How to Manage Financial Risk

Agribusiness has experienced a notable number of upswings in recent years. Grain price hikes, increased crop sizes, higher yields, skyrocketing land values, expanded capacity — you name it, agriculture has experienced it. Grain elevators in particular have been able to seize the opportunities of volatility to become more profitable. Agriculture’s gains have also had a direct impact on the institutions most invested in its success: the ag banks.

“Financing needs have grown dramatically the last few years,” says Galen G. Herr, regional credit officer, Rabo AgriFinance. “The volatility and financing cycle for inventory has been affected by price volatility. 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.”

The potential for strong price rallies — and the tremendous amount of margin calls needed to fund hedge positions — requires grain managers to carry enough line capacity to handle market shifts. Naturally, the demand for extended lines of credit increases to cover grain inventories, putting pressure on lenders to meet this demand. To put it in perspective, the run up in grain prices drove the average extended lines of credit from $10 million to $30 million last year, reports Greg Schopen, vice president of agriculture and rural markets, Badgerland Financial.

Since the agriculture sector has proved an economic bright spot during otherwise trying times, lenders have been eager to support its qualified customers; however, given the current state of the credit market and the dollars at stake, bankers now seek more insight into the risk exposure its clients are carrying. Regardless of whether the relationship with your lender is new or well established, frequent communication and the development of a well-thought-out risk management strategy will strengthen a lender’s confidence in your business.

Develop a formal risk management policy

Risk management is defined as 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; however, within the grain elevator business, it has often been an informal system, says Elizabeth Hund, senior vice president and division head of U.S. Bank Food Industries.

“Today, with so much money on the line, many larger companies have departments devoted to risk management,” she says. “Now what you see is a staff that looks at all types of risk — volatility in price, supplier or counterpart risk — the people who do it very well have dedicated resources toward it.

“To me, risk management demonstrates discipline about looking at this industry in the long view, and knowing there will be downturns and run-ups in the market, but being disciplined about it so your income statement and balance sheet is stable.”

Within grain businesses, where today’s upper management typically consists of the same individuals as it did 20 years ago, risk management policies may not be formally documented. “Many times at smaller regional agribusinesses, these practices are known, but are not recorded,” notes Mitch Ferree, president, South Indiana City, Regions Bank. “If the grain elevator is positioned for drops and rises in the market — can it demonstrate to its bank what it’s doing to lower risk as the market shifts?”

Lenders are especially interested in a grain elevator’s risk management policy, a document prepared internally to 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. [Read more on this in the Manager’s Notebook column, Risky Business.]