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Traversing a muddy field: Key reminders for banks considering ag lending

Mark Belongia September 26, 2018

Ag banking and lending are tricky fields and require a more specialized approach than other borrowing populations. Beyond the normal risks in any business, agricultural enterprises are affected by a host of outside factors and necessitate specialized practices.

We recently attended the Illinois Bankers Association’s Ag Banking conference and left with some great insights on ag finance. Indeed, ag financing can be a great addition to a portfolio, but it does come with risks. The trade disputes between the U.S. and China continue to muddy the waters and, so far, the Farm Bill has not been passed. Until the ag industry stabilizes, a conservative approach is likely the best practice. Here are some things to consider.

A stagnant agriculture industry

The U.S. economy has grown significantly since 2012, but most of the expansion is born from urban jobs, consumer spending, and the services industry. The agricultural sector, however, has not shared in the spoils. In the same time frame, farms have suffered stagnant commodity prices and falling income, which remains less than half of its peak in 2012. While the residential real estate market has mostly recovered and grown since 2007, farmland values have sunk. Overproduction of goods, both crops and livestock, have held back prices. These factors, combined with the uncertainty and immediate effects of ongoing trade disputes with China, have stressed the relationship between farms and lenders.

Understand your borrower

Lenders, however, need not completely avoid the prospect of agricultural financing. Rather, with the above conditions in mind, lenders should fine-tune their evaluation of a farm’s financial health. Dr. David Kohl, Professor of Agricultural and Applied Economics at Virginia Tech, suggested using a point-based assessment of management practices as a threshold for financing options.

For example, a growing operation that maintains detailed financial records and implements careful business plans earns a higher score and is almost certainly a better potential borrower than the grower who lacks written records and cannot specify long-term goals. Further, lenders should come to know their potential borrower personally. At no point should the borrower’s lifestyle habits, family goals, past spending practices, etc., be a complete unknown to a lender.

Quality loan presentations

Understanding the borrower and their business is only half the battle; communicating that information as part of the loan approval process will take significant effort in the midst of a stagnant industry.

Tim Ohlde, CEO of Country Banker, which offers software for agricultural lenders, says a quality loan presentation helps frame the borrower’s operation, illustrate the borrower’s management capacity, and provide a recommendation based on a supporting analysis. A successful proposal should be supported by specific ratios that can be used to assess the financial security of the farm. Don’t weigh any one metric too heavily; ratios should be calculated from balance statements, income statements, and combinations of both.

However, the ratios (mostly) cannot speak for themselves. A lender needs to provide interpretation and context for the data, not only to provide a necessary narrative but to demonstrate intimate knowledge of the analysis.

Mark Belongia is a partner in Thompson Coburn’s banking and financial services practice in the firm’s Chicago office.