I have been getting e-mails and questions coming faster than a Twitter following for a big time professional athlete or high-priced college basketball coach. The questions’ central focus has been: “Should I fix my interest rates in light of the recent run up of long-term rates?” Well, the following is my generic answer, and terms and conditions may vary with individual situations and circumstances.
First, there is a much higher probability of long-term interest rates increasing than decreasing. With stimulus packages being implemented not only in the U.S. and Canada but throughout the world, more than likely inflationary pressures will result.
Next, quantitative easing, or printing more money, by the Federal Reserve may result in a devaluation of the dollar, which will make imported goods more expensive. More money chasing fewer goods results in inflation.
However, before any of the above occurs, consumer and business confidence must be regained. Current savings rates and conservative spending patterns would suggest that the U.S. has a ways to go. Any adversity will result in the so called “green shoots” getting a “killing frost” that may create a false recovery or “dead cat bounce” in the economy.
Producers must determine how vulnerable they are to interest-rate increases. Conduct a cash flow sensitivity analysis to determine how much a 1-4% increase in interest rates would impact financial margins and business sustainability.
Let’s take a specific case:
A large crop producer is considering a fixed 15-20 year amortized rate of 5.75%. This product would have a prepayment penalty only if the institution’s current new customer rate is lower at the time he opts to prepay more than 20% on the principal. The proposed loan would take out a current $250,000 loan at 4.25% (three-year fixed) that the producer has on a five-year amortization that he cannot currently afford. This is a solid operation where long-term debt needs to be structured correctly to weather the future storm.
In this case, a fixed rate of 5.5-6% for longer than 10 years sounds very attractive to weather future financial adversity, especially when a more than 20% prepayment option on principal is offered. A final piece of advice to the producer would be if he cannot sleep at night because of the concern of variable rates, then perhaps he should fix the rates.
Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.