I try to come at all my articles, posts, ramblings, or whatever you would like to call them from multiple viewpoints. I attempt to capture the farmer, the business owner, the banker, the consultant, and probably the therapist’s points of view. So, today I will be starting off with the banker’s point of view on today’s topic of operating lines. If you asked the Ag banking community as a whole how the 2019 renewal season went, the general consensus would probably be – crappy. Of course, it wasn’t easy for the farmer, but the banker was also put through the ringer folks. A farmer must only go through the process once for their individual loan, the banker however has to go through it with every customer. Remember I am coming at this from different angles so don’t fuss at me yet for talking about the poor pitiful banker. But this year really was hard. No banker enjoys telling a customer they need to move their business, or telling them they can’t renew their LOC, and there was a lot of that this year. Prior year losses coming to a head, inability to make term debt payments, working capital depletion, or not being able to pay off the 2018 LOC…. all of those were reasons for the tough renewal season. With the 2019 season being so rough and the continued discussion about it and other means of crop finance, I thought it may be a good idea to throw this post up. I’ll try to address things I have heard from farmers, alternative finance, as well as the recent push to “clean up” and manage LOCs differently.
One thing I hear a lot of is “My banker isn’t making me move all my business, but they said they can’t operate me anymore.” So, what does this mean? It means that the bank has decided that they are in a pretty good position on term loans, but either due to a deteriorating financial condition of the customer or the inability to clean up the LOC, the bank does not want to take the chance that the LOC not pay out. What do you do if this is happens to you? You can move all of your business away from that bank or pursue alternative financing. Let’s talk about alternative financing next.
What is alternative financing? It is just as it sounds, an alternative from what you had been doing which was getting financed for your LOC through the bank. There are a handful of lenders out there now that do exclusively operating loans. However; I do believe some of them get a bad rap sometimes. These lenders only do crop LOC finance (which is a riskier business than farm real estate finance) and they also only do it with crops and crop related collateral (no hard assets.) So, they are taking on a good bit of risk across their portfolio. What does that in turn mean? Higher rates. The higher the risk the higher the reward, remember that saying? Same principle here. If the bank with your RE won’t do the loan, or you just don’t want to tie up your RE, they are an option.
Now let’s talk about how LOCs are generally supposed to work. You secure a line to borrow funds on to plant and “tend to” your crop. You draw the line as needed to pay for the crop related costs. Then when it is time, you harvest the crop. The funds received from the crop are applied to the loan until all principal and interest are repaid, and this is all done before the maturity date of the loan. Well that’s the ideal scenario and how the loan is structured by the bank…but it doesn’t always work that way, does it? You have corn in the bin. Good lord, everybody has corn in the bin at renewal time! So, how do we address that?
It’s according to how your banker treats it. You can convert the current LOC to a single pay loan that you pay down as you sell the corn or if the loan is a revolver it might be left on the LOC with intentions of the corn proceeds being applied as received. With the revolving scenario, that is where there has been some tension over the past several years. Why? Because what happens is, the farmer finds something better to do with the corn money than pay it back on the LOC. The thought is “I’m just going to draw it back anyways, right?” Well, not necessarily. If instead of paying on the line you take corn proceeds and pay your fertilizer bill, is that ok? Yes! That makes perfect sense and would have been a qualified draw off of your LOC anyways. BUT what if the proceeds were used to make the down payment on a piece of property next door? Or as a down payment on a piece equipment? Or to buy a boat? (I have to put in 1 like that) Those are not things that normally come of your LOC. So when the time comes to payoff that LOC the next year and there isn’t enough funds….but you had a decent crop…what happened? You used last years corn proceeds on other things other than reducing your LOC. Then you had an ok/lackluster year following. This cycle is the snowball effect. When capex and losses compound onto the LOC. This has been happening a great deal over the past few years. So, if you are seeing that push by your lender to fully “clean up” your line, that is why. Lenders are now being pushed to have clients clean up their LOCs and not allow the roll over in order to combat the snowballing. Which can suck for those who manage their LOCs well and just want to take advantage of other contracts. I am not saying that all lenders are coming to a screeching halt with allowing rollovers for taking advantage of better pricing. But if they structure your loans differently to accommodate that, you won’t be as surprised now.
Why did I write all of this? Because I think the Crop LOC landscape is changing. There are new alternative lenders in the market, the bankers are being watched closely by auditors and others due to the past several years in the ag economy, and farmers are being pushed to either move their LOCs or manage them/think about them in a new way. Lines of credit are changing folks, don’t be afraid to explore your options and change with them! Think differently about how you manage your credit facilities and know that if you have to move your LOC from the bank you have other options.
If you want to discuss your LOC and its structure feel free to shoot me a question through the contact tab.