In this time of record cattle prices, do you have the capital to buy more cattle?
After receiving record heifer prices at his recent production sale and having more inquiries than animals, you’d think John Malazzo would be rushing to expand the cow factory. But Malazzo is cautious, especially after having to reduce his herd by 25% due to the record drought in Texas last year.
Malazzo Farms is a family farming operation near Caldwell, Texas. The cattle side of the business focuses on raising quality replacement F1 heifers. "Of course years like this make you want to expand, but we will only expand slowly. I use years like this to reduce debt and strengthen our fi nancial position," Malazzo says.
That kind of cautious optimism would serve farmers and ranchers well in the coming years, particularly if they use the good years to improve their financial picture and open opportunities for reasonable lending for expansion. Even in the current market, the debt-to-equity ratios that lenders evaluate remain the same. Now lenders also need to know your plan of action for withstanding the market fl uctuations that are inevitable, especially in the cow business. So what you’re really betting on is that the cow’s production and capacity to produce calves will be break-even at the very least, says Paul Burrough, senior vice president of the National Finance Credit Corporation.
"What scares a lot of bankers right now is folks paying $2,000 for a bred cow. The lender is thinking, ‘An open cow is worth only $800,’ and from a banker’s perspective he’s wondering, ‘Did I loan him that $1,200 difference or did he use some of his own money?’ That liquidation gap is pretty real right now," Burrough says. He explains that there is usually no more than a $300 differential between the salvage value of a running age cow and what she’s worth bred and in production. At the moment, though, that differential is
more than $1,000, creating a wide liquidation gap that concerns lenders.
By putting your own equity into your animals and showing lenders that you’ve taken a hard look at the numbers as to whether or not each cow will be a good return on investment, you will help gain the capital needed in these times of high prices. Share your plan. "As lenders, we need to feel comfortable that you have a good plan of acquisition and production. We need to feel the confi dence you have in that plan," says Ben Novosad, CEO of Capital Farm Credit in Texas.
He says that what he really wants to see is a plan to manage increased indebtedness so you can maintain the cash flow to service new debt before loaning money.
"You need some equity in the deal, whether it’s cash, additional livestock, or other capital," he adds. Still, ag lenders work on an individual basis with producers to purchase cattle. They not only want a good overview of your plan and financial information, but they also must be comfortable with your ability to manage the risks associated with cattle production. "We want to know that you’ve thought it through thoroughly, and you know the possible risks as well as the possible rewards," Novosad says.
Get a handle on risk. With higher prices, risk management is more important. "Basically, you have to have the ability to accept risk," Burrough says. "You have to have your cash
in the business ahead of the banks and also some additional asset base. If you don’t have your own capital base to support the risk, you need to go out and take whatever precautions are necessary. What I try to impress on people is that it’s not just market risk, it’s production risk."
In addition, you need to have a drought management strategy. Plan early on whether you will sell out or move cattle. Make sure your lender is willing to fi nance those cattle if they do move out of the bank’s trade territory. Also, if you choose to place reproductive animals on feed, make sure the lender is on board. Malazzo knows that if you have established a relationship with a lender and that lender sees you know how to run your business, you are likely to get the fi nancing you need.
"It really depends on your personal situation, since everyone is different," he says. "For new producers who jump into the cattle business at this time, it will probably be tough—but not impossible, if your lender knows that you have a workable, practical business plan."
- Late Spring 2012