By DairyBusiness Staff
TULARE, Calif. – Credit and financing are two extremely important elements in determining your success or failure as a dairy producer.
The relationship you have with your lender is a delicate one and must be just as much a priority as your milking protocol and herd health programs.
John Ellsworth, Western DairyBusiness columnist and financial advisor to dairy producers from California to Iowa, pulled together a panel of financial experts with successful long-term track records in working with the dairy industry. They were Sean Haynes of Rabobank in Modesto, Marc Ehlers of Bank of the West in Visalia, and Mitch Millwee of Farm Credit West in Bakersfield.
The panel, moderated by Ellsworth, fielded questions from dairy producers during Dairy Profit Seminars at World Ag Expo earlier this year in Tulare. Here are some of the issues raised and responses from the experts.
Q: Where are interest rates heading and should we be looking at locking in long-term?
HAYNES: Can interest rates go any lower. Can you borrow money for free? No. So chances for rates going up are better than they are for going down. Don’t know when it will happen. Do you lock yourself in on all of your finances. Don’t lock all of it. Lock half and cut your risk in half. You can look at it as a forward lock. Not looking for rates changing right now, pretty low and have to go up quite a bit before you feel the pain, but maybe a year from now your rate is fixed. So flow for a bit and take the gamble that rates are going to rise during that period of time and then convert to a fixed rate with a little less pain. A good time to look at it because with lower rates on the short side, rates are very low and will pull down that curve for long term market. Now is a good time to lock it up. Half and half hedge so you have room to move if it doesn’t go up.
EHLERS: Part has to do with the time frame your looking at. We look out three years and think the economy is going to increase enough to generate enough demand to force some type of inflation, which is the biggest issue I see out there. If you take half of it your basically hedging your position, but half of your payments will be twice as much as they are today. Every interest rate out five years will probably be double what a 30-day or 90-day rate is. If I really knew what it was I wouldn’t be speaking here…Sean hit it on the head. It’s not going to get any lower on a short term basis. Question is, is it going to get any higher on a long-term basis? What’s going to drive it?
MILLWEE: I think you have to look at what your overall blend of debt is. Are you carrying a lot of commercial debt? Have you blended that with mortgage? Have a balance within your debt stricture. With mortgage rates, I think right now it is just good to keep in touch with your lender and find out how they are doing. Keep a portion – as much as you can – on the variable rate…and see where it is going. Things can get away from your pretty quick. Checking in regularly with your lender is a good strategy, because if you start to see things move, maybe that’s the time. It is pretty tough to lock yourself into an interest rate that is going to be quite a bit higher at a time when break even or some losses are occurring.
Q: What is the availability of funding, bank financing, for a startup operations, specifically dairies industry?
EHLERS: If you have a track record in something that is related, it is going to be easier. If you have no track record I would put it at pretty close to impossible from a standard of what the industry is financing today. Your capital level is going to have to be significantly higher than they were historically. When I was in the Midwest we had a lot of startups and those wouldn’t get financed today at the levels they were financed then. The access to capital from a bank standpoint…because cost has gone up when you get to the equity side of it that cost has gone up significantly too. Nobody really wants to get rid of their money on the equity side unless it is a pretty significant advantage.
MILLWEE: I’d agree with Marc. Experience is important and capital is very important. If that’s not there, maybe a reliance on some outside guarantor…But it needs to be a constructive business, something that is profitable and makes sense…a lot of operations can start up with a pretty good amount of debt, but in this environment you’ll have to startup with more equity when you are beginning.
HAYNES: I think the startup thing is a hard question. There are some programs you can look at but at the same time have to look at credit scores and maybe requires someone to sign for you. As a lender, I look at it as an investor in your startup operation which is capital intensive and not much equity to burn through when things are bad. A lot of times looking at startup or mature operations we’ve got to say what’s the survivability? That’s part of the startup nature, startup and build the capital base and…look at what levels do I have to have in business to demonstrate to the bank that I can survive a downturn and make myself a good credit risk.
Q: Is there a shift taking place in how lenders look at financial deals?
MILLWEE: Yes, I think so. Let me just talk about risk management. I think it is important…as a producer you need to be proactive, and work to reduce your expenses and be more efficient. Ultimately it is your business.
As a bank we always look at cash flow. The balance sheet has been there to support it and we look at averages because we see those cycles and the years you’ve had losses and look at overall the trends and how the business is going so the well capitalized businesses are able to ride those out verses those that are no so well capitalized.
Going forward in today’s environment you see those wider variances in these spikes between highs and lows. Somehow have to work to level those out because seen what has happened here and a lot of equity lost. To me it’s not so much what you can make on the upside, but what you can preserve on the downside.
Discussions have been about using option pricing – puts on milk, calls on feed – trying to match that up, and not so much trying to ride out a $20 market to get it all back. But maybe have some options there to perhaps ride that, but then have a floor, because you can survive with a $14 milk price better than at $9.
Those are some strategies to look at and to talk to your lender about. Dairymen are becoming more efficient as production per cow is increasing and more efficient at herd replacement with a tremendous number of heifers coming online. So the efficiencies are there on that side, but where can we come with efficiencies on the expense and pricing side?
HAYNES: Speaking to your cash flow question, as a commercial bank that’s what we worry about first. Is there going to be cash flow enough to pay-off your debt over time? We have to look at, what is your break even cost? Are you going to be in a position where more times that not, are you making more money than you are losing during a downturn. That’s the first thing we look at…on the foreseeable chance that we will get paid back?
One of the things that has changed, on the whole in the banking business is, there is more concentration on the balance sheet as well, with the volatility in the market, everybody is going to understand that it’s not “if,” but “when” you’ll be losing money again. “I have this cash flow, and I think it’s going to be okay, but I can’t look out even more than a year – maybe six months – as far as what’s that cash flow going to be doing? Against your peers how well do you do produce milk. What’s your cost of production? Are you $17 break even or $12 break even? Your Risk of losing money at $12 is much less than a guy with a break even at $17. That‘s my cash flow component.
As a lender look at the balance sheet, okay when we lose money again when milk is at $9 again, and I’ve locked my feed in like in 2008-09, so I need $18 milk to pay for it. How long can I do that for? That is the “burn rate.” How long can I burn directly before I hit levels that the bank is uncomfortable?
That will determine whether you will get a loan going forward. A dairyman has to ask himself, at what point do I want to be a minority owner? Looking at the balance sheet the dairyman might have a net worth of $10 million, but the bank has invested $30 million.
For the complete panel discussion via podcast, please visit www.DairyLine.com and click on “Dairy Profit Seminars.” Then click on “WDB Seminar #3: Ag Lending.”