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The scrutinized refinancing request

Factors to look at when looking to stretch payment terms on ag loans.

The agricultural economy is now in its fifth year of the economic reset, which is a sharp contrast to the short and abrupt downturn of the 1980s. In fact, this reset is often called the “grinder” as it slowly erodes equity and financial flexibility. Another significant factor with this reset is the emotional toll it carries, which can be equally difficult as lost profits, if not more.

In recent surveys conducted by agricultural lenders, nearly half of their producer customers are seeking refinancing to cover negative margins and diminished cash flow. Most often, these requests utilize equity in land to secure the restructuring of operating loans into term debt. In other words, what was expected to be a three- to five-year amortization is now a 20- to 30-year period, in some cases. Yet, many of these requests will be more closely examined as state and federal regulators are monitoring lender practices, especially in this part of the economic cycle. Let’s take a look at the questions some producers may have to answer as they seek to stretch the terms on their payments. 

First, how much of the business income is dedicated to supporting lifestyle and family living expenses? In recent schools and seminars, agricultural lenders have indicated that up to 40 percent of requests are for lifestyle habits created during the great commodity super cycle. It is no surprise that higher profits led to a higher standard of living, but the struggle now is to scale back expenses to align with lower commodity prices. In actuality, family living expenses are decreasing, but still not enough to line up with current margins. Numerous lenders are requiring family living budgets, and some have even established a set withdrawal amount from the business for the family. 

Next, lenders will analyze business management. Marketing execution and financial habits will be scrutinized especially in cases of repeated financial issues. \Specifically, lenders will look for the ability to execute a marketing and risk management plan that is based upon logic, instead of emotion. Trends in one’s management and marketing history will also be carefully examined by credit analysts, loan committees, and in some cases, regulators. If your farm shows up on this watch list, be ready to present current corrective actions and adjustments already made. 

In other cases, working capital, the secondary financial buffer, has not been preserved. Either working capital was not built to sufficient levels during good economic times, or the reserve is now gone. Perhaps the reserve was used for growth, family living, or to bridge the gap in profits; but whatever the reason, past habits will be examined critically.   

In keeping with the examination of past performance and habits, lenders will also factor in how many times a producer has previously refinanced. Most likely, lenders will be more accepting of one or two requests over the past five to seven years. However, if requests are habitual, showing up every two to three years, lenders will not be so accepting. Often, this indicates underlying issues in the aforementioned areas of management or expenses. 

Finally, lenders will scrutinize these underlying issues and determine the causes behind the loss of profits. Were there uncontrollable events such as weather, fire, or health problems?  During the life cycle of a business, usually one or two of these outside events will be presented, which lenders will take into consideration. Yet, more than one or two may be cause for further investigation. 

In the reality of today’s economics, producers need to maximize their advantages in order to secure financial flexibility and debt restructuring options. Mitigating potential risks, examining past trends, and outlining corrective actions are all proactive steps that can work in a producer’s favor. Even though financial realities may be tough, knowing what to expect and how to navigate additional scrutiny may make the difference for some in securing their borrowing needs. 

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