Get Fiscally Fit

February 6, 2011 07:01 AM

Agricultural banks are loaded. However, don’t assume obtaining loans will be easy this spring. Farming might be one of the brightest sectors in the U.S. economy, but tough lending rules await those seeking loans.

"Credit availability for top producers will be good to very good this spring, but producers should expect tight credit conditions," says John Blanchfield, senior vice president of the American Bankers Association Center for Agricultural and Rural Banking in Washington, D.C. New credit policies are being caused by the economic recession that began in 2008, he says.

Blanchfield says lenders will be asking for more documentation and better numbers to obtain credit. A high-quality financial statement and balance sheet, inventory statements and a written marketing plan aren’t enough. You’ll also need proof the paperwork is being implemented.

Prepare to provide specifics of what you plan to do with the money, too. Put simply, you need a story or narrative of your operation: where it’s been, where it is and where it’s going, Blanchfield says.

Bankers will be looking to lend money to those producers who can demonstrate that they have a "firm grip on the management and marketing of their operation," he says.

Cash-flow Lending. Loans are now based on more than net worth, in part because land values have risen so rapidly and to such heights that there is risk of a partial retreat.

"We have plenty of money for people who have a plan to pay it back," says Bruce Everhart, vice president of Wells Fargo Bank in Rushville, Ind. "The only thing that has changed is that we ask for more information, such as what are the farmer’s marketing program and margin management strategies.

"Most farmers know their cost of production and are stepping up to protect their input costs," Everhart says. Producers and bankers know that agriculture is a volatile and cyclical business, so bankers look at a producer’s trend line instead of a year’s financials when making loans.

The Wells Fargo branch Everhart works for is no less likely to make expansion loans, provided the balance sheet looks good and the operation has the ability to pay back the loan out of cash flow.

Everhart says that with the current low interest rates, now is the time some operations should be thinking of expanding. Some of his farm customers are doing just that.

"Agriculture has a good future and is the bright spot in the economy. We still have a hungry world, and the most efficient producers in the world are here in the U.S.," he says.

Nevertheless, regulators are taking a strict look at loans since the recession, so "we have to more carefully monitor our portfolio. All banks should and that’s OK," Everhart adds.

Creditworthiness. "There is adequate credit available. The bigger issue is the creditworthiness of the borrower," says David Oppedahl, an economist with the Federal Reserve Bank of Chicago.

"For farmers, that’s kind of a catch-22," he adds. "But it’s not as bad for agriculture as for the general economy. Some farmers who overextended themselves possibly are not getting the loans they need."

Some producers, particularly in troubled ag sectors, such as dairy, might have to exit the industry, Oppedahl explains.

repay rates

Even in the dairy industry, the exit rate has not been all that high in the states comprising the Federal Reserve Board’s Seventh District, considering the current low milk prices and high feed costs. The district includes parts of Illinois, Indiana, Iowa and Wisconsin.

Overall, the ag loan portfolio of banks in his district is very strong, and repayment rates high, as the graph to the right shows.

Strong Portfolio. "We have full access to funding for our customers and our portfolio is growing," says Doug Hofbauer, president and CEO of Frontier Farm Credit, Manhattan, Kan. He says that compared with this past year at this time, fewer loans have financial issues and most customers are doing quite well. That’s much better than this past fall, particularly for pork producers.

farmloan int rates

"Agriculture overall has been doing well," Hofbauer says. He adds that because of the recession, "we’re seeing some of our competitors pull in their horns and, depending upon their own financial condition, some are even leaving the ag market—not rampant leaving, but occasionally here and there."

Despite high land values, he says, "our biggest competition in the real estate market is cash—from grain producers with strong profitability the past few years, or occasionally outside investors."

You still need profitability for land investments to work, Hofbauer states, but he’s optimistic about the outlook, which will give producers some cushion.

Julie Wuthrich, vice president of Citizens Bank, Amherst, Wis., says that even though milk prices were low this past year and many dairy producers could not cash-flow, "money was available and we were lending."

Citizens Bank looks at more than one year’s trend line and incorporates net worth, cash flow, liquidity and a credit bureau score before making a loan, she says.

"Agriculture is cyclical," she says, and fortunately, "the milk price has been improving."

Strong Liquidity Wanted. "We’re certainly looking to take care of our existing customers and expand our footprint," says Brian Newcomer, executive vice president of Rabo AgriFinance in St. Louis. "Our credit requirements have not changed at all in the past three to four years."

