I know this is how a lot of farmers are feeling right now. Why am I hearing SO much about equity right now?! No doubt equity has always been an important factor in assessing the financial condition of a farm operation, but with commodity prices making cash flow tight – equity could be the saving grace. When cash flow and ability to repay are strong, yes equity still matters, but not as much is often required. Now with ability to repay calculations coming in at 1 to 1 or breakeven, those providing the financing are asking for more equity or are not willing to lend as much as in prior years.
For example: In the past lets just say Bank ABC had required 25% down payment on equipment, so they finance 75% of the purchase price. Well, now that the markets are they way they are Bank ABC has tightened up on how much they will lend and now will only finance 60% of the purchase price of equipment. Since they are aware that equipment prices are being hit with the depressed commodity markets they are attempting to protect themselves from being “collateral deficient.” They want more equity up front.
This is why equity is so important right now, because Equity = Borrowing Power. If you do need to purchase or replace something for your farm and can’t put up the 40% they now want you could use that equity as a supplement. When you are cash poor the equity in your assets gives you the borrowing power you are needing. It can also provide a small bit of “peace of mind” when you know that you have that cushion to fall back on.
Equity also is of the utmost importance in the event you do not hit the 1 to 1 mark and do not breakeven. If you are short paying back your line of credit you have to clean that up in some way, unfortunately it is not wiped away. We wish! In the event you have to take out a loan to cover this shortfall you will need collateral for the loan. Being that you are not buying anything that could serve as collateral (you are just covering the shortage) you will have to use an asset you already have for that collateral. That asset will have to have enough value to stand for the loan it currently is held on and this new one.
In the past I have encountered farmers who could afford the payment on a shortage loan, and the payment fit into the plan for next year fine. Then when we would look at the collateral for the loan, there was no equity to be found. Even though they could afford the payment on the loan they were still in big trouble because they had no equity or not enough equity for the bank to be comfortable doing the loan. This is a tough position to be in. FSA was able to help in some cases with their guaranteed program, thank goodness. Unfortunately, sometimes it doesn’t work out and that is hard pill to swallow. They had a good plan for the next year and were projecting to make the payment, but what stopped them was equity position.
I know you can’t gain equity over night. This is a fact. Also, it is even harder in these current times to gain additional ground on your debt payments. It is hard enough to make the regular payment, much less to pay more! I would just say to think about this for the future. When the markets improve work on building that equity cushion if you don’t have a very substantial one. Consider a more aggressive amortization if you know you can afford it. Chip away at that principal balance. To those who have a solid equity position – congratulations! Protect that equity and think very hard on what you cash it in on. It is necessary and a wise idea to cash it in at times, but remain aware of how much you are leaving and if you are comfortable at the reduced level. According to how the current climate is in agriculture different items are considered to be “King”. Cash is always King, but right now I think it has to share the throne with equity too….it now has Royal status!