Bankers, those professional analyzers of risk whose institutions are constructed upon centuries of built-up knowledge about financial risk and its mitigation, know the secret to a successful risk management strategy.
And they’re willing to share it with farmers for free.
The secret to a successful risk management strategy is: (drumroll please):
Have one.
It’s as simple as that.
“I don’t think we’d say you have to forward contract versus hedge (with futures and options),” Brian Little, manager of agricultural banking for Royal Bank, said when I called him to ask for the best approach to risk management for farmers.
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“We just highly recommend they put in place some risk management tools to minimize the risk.”
Mike McAllister, a senior credit manager with Farm Credit Canada, said his institution also doesn’t suggest any one method, strategy or instrument as superior when it deals with farmer borrowers.
“We don’t advocate one over the other,” said McAllister.
But both said they focus on a farmer’s risk management strategy when he’s applying for credit.
“We definitely look at it,” said McAllister.
“When we’re assessing lending proposals, we look at the risk management tools that are available to the client and whether they are actually using them. The degree to which we rely upon them depends on the financial strength of the operator.”
That can mean that no risk management strategy means no financing.
“In those cases, we may make it part of our loan package, where maybe you do have to align yourself with some production insurance or maybe look at locking in some sort of contract price on your commodity,” said McAllister.
The main thing bankers want is for producers to understand their risks and to attempt to protect themselves against disasters. Banks like investing in operations that have a reasonable likelihood of profit. They are not interested in long shot gamblers.
Farming is among the riskiest businesses in the world, so reducing risk makes sense.
Luckily for farmers, there are few businesses with more risk management tools available, starting at the beginning and going to the end of the business of farming.
“It starts with something as basic as crop insurance and participation in any federal-provincial income stabilization or disaster relief program,” said Little.
There are many price protection strategies for grain that analysts and brokers recommend, and all have their place, bankers say, whether it’s a cash grain marketing program, one using derivatives, or one using forward contracts.
Each has its pros and cons, but each lessens volatility from the price.
“We’ve never gone broke forward contracting or hedging at a profit,” said Little.
Livestock producers can get involved in contracts with marketers, processors and others to reduce market price volatility, as well as using futures and options.
These days, currency hedging has become important and some larger producers attempt to lock down every cost and price they can before they begin producing any commodity.
“They’re trying to lock everything up all the way through from their inputs to whatever they sell,” said Little.
Smaller producers might have trouble nailing down every cost or price because they don’t have the same market power, but they also don’t have the same need.
Today’s big, capital intensive operations, such as hog barn complexes, leave little room for sudden slumps in profitability, so most of these operators have no choice but to erect an all-encompassing risk management strategy.
“The risks are so much higher today,” said Little.
“You need to protect yourself. They allow you to buffer those wide market swings.”
Little and McAllister said no risk management approach is perfect, the best, or even better than the others.
But they do want to see that borrowers take risks seriously. And while a farmer has to be an optimist and a gambler – at least with the weather – the lenders say they look at a defined risk management strategy, any strategy, as a sign that a farmer understands his risks.
And that means any form of risk management is better than nothing.
And nothing might not be good enough for anything.
