How to Manage Financial Risk

“Nobody likes to go home at night with open positions in grain,” says Sam Miller, managing director, group head, agriculture, BMO Harris Bank. “A policy included in a company’s risk management policy may state that its goal is to make sure there are no open positions before they leave for the day. Bankers like to hear things like that because it means they have their risks hedged.”

If your company’s grain merchandising plans cover most of the important risk elements, management may want to present spreadsheets to demonstrate its projected positions on a monthly basis.

“Even if it’s verbal description and the borrower explains what it plans to carry and what it plans to market, we want to know,” Herr says. “It’s a two-way conversation. Lenders should make sure the borrower understands what may be expected of them during that time frame, and make sure they support the plan and its implications.”

If the company is involved in trading or using futures markets, banks will add in tolerances for special circumstances, with leeway for same-time decision making, but the guidelines may be monitored and enforced for risk management. “In some cases, if the market is closed, but you’ve written a contact — you can’t get that position until the next day — we will allow for 5,000 bushels to be open at anytime,” Miller cites as an example.

Improve communication

If your business plans to expand its storage capacity or a member of upper management is planning to retire, minor changes, internal or external, may impact your access to extended lines of credit. Diligence in communicating with a lender and the borrower’s ability to articulate its strategy for navigating these potential risks can make a difference.

“Assessing management is a very subjective thing; we look at numbers and past performance, and management’s adherence to its own policies,” Herr says. “Good budgets and timely, accurate financial reporting are good indications of management’s ability.”

Include lenders 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, i.e., the associated increase in financing needs that comes with handling more grain.

“Don’t overextend [the company] by expanding too fast,” Schopen urges. “You must be in the financial position to do it without putting a lot of stress on the balance sheet. If you put up a 600,000-bushel bin, it’s not just the cost of the bin you need to consider, it’s also the larger line of credit you’ll need to cover the futures contacts and buy the grain.”

Frequent communication with the bank may also aid in softening the impact of losses because the bank will be aware of the circumstances as they develop.

“Even if it’s a quick 15-minute update, if anything is changing — in the grain merchandising plan or the company’s plans for major capital expenses — keep your lender updated with what’s going on in your business so it doesn’t come as a surprise later on,” Herr stresses, noting too that if you don’t hear from your loan officer, take initiative and reach out to him/her.

Along the same lines, don’t be afraid to ask about how your business compares to other grain businesses in your lender’s portfolio. Most lenders will have benchmark averages to draw comparisons; and it can send the message your company is interested in its financial performance.

“Interest in your company’s performance against its peers demonstrates that you as a manager are on top of things and being proactive,” Herr says. Also, as a borrower, it sheds light on your lender’s depth of knowledge of the grain industry.

Manage counterparty risk

Many variables influence a grain business’s ability to manage risk, but counterparty risk can be more difficult to quantify. Counterparty risk, or the exposure resulting in another business’s inability to deliver on its contractual obligations, in the grain industry is most closely hinged on the contracts it has with its producer partners. The lender is especially interested in how a company forward contracts with producers and the elevator’s history with its clients.