Some crop producers are enjoying record revenues thanks to strong yields and buoyant prices. That makes it a time for caution, says David Kohl, Virginia Tech professor emeritus and a consultant to the agricultural banking industry. “It is all too easy to channel profits into exuberant consumption, sometimes called ‘killer toys,’ or sideshow business ventures that are outside the expertise and scope of management,” he says. But in the current post–banking crisis environment, bankers are looking for disciplined profit managers and such purchases may be viewed negatively, he adds.
It’s a great time to put debt to work for you since interest rates are at their lowest levels in decades. But planned and careful investment is key, Kohl says. And, of course, not everyone gets the best rate. To wow your lender so you get the money you need at the lowest cost, pay attention to the traditional “five Cs of credit”:
Capacity to Repay. Some lenders say this is the most critical element. It encompasses cash flow, all sources of money available to repay the loan, etc. Lenders look at how predictable and dependable the source of repayment is.
Collateral. This guarantees the loan in case you have a problem repaying. It needs to be enough to cover all costs associated with liquidation.
Capital or Net Worth. “It is obviously important to know how your net worth, financial structure, historical cash flows, profitability and risk exposure will be affected by the loan,” says Danny Klinefelter, business adviser with Texas AgriLife Extension.
Lenders want to know that you have your own money invested in the business and that there will be a gradual growth in net worth. “Bankers are looking for a lot of equity today,” says Moe Agostino, an analyst with Farms.com based in London, Ontario, Canada. “They are not interested in funding expansion unless you bring a lot of capital to the deal.”
Conditions of the Credit. What will the loan be used for and will more be needed later? “It is not enough to say ‘operating expenses,’” Klinefelter says. “Plans need to be supported not just by budgets but by documentation showing they reflect past experience or explaining how improved performance will be achieved.”
Character. In today’s numbers-driven environment, your reputation as a businessperson who makes sound decisions based on solid analysis counts to a lender.
The New “C.” Kohl adds a sixth “C”: Cranium. This goes beyond character; it involves your business acumen. “The mental pressure of handling a $3 million obligation with numerous backers and guarantors compared with a $300,000 single-purpose loan can be intimidating. Lenders need to assess whether you have the management ability and attitude to cope with growing lines of credit,” Kohl says. In addition, they look for managers who are building links in the value chain, formalizing such arrangements and handling their risks.
Lenders are likely to want to see a written business plan. “Are systems, strategies and standard operating procedures in place for the various components of the business, including production, risk management, marketing, operations and even exit strategies?” Kohl asks. “Business plans also should include structured adversity management shock absorbers in case of an unexpected ‘black swan’ or tail risk.”
No Run-up in Rates Imminent
The Farm Credit System has dropped its 20-year fixed rate to its lowest level since 1958: 5.2%. That compares with 6.75% last January and an average of 9% for the past 30 years. No increase in short-term rates is expected any time soon: The prime rate is expected to stay at 3.25% through May 2011. The three-month LIBOR and one-year and five-year Treasuries are also expected to only creep higher.
“Rates will rise eventually,” says Moe Agostino, a commodity analyst for Farms.com, based in London, Ontario, Canada. “We expect 4.1% to 4.2% global economic growth in the year ahead. Canada has had three increases since June, and China has raised its rates by a quarter-point. But the U.S. is lagging behind the world rate and the Federal Reserve would like to see job creation of 150,000 per month before raising rates, which probably means another quarter or two,” he says.
Top Producer, Mid-November 2010