Something other than inflation has also been rising. In the past 120 odd days, prime lending rates have gone from 2.45% to 4.7%1. The prime rate has been at 2.45% since April 2020. Before that, it was 3.95% from October 2018 onward. Outside of that period in late 2018 up to the start of the pandemic, the prime rate was between 2.5% and 3.5% since December 2008. Interest rates have been fairly stable for more than a decade. You can see this on this chart from the Bank of Canada.
That trend of super-low interest rates might be over. It is now more important than ever to know how this could impact your farm operation. Before the economic recession in 2008, interest rates usually ranged from around 5% to 8%. Overall, even the average 5-year fixed interest rate has been 10% or less since 1992. That means if you’ve been farming for the past 30 years, it’s unlikely you’ve had double-digit interest rates.
A Page the History Books…
Yes, we could discuss the 80s when the prime interest rate peaked at 21.75% in August 1981 (it was back to 17.25% by that winter); however, farming has changed in many more ways since then. Modern hog operations were just getting started in the 1980s, now they’re the norm. Supply management was barely a decade old, and the quota exchange for dairy didn’t exist before March 1980. Agricultural Economic Insights (AEI) has a great podcast that breaks down what happened in agriculture in the 1980s from an American perspective.
…Or Not.
That was 40 years ago. In 1981, Canada’s total farm assets were worth $130billion. Today (2021 statistic) they are $748billion. That return on assets has dropped from 0.055 down to 0.017. Farm liabilities have risen from $16billion to $121billion. So while both assets and liabilities increased, liabilities increased at a much faster rate over the same time period.
Today as back then, rising interest rates should be of concern to you. Eventually, all of those loans have to be paid back. The current liquidity ratio was 3.8 compared to 2.3 now. That current ratio is the short-term ability to repay bills and debts due within the next 12 months. If you have an operating loan that is based on the prime rate (fixed or variable), your interest expense has almost doubled since March 2022.
Straight Math
If you had an operating loan of $100,000 maxed out with an interest rate of prime plus 1%, then your monthly interest payments went from $287.50 to $475. Any loan with a variable rate will have increased over the last few months. Any new projects under financing likely also increased or changed.
In the residential housing market, there is a key measure for lending called the stress test. This test adjusts the interest rate to either the test rate or your offered interest rate plus 2%, whichever is higher. The rate has been 5.25% until now, with the 1% jump, your stress test for a prime rate mortgage would now by 5.7%. Keeping an eye on this test is a good way to run scenarios for your own budgets, you should probably be using a rate of at least 6% if not 7-8%.
Fixed Rates
I’ve had some interesting conversations lately from businesses waving off concerns about rising interest rates because they were all locked in. For the most part, the longest interest term many businesses lock into is a 5-year term. If your interest rate term is up any time between now and early 2025, you should be concerned about the interest rate increase.
If you owe $500,000 and have currently had a rate of 3.5%; your payment is likely around $2,500 per month. If your rate goes to 7% by next summer, your monthly payment will go to $3,500 per month. Every 0.1% rise in interest is $5 extra per month per $100,000, every 1% is $50 per month. Even if you are locked into a rate until 2025 or later, you should still calculate the impact and consider making more principal payments at this point to reduce further interest costs.
Consequences
Overall, the rising interest rates will just compound problems that are already making 2022 a challenging year for farming. Odds are your operating loan (if you have one) has already increased compared to 2021 to deal with the doubling (and tripling) of input put costs. This is going to be harder to pay back on mutiple levels, if you initially borrowed more to cope with inflation, rising interest rates will hurt twice as much as they take a bite out of cash flows that are already constrained.
There are not many solutions to this situation are this point. For starters, update your budgets to take into account higher interest rates. If you have a fixed rate loan and are in a position to make additional payments, this can offset the shock at renewal time. Read your loan agreements and check the covenants. If your business has to meet certain conditions, make sure you are still meeting those conditions.
If you do need to extend your borrowing, the Advance Payments Program’s interest-free portion has been increased to $250,000. This program provides advances against expected commodity sales and covers a wide range of production.
Interest is just one more cost in a long list of rising costs for farms. It’s now more important than ever to keep an eye on this. It’s not an expense that can be ignored as your payments can jump by a noticeable amount overnight.
Thanks for reading! I wish I had great news but this one percent increase is just another stress factor as harvest starts up. Keep your bookkeeping up to date as you can be sure your lender is going to take a close look.
As I write this, the major banks’ prime lending rate is 4.7%. However, the overnight BoC rate is forecasted to rise by another 0.5-1% increase by the end of the year. A prime rate over 5% is definitely possible.