Managing Financial Risk is Becoming More Important for Grain Elevator Operators

Across the country, strong commodity prices are showing an increase in lending needs of many food-related businesses, including meat producers and grain merchants.

Many agricultural lenders expect the demand for agricultural loans to continue to increase. In many instances, the loans are attractive because agricultural borrowers boast high incomes (paired with attractive collateral) to fund repayment.

“Access to capital is just one part of the equation,” said Larry Davis, Rabo AgriFinance vice president. “Volatility in most agricultural commodities over the past few years reveals the need for other financial management tools to help farmers, such as hedging feed costs and milk prices.”

Turning High Prices into Profitability

While volatility may present some concerns, it also presents opportunities. Grain elevators, for example, have been able to seize the opportunity to become more profitable.

“The financing cycle for inventory has been affected by price volatility,” said Karen Wheatley, Rabo AgriFinance relationship manager. “You may have higher spikes in the peak financing needs for (grain elevators) during the course of the year – much more than what we have seen in the past.”

Grain managers need to carry enough line capacity to handle market shifts, and demand for extended lines of credit typically increases to cover grain inventories. As a result, there is increased pressure on lenders to meet demand.

 “The capital required to run a farming operation continues to increase,” Davis said.  “We’re seeing prices for fuel and fossil-fuel-based fertilizer increasing across the board, as is the cost of seed.”

Entering Risk Management Mode

Agriculture has been an economic bright spot during otherwise trying times, so lenders have been eager to support qualified customers. However, given the current state of the credit market and dollars at stake, bankers are now seeking more insight than ever into the client risk exposure.

Risk management is the identification and assessment of risks and the efforts to minimize, monitor and control the impact of both positive and negative events. In practice, risk management isn’t new to the business community, but grain elevator businesses may not have thought about the financial capacity needed to maintain their hedge position in today’s volatile markets.

Within grain businesses, risk management policies may not be formally documented. Even if formal documentation is lacking, lenders will be especially interested in a grain elevator’s risk management policy. This policy should aid in avoiding, mitigating, transferring or accepting risk and the actions the company will take given different scenarios, because it helps confirm the security of the company’s finances.

Elevator/Lender Communications

If a company’s grain merchandising plan covers most of the important risk elements, management should be sure to communicate this to the lender. One way to do so is to demonstrate monthly projected positions.

“Even if it’s a verbal description and the borrower explains what the elevator plans to carry and market, we want to know,” Wheatley said. “It’s a two-way conversation. Lenders should make sure borrowers understand what may be expected of them during the next year, and borrowers need to make sure their lender supports their plan and its implications.”

Diligence in communication with a lender, and the borrower’s ability to articulate its strategy for navigating potential risks can make a difference.

“Without direct contact with the borrower, assessing risk management is a very subjective thing; we look at numbers and past performance,” Wheatley said. “Well-managed budgets and timely, accurate financial reporting are a good indication of management’s abilities.”

Wheatley suggests including a lender in the discussion of any major changes – a facility expansion, for example – on the front end to find out if the bank will support the project. The lender will want to understand the company’s position and evaluate its capacity to borrow additional long-term debt. For example, if an expansion is in the near future, the lender will need to understand the associated increase in financial needs that comes with handling more grain.

Wheatley also encourages an open dialogue with the lender. Investigate how your business compares to other businesses in the lender’s loan portfolio. Most lenders have benchmark averages to draw comparisons.

“Interest in your company’s performance against other companies demonstrates you, as a manager, are on top of things and being proactive,” Wheatley said.

To mitigate risk, it is recommended all grain contracts go through legal counsel each year to evaluate enforceability of the contracts.

Calculated Risk

While grain business managers can’t possibly avoid all risks, they can identify those that could have the greatest impact and prepare for a wide range of circumstances. By demonstrating the protocols an elevator has in place to diligently monitor finances, the lender/borrower relationship will begin on strong ground and allow for informed decision making that will ultimately help grow the business.