Ag Lending Considerations in 2020

By: Robert Viering, Director of Lending

On January 28, 2020, the FDIC published Financial Institution Letter (FIL-5-2020) Advisory: Prudent Management of Agricultural Lending During Economic Cycles. It’s a good summary of many items to consider in the management of your ag portfolio and I recommend you taking a few minutes to read it.

In our loan review practice we have many clients that have a reasonable exposure to agriculture, including agribusiness. We’ve seen a decline in the cash flow generated by these borrowers as the ag sector declined from the historic highs of a few years ago. Over the last two years, we have seen this sector stabilize as most producers have been able to make adjustments to their operation and, while not back to the same levels of profitability, reach a level of acceptable cash flow. For many it has been a case of reducing expenses not only for crop inputs, but also cutting family living. For some that were over-leveraged, we have seen the sale of land (or sale-leaseback) that has brought debt service in line with today’s cash flow or a slowing of capital expenditures. We’ve seen many instances where debt was refinanced to a longer term to bring payments in line with cash flow. However, even with the vast majority of borrowers making adjustments, we have seen more classified ag credits and increased non-performing loans. This has typically been due to high leverage or not being able to make the tough decisions needed to operate successfully today. Management skills are near the top of the list for success in agriculture today.
Based on what we have seen in our reviews of our ag clients and our own experience managing ag portfolios, the following is our list of “best practices” for 2020:

• Have all the information needed to make an informed credit decision at renewal, including:
  • A complete financial statement with detailed schedules. Take the time to review this with your borrower and ask if they have any other bills, such as payables to input providers or loans from family or friends.
    • For more complex borrowers that may have various partnerships or corporate entities that make up the farming operation, make sure you have financial information for each of the entities, not just the one you may be financing. You need a global financial statement, as well as a global cash flow.
    • Ask about actual ownership of assets. Some assets may be owned by a trust; if so, consider making the trust a co-borrower or guarantor.
    • Have your borrower complete the financial statement as of 12/31 each year. You’ll need this to make accurate accrual adjustments when used with the tax return.
  • A credit report on all individuals that sign personally. Use this report to check for levels of personal debt and compare this report to past years to see if personal debt is increasing or decreasing.
  • A new UCC search. Use this to see if there are other secured lenders.
  • Estimated Costs. If you are getting a cash flow from the borrower to support an operating line, compare the estimated costs to historical costs. We see a lot of borrowers that underestimate their actual costs.
    • Government payments have been a big part of some farms’ cash flow. It is important to understand the impact of those payments on an operation. Consider what happens if the Market Facilitation Program is not extended in 2020.
    • Obtain a basic stress test on the borrower’s cash flow. If small changes in revenue or expenses will bring cash flow below break-even, do understand the level of crop insurance, any hedging program, and have a “Plan B” discussed with those in the operation regarding how they will get through if things are tough. It’s a lot easier to have that conversation about selling some land now than when payments are due in the fall if things don’t go as planned.
  • Cash Flow for New Debt Structure. If you’re going to restructure debt, make sure the operation can cash flow the new debt structure. If it can, great; you probably have a pass loan (or will be soon). If not, then you probably have a classified loan.
  • Trends. Trends matter. What direction are leverage, liquidity, and cash flow going?
  • Working Capital. Working capital is your real secondary source of repayment. If working capital is strong, that will cover an off year and not require a restructure or asset sale.
  • Future Plans. Ask about the plans for 2020, including any capital expenditures (for your good borrowers, don’t forget to pre-approve them for these loans); their marketing plans; and any changes in expenses from the prior year.
• Know your portfolio:
  • Track risk rating changes for the portfolio. What is the direction of your average risk rating?
  • Stress test your portfolio. Develop moderate and high stress scenarios. Stress revenue, expenses, and collateral values. Understand the impact of moderate and high stress on your capital. (Young & Associates, Inc. can work with you to provide a stress test of your ag or CRE portfolio.)
• Be proactive:
  • Don’t put off those farm visits. You’ll learn far more about your borrowers’ operation, their concerns, and what they most enjoy by spending a few hours with them at the farm than you ever will just talking in your office, making phone calls, and sending emails or text messages. Document those visits and take pictures for the file. Some banks list all farms they need to visit, estimate when the visit will take place, and track their progress each month.
  • Ask your borrower what information they monitor to manage the farm. You’d be surprised how many operators have a lot more information than they share with you. It’s almost never that they are holding information back as much as it is we haven’t asked.
  • Develop an exit plan if needed. If you have a struggling operation and there doesn’t appear to be a good way to turn it around, you need to have that tough conversation with the borrower about how you will get repaid sooner rather than later. Having a well-planned, cooperative exit plan is almost always in everyone’s best interest.
• Know that best practices are not for every borrower:
  • Having more information than less is always best, but sometimes we have those very strong, long-time borrowers that provide minimal information. If every indication says the operation is strong, then sometimes you can get by with more limited information. But, in those cases, spell out in your loan presentation what you are not getting and why that does not pose a risk to the bank.

Need Assistance?
Please feel free to reach out to us if we can help you with your loan review, stress testing, or other aspects of your lending operation that you’d like to improve. Our lending team is made up of well-experienced bankers that provide you with realistic solutions. For more information, you can contact me at [email protected] or 330.422.3476.