December 1, 2011
If you use futures contracts to manage your commodity price risk, you may face the dreaded margin call at one time or another. Goes with the territory. But will your regular operating loan cover a major margin call? Will your banker understand the situation? Is a separate margin account needed?
With corn, soybean or wheat futures contracts fluctuating by 40¢ to even 70¢ or more any given trading day, volatility is a problem for anyone hoping for a stable marketing plan.
At the same time, financial requirements are much higher for operating loans to cover input costs. They may or not be set up to cover price risk-management expenses, in which thousands of dollars may be required at any time to cover a margin call.
“Many times regular farm operating loans are not large enough to account for the temporary credit needs required by margin calls on hedge positions,” says Kent Thiesse, vice president of MinnStar Bank, Lake Crystal, MN.
In a typical commodity futures contract, a grower would be asked to put up a performance bond, or margin, of about 5% of the contract price.
As an example, if a grower sells a March $6 corn futures contract, the performance bond or margin is about $1,500. That’s based on the total contract being worth about $30,000 ($6 x 5,000 bu. for one contract).
If you’re a large operator and have hedges involving 20, 30 or even 50 contracts, that $1,500 multiplies faster than a surprise disease or insect outbreak. Then there’s the dreaded phone call – “Uh, Joe, this is Ed over at XYZ Brokerage. Corn closed limit-up today. You’ve got a margin call of....”
Of course, your goal is to see a higher price. The $6 hedges are protection against a drop in prices. If the futures contracts close at $7 in early March, your margin money will be more than returned.
“It may be more prudent for farm operators to work with their ag lender to set up a specific margin account, separate from their operating line of credit, to manage those transactions,” Thiesse says.
“This may also make it easier to document financial activity related to those transactions.”
What’s the difference? “Farm operating loans are normally for all aspects of farm operation and disbursements, coordinated between the farm operator and ag lender,” Thiesse says.
“Margin accounts are usually specific to hedging activities.”
The farm operator typically works with the ag lender to determine the maximum credit needs for a margin account.
“In a single hedge position, the margin account principal and interest is usually fully satisfied when the grain or livestock is sold. However, most producers likely have multiple hedge positions at the same time.” More ag lenders are upgrading their knowledge of risk-management tools, Thiesse says.
“Banker organizations, universities and private industry provide adequate lender training on grain and livestock marketing, and other risk-management tools,” he says.
Most ag lenders can handle margin accounts.Thiesse says the use of a margin account may expand a grower’s maximum credit needs beyond the legal lending limit of a smaller community bank.
“However, most community ag lenders now have working agreements for participation loans with other community banks in order to meet theexpanding credit needs of farm operators,” he says.
Accurate records and accounting of marketing positions are a must. “Many ag lenders will likely require monthly or quarterly statements on grain positions and hedge-account transactions,” Thiesse says.
Lenders may also want to know which firms are handling the hedge accounts and futures transactions to be assured of their financial stability, Thiesse adds.
He advises to seek input from lenders on the need for a margin account in order to manage price risk. Volatility may demand it. And, because futures contracts and margin calls go hand in hand.
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