Renewing Credit Line: What Should Producers Expect?

By Jane Fyksen Crops Editor
Thursday, October 30, 2008 7:19 AM CDT

While there’s been very little good news in the global economic slowdown, Purdue University Ag Economist Michael Boehlje has some. He doesn’t anticipate agriculture being hit as hard as other sectors. Credit will be available for producers, but with more strings attached.

Agri-View this week kicks off a series on agriculture and the financial crisis, with Boehlje sharing insight into what growers might expect from their lenders as they review this year’s financial performance and renew their credit lines for 2009.

He believes credit will be available for farmers, but they might have to jump through more hoops to borrow. Lenders could require more information and documentation from producers.

"At a minimum, producers are going to have to do a better job of showing their lender what kind of profitability they've had and what kind of income they're generating," says Boehlje, adding that it's “quite possible” lenders will also be asking for more detail on the inventory side of a producer's balance sheet.

For instance, he suspects growers might be asked, “Have you got some of your products priced with futures or forward pricing contracts for next year? Have you got some of your production costs locked in for next year, and how much?”

"Producers might end up with more projection work. Whether they'll have to do a full-blown cash flow projection isn't certain. But they certainly are going to at least have to give some additional evidence than they've given in the past of the cash that's going to be generated by their operation next year," Boehlje mentions.

Lenders might also increase their oversight of borrowers, he continues of possibly more frequent farm visits to check inventories and growing conditions and monitoring checking and deposit account balances and spending. There may be more frequent requirements for progress reports and financial documents including cash flow projections and expenditure summaries “to make sure financial performance has not deteriorated unexpectedly,” this ag economist states.

Producers might also discover lenders aren't willing to loan them as much money as they ask for particularly if they want to buy machinery or more land. "We're probably going to see capital expenditure loans are a little more difficult to obtain this next year than they might have been otherwise," Boehlje remarks. "I suspect lenders are going to be asking more questions about land purchases n particularly, what kinds of financing will be needed to buy land.”

"My sense is we already have seen some indication that lenders are being more conservative in their financing of land purchases. They are worried about the land prices. They might not be willing to finance 80 percent of the land purchase. They may only want to finance 50 or 60 percent of the land purchase. So if a producer wants to make that purchase, they're probably going to have to come up with more cash out of their own pocket," he warns.

“Without a doubt,” the increased price volatility combined with significant cost increases have resulted in increased risk in agriculture, continues Boehlje, who maintains farmers shouldn’t be surprised if their lender this upcoming year will be asking for additional documentation and evidence concerning plans to reduce or mitigate risk, such as the kind of land rental arrangements that have been negotiated and at what price. In some cases, he thinks lenders may request additional security or collateral for a loan, or be unwilling to fund the entire request “because of concerns about the risk and repayment capacity of the borrower given the increased risk in the industry.”

In the months to come, he says producers might also face:

- Less aggressive lending: "When there's a lot of uncertainty and increased risk in the markets, lenders turn conservative and are less likely to take on new customers," he notes. "It's probably wise to stick with your current lender and not shop around for a better interest rate."

- Increased restrictions or covenants at loan signing: Lenders might, for instance, require borrowers to have crop insurance or insist on prior approval for capital purchases, Boehlje details. They might be asked to provide quarterly summaries of inventories as well.

- Modestly higher interest rates: "Since we don't see the same kind of risk in the agricultural sector that we see in other industries, we don't expect to see dramatic rises in interest rates to reflect those increased risk premiums," Boehlje says of more good news. He notes, though, that longer term interest rates of mortgage and capital expenditure debt may increase slightly n 0.5-1 percent n as a result of the financial crisis.

“Because most of the credit providers for farmers n rural commercial banks, the Farm Credit System and mid-size banking institutions n have not participated to the same degree in the sub prime mortgage lending business, they have not incurred the same level of losses and financial stress as investment bankers and some of the national and international commercial banking institutions,” Boehlje points out. Furthermore, farm lenders typically source their funds from more reliable and readily available local deposits and agency loans, rather than what Boehlje calls “hot money,” such as inter-bank/inter-institutional loans, daily money market funds or similar purchased funds that have become increasingly unavailable as the financial crisis has sped throughout the banking and investment industry. Thus, the ag sector hasn’t been significantly impacted by the “freezing up” of funds sources.

Further, “the strong repayment performance of the agricultural sector during the past few years has generally given farm lenders confidence in their farm borrowers’ repayment capacity and credit worthiness,” he notes, adding though that higher input costs and declining prices, combined with increasing scrutiny on the part of examining agencies n irrespective of lending institution n has lenders more concerned about their farm customers’ financial condition “irrespective of their past history and performance.”

As for operating line requirements, Boehlje says the size of the loan needed to plant their crops this year almost doubled compared to last year, and further increases are expected for 2009. For those who have livestock, though, recent declines in grain prices will likely moderate their credit needs this next year.

“Farmers should anticipate that their lender will expect more accurate documentation or how much they expect to have to pay for fertilizer, seed and chemicals, and whether or not there is a risk that the input supplier may not be able to fulfill their commitments,” says Boehlje. “Lenders may even ask questions about the financial stability and solvency of the input supplier. Higher cost and increasing requirements to pay cash to input manufacturers has put some input suppliers under severe financial pressure, and due diligence concerning the ability of the elevator or supplier to deliver inputs or pay for the products purchased is increasingly warranted.”

Producers could be in for one unexpected shock - higher taxes. Many producers pre-pay fertilizer, seed and chemical expenses to reduce taxable income. “It is possible that this procedure of prepaying expenses and delaying cash sales may be less effective this upcoming year in managing the income tax liability, and income tax obligations could increase significantly, exactly at a time when the farmer is facing capital and credit constraints,” says Boehlje.

“This year, particularly for those who have cash flow problems and find themselves needing to liquidate some assets or sell some of their inventory, that could mean an increase in their taxable income. It's a technical issue, but the tax basis for all raised grain and livestock is zero, so every dollar of sale of that inventory is ordinary taxable income," he points out.

He says in other industries, it’s not uncommon for businessmen to arrange a line of credit and pay a fee to guarantee or insure that full line of credit is available when needed. This commitment fee is frequently set at a modest level n like 0.5 or 1 percent of the entire line of credit. “For those farmers who are concerned about whether or not funds will be available when needed, it may be worthwhile to negotiate such an arrangement and pay a commitment fee,” says Boehlje.

Agriculture remains a strong industry and credit risk, he concludes.

Producers who practice sound money management and accousnting should weather the economic storm, he assures.

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