Cash Will Be King

By Elizabeth Williams
DTN Special Correspondent

INDIANOLA, Iowa (DTN) — When grain markets began their free fall, Indiana farmer Gordon Millar eyed his farm’s financial projections and knew he needed to come up with more cash to keep his lender happy and his operation prepared for tough years ahead. During hard times, working capital would be king.

"In 2013, we had the most profitable year we ever had, and I’ve been aggressive in pre-selling our 2014 crop, which should keep us above breakeven this year," the New Carlisle, Ind., farmer said. But 2015 shows negative profit margins, even for an operator with crops as diverse as tomatoes, seed corn, sod and row crops of corn, soybeans and wheat.

"My goal was to lock in historically low fixed rates and ideally not have to borrow any short-term money," said Millar. He’s been farming full-time less than a decade and bought out his parents, David and Renee, several years ago.

Farmers in the 1980s discovered what can happen when interest rates start stretching higher. "It was nasty for people who were victims of exploding interest rates," said Mark Nowak, retired Minnesota banker, now farmer and farm consultant in Wells, Minn.

While many farmers’ financial situations are more secure now than 30 years ago, agriculture is still vulnerable to interest rate shifts. In a DTN August online poll, about 20% of the respondents said their operation could not handle an increase in interest rates. One in eight said a rate hike of 1% or 2% would be trouble. Twenty percent worried about a rate hike over 2%. On the other hand, 44% of the poll respondents said a short-term interest rate hike would not affect their operation since they borrowed so little money.

The problem for borrowers is that the Federal Reserve remains on course to begin raising short-term rates in 2015. Once that happens, Farm Credit System lenders expect rates to jump as much as 200 to 300 basis points in a 24-36 month period (see Minding Ag’s Business "Defend Against Reversals of Fortune," http://goo.gl/…)

"When interest rates start to rise, it’s too late to take advantage because markets move so fast," cautioned David Lynn, a senior vice president at Louisville-based Farm Credit Mid-America.

Millar restructured his debt by refinancing equipment that he had purchased for cash in the past 12-18 months. This effectively gave him working capital cash on a fixed, five-to-seven-year note. "I knew my lender was concerned about lending on specialty crops and this helped reduce my exposure to interest rate hikes," said Millar, who had worked for Farm Credit Services for three years before returning to the farm. "I looked at my 12-month cash flow needs and figured out how much I needed to get through the lowest point. I want to have enough liquidity so I don’t have to borrow operating funds for more than six months in a year."

Bankers today are looking at minimums of 30% of gross revenue for farmers to have on-hand as working capital. "I would like to see that at 50%, heading into low-profit years," said Nowak.

"It’s easier to restructure your balance sheet now when farm values are still relatively high, income statements from the past three years are still favorable for credit standards and interest rates are historically low," Nowak added. That picture may change 12 months from now.

"If you wait a year or two and the cost of production is higher and your cash is drained and you have no cash flow, you won’t have the strength in your balance sheet and income statement to re-finance," said Bob Campbell, a senior vice president with Omaha-based Farm Credit Services of America. "Now is the time to tweak your income statement to give it some breathing room."

Even locking in a one-year fixed rate may look smart a year from now. FCS Mid-America is offering operating lines of credit as low as 2.99% on a one-year fixed rate.

"My goal is to have as much cash as I possibly can," said Millar, but he is not opposed to borrowing short-term money to help him achieve his tax-saving strategy. "Right now, I plan to borrow some short-term money at current low rates to pre-pay 2015 crop inputs. Then, I’ll pay that off in January," Millar explained.

Managing taxes is getting as much attention from Millar as managing his interest rate costs. "I think farmers are going to hit a wall at the end of 2015 where they have no equipment write-offs and they don’t have the money to pre-pay expenses. They’ll have income from the previous year’s crop but no deductions," he said.

Millar aims to show a minimum taxable income of 1.4 times the principal payments on non-depreciable assets. "Looking ahead, I want to be sure I don’t incur excessive tax liability," said Millar as he plans his 2014 and 2015 income tax strategies.

"My dad always said, ‘It’s not the decisions in the bad times that will kill you. It’s the bad decisions in the good times that will get you. The good times we’ve had in agriculture the past couple years have covered a lot of bad decisions in ag," Millar noted. He is hoping his attention to details and conservative financial strategy will help carry him through the tough times ahead.

Elizabeth Williams can be reached at elizabeth.williams@dtn.com

(MZT/AG/SK)