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Back to the Future, Part 2: Ag lending and financial management

Let’s hop back into the “Back to the Future” time machine to continue discussion comparing and contrasting the current times with the dreaded 1980s in agriculture. A panel of professors at a recent lending school received this question from a relatively new ag lender in the audience.

An interesting trend in both the 1980s and today is that late in the economic cycle, many lending institutions saw opportunity in the agriculture industry, and thus came into the field of agriculture for profits. Often inexperience, low rates, and some enticing loan structures are common with these new entrants. One such product that is now being offered is a super equity loan for operating money. That is, using equity to provide cash for the business on a 20-year fixed rate. While this is a good way to generate cash to improve liquidity, in the hands of the wrong manager it can provide a feeding frenzy of nonproductive asset purchases and misallocated funds. There is an old saying that cash will burn a hole in your pocket, and, unfortunately, this will happen again particularly with organizations using collateral lending. On a side note, this was one of the lending techniques frequently used in the red-hot housing market just before the big crash in 2009. Hopefully, agricultural lending will not experience a similar fate.

One observation when comparing both eras is that farm financial records, while not perfect, are much better now than in the 1980s. However, a real problem in U.S. ag lending is that many producers are making decisions based on tax records instead of accrual adjusted financial statements. Others who have CPA audited financials often do not use them in making management decisions. A student in a Farm Credit University class who has made loans internationally indicated that the poorest financial statements usually come from U.S. producers who are managing to minimize taxes instead of for generating a profit. This should be a wake-up call for all of us involved in financial management education here in the U.S.

In both eras, financial stress first occurs on the operating side as high prices cure high prices and drive profit margins to negative levels. The good managers will adjust by shedding underutilized assets, i.e. machinery, equipment, and marginal inefficient assets such as land, livestock, etc. Below average managers will seek refinancing opportunities utilizing collateral and often this will happen multiple times, eventually eroding net worth from the balance sheet.

Next time, I will cover more food for thought from the professors’ panel discussion.

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