Originally appeared in The Show-Me Banker magazine, May 2017
Tough times can stress even the strongest banker-farmer relationships. The best outcomes grow out of time-tested and trusting connections. Sometimes that means asking difficult questions and going beyond the “traditional” banker role to help farmers perform better. Here are five tips for getting the most out of your ag lending relationships and avoiding problems down the road.
- Have a Concrete Plan for Carryover Debt
When a producer is unable to pay a portion of an operating line with production revenue, carryover debt can occur and ag bankers are seeing this issue with increasing frequency. The Federal Reserve estimates nearly one-third of farmers saw an increase in carryover debt in 2016. While carryover debt is part of doing business in ag lending, it presents risk, and regulatory guidance is clear: Carryover loans are to be identified, collateralized, and properly structured. This requires a plan.The first step is identify whether the inability to pay stems from low prices, yields or expenses, such as living expenses, that are out of line. Carryover debt resulting from the inability to generate sufficient cash flow from sales to repay the current cycle’s production loans reflects credit weakness and will receive close analysis by examiners. Banks will consider the following, and you should, too:
- Size of the carryover debt in relation to the size of the borrower’s operation.
- Whether the borrower can amortize the carryover debt within a realistic time frame while reasonably servicing all other debt obligations.
- Borrower’s historical cash flow, liquidity, and leverage, to assess the ability to absorb carryover debt and the potential for reasonable debt restructuring.
Once these factors have been weighed, you can decide whether it makes more sense to leave things as they are or move the debt to term financing. Understand that even a strong financial statement has limitations. Be realistic in your long term plan for repayment.
- Maintain a Global Perspective
We’re at a crossroads in agriculture. The increased connectivity between the U.S. economy and producers and consumers around the world demands greater attention to global events. Economic conditions in China and weather in South America have a direct impact on U.S. farmers and rural Main Street. One-fifth of U.S agricultural production is exported, making domestic and international trade policies and conditions in emerging economies more important than ever. Taking stock of what’s going on worldwide is one way of staying out in front of potential opportunities and missteps.
- Prepare Now For Interest Rate Hikes
It would be easy to say that higher rates are always a good thing, but as you know, this is not always the case. An increase in short-term rates, without an accompanying increase in loan demand, could lead to tighter margins. In fact, the Federal Reserve reports bank-reported ag loans down 40% last quarter, the largest drop in 20 years. In addition, higher rates will create increased demand for cash flow on the part of borrowers. It’s a good idea to stress-test individual ag loans and portfolios under various interest rate, price, and cash flow scenarios to determine their resilience.
- Be a Pragmatic Partner
When it comes to ag lending, emotion can be a double-edged sword. While it’s good to develop attachments to customers, too much familiarity can cloud judgment. Also, becoming overwhelmed by all the negative news out there can drain you. The best way to combat negativity is to focus on what you can control and respond to changes with a measured, well-researched approach. And remember, just because your best friend has been a customer for 20 years doesn’t mean he or she always makes the best decisions. Use the strong relationship to your benefit and use it as an avenue for making solid, objective recommendations.
- Create More Great Customers
One of the best things you can do for your business is to find out what makes customers great and create more of them. Great ag borrowers are great in a few key areas. Become an active participant in helping customers excel in financial management, marketing, and developing a CEO business sense. Encourage them to attend targeted training sessions and facilitate relationships with key business advisors.
BONUS TIP: Banks review results and performance at least monthly. Are your customers?
Market prices, business conditions, income, and costs can turn on a dime. A lot can change in a quarter, and by then it may be too late to take action that makes a real difference. We advocate, on your behalf, with producers to maintain regular contact, but you might have to take the lead. Managing cash flow and working capital is a constant, fluid process, not a “set it and forget it” exercise. Making time to review with your ag borrowers each month keeps you in touch with what’s happening and gives you a chance to correct little problems before they become big ones.
ABOUT THE AUTHORS
K·Coe Isom’s Chuck Marshall improves the financial performance of community banks through strategic planning, management consulting, and enterprise risk management. With over 20 years of experience in banking, he advises bankers toward optimal solutions that address both bank and community needs.
Bringing over 20 years in credit analysis, commercial lending, tax planning, estate and succession planning, and business planning, K·Coe Isom’s Dennis Roddy educates farmers on the financial aspects of their operations to ensure they can make better business decisions, faster.