In the last two articles, discussion centered on profitability and efficiency based on benchmark data provided by the farm management educational program in Minnesota. My recent trip to Canada confirmed that the U.S. is light years ahead of our neighbors to the north in compiling and analyzing peer benchmarking data. When I asked bankers and producers what their coverage ratio was after expansion, they shrugged their shoulders. Many lenders in Canada are making loans based on collateral and equity rather than cash flow and repayment ability.
Speaking of the ability to repay, let us proceed forward and examine benchmark data. The term debt and lease coverage ratio is the mainstream metric used by U.S. ag lenders, and those in Canada as well, to assess repayment ability. Ideally, one would like to see 150% coverage ratio. That is, 150% debt servicing capacity compared to debt service obligations. A quick glance finds that the top 20% of producers generated a 200% coverage ratio in all but two of the last 15 years. In recent years, this ratio has been above 400%. Over half of the time, the average producer group exceeded 150% coverage.
At the low end of the spectrum, the bottom 20% failed to hit 100% coverage every year for the last 15 years. How has this group stayed in business? Fortunately for this segment, land has been appreciating and willing lenders have been open to refinancing losses through paper equity gains. Like their Canadian counterparts, as long as land appreciates, this practice may not have negative ramifications. However, the first sign of adversity will result in financial stress like the 1980s, particularly with this group.
Maintaining strong coverage ratios is critical in an era of increased volatility and uncertainty in the marketplace.
Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at [email protected]