre the first year, and more than $300 per acre over the life of the loan.

Future increases in short- and long-term interest rates may not move in unison, so operational risk for each could be different. An effective hedge against rising short-term interest rates is to maintain adequate levels of working capital. A good strategy for managing long-term interest rate risk is to structure loan maturity and interest rate options to match goals for paying off a loan.

Producers have time to lock in very favorable long-term fixed rates and to address their working capital. But the time to act is now.

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