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FCC says be prepared for interest rate increase


January 24, 2013
By Farm Credit Canada

Jan. 24, 2013, Regina — Agriculture producers and agribusiness operators
must continue to monitor the Bank of Canada‘s analysis of the Canadian
economy following the bank’s decision yesterday to keep its overnight
lending rate at one per cent.

Jan. 24, 2013, Regina — Agriculture producers and agribusiness operators must continue to monitor the Bank of Canada‘s analysis of the Canadian economy following the bank’s decision yesterday to keep its overnight lending rate at one per cent.

While the key interest rate of the bank hasn’t changed since September 2010, it is always appropriate for producers and agribusinesses to review their financing strategies, according to J.P. Gervais, Farm Credit Canada‘s (FCC) chief agricultural economist.

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The Bank of Canada closely monitors inflationary pressures for signs that might warrant increases in the overnight rate.

“Low inflationary pressures throughout the country and a cloudy world economic environment suggest the overnight rate should remain at its current level well into the second half of 2013,” Gervais said.

“If rates do start to increase towards the end of the year, we anticipate it will be a slow and gradual increase, reflecting the speed of Canada’s economic growth.”

Gervais said signs of inflationary pressures to watch for include an improving outlook for the labour market – especially in Eastern Canada – an increase in business investments and broad attempts to pass on higher production costs to consumers.

The Bank of Canada’s overnight target rate influences variable mortgage rates. When the overnight rate changes, the prime rate typically changes by the same amount.

BE ABLE TO WITHSTAND A TWO PER CENT RATE HIKE
“It is prudent in the current environment for agribusinesses to ensure that they can withstand a two per cent increase in interest rates. This will ensure long term viability if interest rates climb,” Gervais said.

“Because mortgage costs are often a key cost in a farming operation, one of the most frequent questions we hear is: ‘Should I go with a fixed-rate or a variable-rate mortgage?’” said FCC vice-president, treasury, Don Stevens.

“The answer is that it depends. Sound information and an assessment of personal risk tolerance can help make the decision easier.”

When interest rates are low, variable rate loans are a popular choice. Over the past year, about 65 per cent of new FCC loans to farmers and agribusinesses were made using the variable rate, compared to 80 per cent in 2010. About 60 per cent of FCC’s $24 billion portfolio consists of variable rate loans.

“If a farmer is already carrying significant financial risk, then reducing interest rate risk may be a smart strategy,” said Stevens.

“Although everyone wants to save money, sometimes it’s prudent to proactively take risk off the table. I’m not saying that everyone should lock in; however, every producer needs to understand what different scenarios might mean to them and do what’s right for their business.”

One method to reduce interest rate risk is to have more than one mortgage, with different terms and a combination of fixed and variable rates. The borrower can then reprice debt at different times. This has to be weighed against the complexity of managing multiple mortgage terms.

Here are some other considerations:

Fixed rate advantages
•    Protection against rising rates until the end of the fixed-rate interest term (the longer the term, the more constant the costs).
•    Easier to predict interest and principal costs to calculate profit/losses.

Fixed rate disadvantages
•    Generally, fixed mortgage interest rates are higher than variable. Therefore, the longer the term, the higher the interest rate.
•    Break fees or prepayment penalties may be incurred if the loan is paid off prior to the end of the term.

Variable rate advantages
•    Studies show that historically, variable rate mortgage owners pay less most of the time if interest rates are falling.
•    Ability to convert to fix without penalty.

Variable rate disadvantages
•    Risk of higher rates if prime increases.

Agriculture matters to this country and FCC is committed to the long-term success of the industry. The success of individual producers impacts the success of the industry.

You can find information online about interest rates from FCC at www.fcc-fac.ca. Producers who want to review or establish their financing strategy can contact the nearest FCC office at 888-387-3232.


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