Newcomer says that Rabo AgriFinance is looking for customers who have strong liquidity and are in a good working capital position with solid balance sheets.

"The bulk of our credit quality right now is sound," he says. Newcomer adds that Rabo AgriFinance is strictly a cash-flow lender. "If it won’t cash-flow, we don’t bank it—we won’t be a player in that area," he explains.

With that said, Rabo AgriFinance takes a three- to five-year look at cash flow and liquidity and makes loans based on both.

"Our customers have to look longer-term than what’s right there in front of them," he says.

More Cash-Flow Lenders. Producers should find "very adequate credit" in the coming months, both by the Farm Credit System and community banks, says Doug Stark, president and CEO of Farm Credit Services of America in Omaha, Neb.

He adds, though, that because of the "spike in land values, and the potential risk of their going down," more lenders are switching from collateral to cash-flow lending, if they haven’t already.

"We feel good about our portfolio," Stark says. In Iowa, Nebraska, South Dakota and Wyoming, past due delinquencies are below 1%. A year ago, in contrast, there were increases because of problems with the hog and dairy industries. "This year, those livestock sectors, while still not out of the woods, have stabilized," Stark says.

Give Fixed-Rate Products a Hard Look

Short-term interest rates are unlikely to change much in 2011. In fact, they could even move lower, but look for longer-term rates to slowly move higher, many lenders say. As a result, if producers have not done so already, it could pay to lock in fixed-rate financing.

"It appears that investors are concerned about the level of U.S. debt and the required inflow of capital," says Doug Stark, president and CEO of Farm Credit Services of America. As a result, he says, the 10-year U.S. Treasury bill increased 1% in late December from its low.

Because of the risk that interest rates could rise, Stark says that locking in fixed rates is a good option. In the past year, 23,500 of his farm customers in Iowa, Nebraska, South Dakota and Wyoming have done just that.

Rates are likely to go up sometime in the next year or two and could rise by as much as 2%, predicts Bill York, president and CEO of AgriBank, the largest of five wholesale banks within the Farm Credit System.

"About any economic shock would push rates higher," he says.

The reason many producers have used short-term variable-rate financing, York says, is that one-year variable-rate loans have been in the 4% range, while a 20-year fixed note has been about 6.5%. But with the odds for rates to increase, he thinks it wise to consider locking in fixed rates.

Risk on the Upside. "I can’t see interest rates going much lower, although there is no indication of any major swing in either direction anytime soon," says Julie Wuthrich, vice president of Citizens Bank, Amherst, Wis.

With that said, any economic crisis, such as an indication that inflation is returning, could cause interest rates to rise again.

At today’s rates—even fixed rates, bankers say—the cost of money is a very small cost compared with previous years, when it was a large input cost.

Brian Newcomer, executive vice president of Rabo AgriFinance, St. Louis, says that while it looks like short-term rates will hold steady in 2011, it appears long-term rates will increase. He says it makes sense for farmers to lock in fixed rates when possible or use swaps or interest rate hedges.

FDIC Issues Caution to Bankers on Ag Loans

One would think that the federal regulator for agricultural bankers would be very satisfied with banking performance on farm loans, with loan delinquencies and charge-offs at their lowest levels since the early 1970s.

True, the Federal Deposit Insurance Corporation (FDIC), the nation’s federal banking regulator, lauds community banks in particular for their strong commitment to agriculture—and notes that six of the past eight years rank among farming’s top 10 income years since 1980. But at the same time, the FDIC advises banks to put on the brakes, at least somewhat.

Risk Mitigation Strategies. In a letter issued to banks in December, FDIC says that "even during this period of strong financial performance in the agricultural sector, banks must remain diligent in developing and enforcing sound underwriting principles and establishing effective risk management and control procedures.

Because agriculture is vulnerable to sharp shifts in commodity prices and operating costs, this level of volatility warrants implementation of strong risk-mitigation strategies."

The FDIC letter continues that banks should implement "a prudent credit risk management process that places a strong emphasis on borrower cash flow and repayment capacity, and does not place undue reliance on collateral."

Moreover, the letter adds that farm credit analytics should be thorough and include projected cash flows for a reasonable range of future conditions that could affect commodity and farmland prices.

Other factors that are critical components of assessing farmers should include the borrower’s management capability and experience, FDIC states, along with a borrower’s informed use of crop insurance and true hedging that can reduce risk for a financial institution.

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