What Makes Bankers Nervous

April 7, 2010 11:18 AM

Ag lenders agree that the bar has risen to qualify as a borrower. Equity requirements are increasing, the cost of renting money is rising, loan structure is tighter and lenders' attitudes are "trust but verify”—reporting requirements are also increasing. In an environment of tighter credit and cautious lenders, knowing how they think will give you an edge when the time comes to borrow money.

A panel of four ag lenders with 122 combined years of experience shared their thoughts at the 2010 Top Producer Seminar. The bankers discussed what they look for in a good lending relationship and the warning signs they watch for when a customer may be in trouble (see sidebar below).

John Blanchfield of the American Bankers Association listens for the telltale "sucking sound”—the sound of equity in the business being depleted outside the business. "That means nonproductive assets bought by someone without a healthy cash reserve,” Blanchfield said. Examples include too many high-tech toys and a condo in Cancun.

Bankers also watch carefully when a farmer suddenly introduces Junior as a business partner. "We expect the younger generation to come in, but with a transition period,” said Sam Miller of M&I Marshall & Ilsley Bank in Appleton, Wis.

Another red flag that makes bankers suspicious is when a farmer proposes a new line of business way outside his core strengths. Is this a well-researched opportunity or a sign of desperation?

Distressed Borrowers. Borrowers who cannot repay are distressed borrowers, said Curt Covington of Bank of the West in Fresno, Calif. "They often feel denial and fear. Reactions range from ‘It's not my fault'; ‘I don't want to deal with it'; and ‘I own the problem, but you need to fix it' to ‘I own the problem and I need to fix it,'” he said. "Clearly, we prefer clients who fit the last category.”

To avoid becoming a distressed borrower, the panel suggested communicating with all creditors, enlisting the help of experts on the front end of the situation and framing the situation from all perspectives, including financial, legal, social, emotional, personal and family.

It's important to take action on the problem and devise a plan that works, Blanchfield said. "If you are restructuring your debt, it must be in writing, achievable, executable and designed to return the business to viability,” he added.

Lastly, don't look back. "There is no sense in beating yourself up about the past; learn from it and look to the future,” said Roger Schlitter of Roger's Farm Financial.

Cash Is King.
Manage your margins and build liquidity and working capital, the lenders suggest. "Working capital is king during periods of volatility,” Covington said. "Farmers have been too reliant on real estate equity as a backstop in the years past.”

The lenders recommend that producers have cash on hand equal to at least 20% of their operating expenses for the coming year. 

"Lending has to be driven by repayment capacity,” Miller added. "Going forward, profitability and cash flow will carry a heavier weight, rather than asset value.”

Top 10 Warning Signs
Bankers watch for the following warning signs regarding agricultural loans:

1. Inability to pay off annual operating loans

2. Loss in business net worth year after year

3. Less than 30% net worth or equity

4. More than five creditors on the balance sheet (this includes supplier credit)

5. Unpaid trade credit (more than 60 days old), especially if creditors call the bank wanting to know when they will get paid 

6. Unpaid taxes

7. Operating expenses greater than 80% of gross income, especially if the trend is on the rise

8. Lack of financial statements

9. Rapid, leveraged expansion

10. Turnover in management and/or advisers


Will History Repeat?

The farm crisis of the late 1970s and early 1980s may be an unpleasant memory, but several conditions in today's economy are eerily similar to that tumultuous period in the agriculture industry, says Jason Henderson, vice president and branch executive with the Federal Reserve Bank of Kansas City, Omaha branch.

In the previous period, we had surging Russian exports, low real interest rates, a general economic recession and a weak dollar. Farmers saw opportunities with stronger export activity and paid for much of that expansion via huge debt loads, Henderson says.

"Then, on Oct. 6, 1979, the Federal Reserve slammed on the monetary brakes. By December 1980, interest, especially the short-term rates, began a very sharp climb, reaching the 20% or greater range,” notes Neil Harl, emeritus professor of economics at Iowa State University.

By comparison, recent years saw record exports and ethanol demand, causing crop prices to surge. Some economic indicators point to the general economy rebounding, which could help fuel another surge in demand. The demand for food has also been responding to higher average per-capita personal incomes in lower-income countries.

"The two things we have not yet seen are a rise in inflation and producers being highly leveraged and adding on debt,” Henderson says. Current data show that producers are on sound financial footing, with much of the current growth being paid for in cash. "But we have to remember that the high debt load of the 1970s did not occur overnight.”

Moving forward, Henderson advises a good balance of equity and debt. "Think about the return on your assets and take a hard look at the ratios and returns on your farming investments,” he says. "Then determine the best way to finance those investments.”

Interest Rates. Using debt wisely can be an effective way to grow your farming business, but interest rates, while low now, can't stay that way forever, Henderson cautions. "At some point, they will rise. You must be prepared for when that occurs.”

Harl notes what happened in the 1970s: "Those farmers with too much short-term debt were caught in a very vulnerable position when lenders gradually tightened up on credit.

"Agriculture is not an economic island,” Harl says. "If economic trauma in the general economy continues long enough, it can significantly affect the agricultural economy.” —Mark Moore


Top Producer, Spring 2010


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