Get ready for challenges this year. On the negative side, decreasing milk prices threaten to create an obstacle to profitability. On the positive side, we’re seeing some decreases in feed cost as well as the energy needed to run our operations.
Meanwhile, the current U.S. financial storm may create some future concerns for the fiscal health of your dairy. The various financial bailouts mean that the federal government needs to borrow a great deal of capital to meet its obligations. You may actually be competing with the federal government to obtain funds to finance your operation.
How could an interest rate increase affect you?
Let’s look at an example of a $500,000 facility loan with a current rate of interest of 5 percent and payments due on a 20-year amortization schedule. Also assume that this is a 300-cow dairy with average milk production of 26,000 pounds. The payment on this loan would be $40,544 per year, $135 per cow, or 52 cents per hundredweight of milk.
Now, assume that the interest rate on this loan increases by 3 percent to a rate of 8 percent per year.
What happens to the payments? The new payment is $52,174 annually, $174 per cow, or 67 cents per hundred weight of milk, a significant increase.
Could we see large increases in interest rates? Do you remember the 1980s?
David Kohl, Virginia Tech agricultural economics professor emeritus, thinks that it is possible that we could see double-digit interest rates within 18 months — dependant on events now occurring in the economy. Note that Kohl says “possible and not necessarily probable” at this time.
Each financial institution you work with may have a different cost-of-funds dependent on its source of money. Smaller country banks rates may be more predictable than the Farm Credit System or the large regional banks, since the smaller banks rely on stable local deposits to fund their lending activities.
Your first step should be to prepare a schedule of your loans to analyze your risk. Concentrate on loans that have more than five years to reach their maturity. You may want to consider locking in the interest rates on a portion of your longer-term loans to minimize risk.
If you have extra cash, pay off loans with the least maturity to allow you to increase your future cash flow.
Finally, address any concerns you may have with your lending officer.
In addition, good dairy managers should take a hard look at taking advantages of today’s low grain prices to lock in a portion of their needs for the coming year. Also, consider locking in liquid petroleum, since current L.P. costs are as low as we have seen in some time. Diesel fuel has not seen the same price decreases seen with gasoline, but if current trends continue, carefully examine your need for diesel fuel and consider locking in a portion of your 2009 needs.
The next 12 to 24 months are going to be some of the most volatile that we have seen in agriculture for quite some time. Carefully examine your financial position, meet with your financial consultants, and decide what steps you need to take to minimize the risks to your dairy operation.
Darrell L. Dunteman is a partner in Bonnett and Dunteman, Certified Public Accountants and Consultants in Bushnell, Ill. Dunteman also edits the Farm and Ranch Tax Letter, a monthly agricultural tax publication. Contact Dunteman at: email@example.com.