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Cheap money

If you need money for operating expenses, new equipment, buildings or land, you're in luck. Rarely has money been so available and so cheap to borrow as it is today.

Plus, agricultural lenders are using more deals to draw buyers. Growers can find 0% financing on new or used equipment or refinance long-term land loans at interest rates that are at 40-year lows. And if growers can't find financing at traditional institutions, they can find it at ag retailers and manufacturing companies. Some experts suggest that more ag equipment is financed by manufacturers than by banks.

Triple whammy

The cheap cost and high availability of money couldn't come at a better time. Many farmers across the Corn Belt will need the cash this winter. They have been hit by the triple whammy of low livestock prices, drought and fewer government payments.

“The low livestock prices in all commodities have pulled down the capital expenditure perspective of most people in livestock,” reports Mike Boehlje, Purdue University agricultural economist. “Because many grain farmers have livestock, they find that although their grain income may not be all that bad, their livestock has pulled down their total farm net income.”

Drought in many areas has hurt cash flows. “I would say that not as much capital will be spent in general as in prior years,” says Doug Stark, Farm Credit Services of America, Omaha, NE. “Farmers tend to pull in and be conservative, which they should.”

And income from government payments is down. “Because government payments certainly have been less than last year, I think there is an increased need for financing this fall and winter,” reports Mark Cox, First Mid-Illinois Bank & Trust, Mattoon, IL. “Unfortunately, I'm also sitting in an area where we had some pretty tough production. So there's going to be a lot more emphasis on cash flows and looking at debt coverage ratios this year.” He also expects to see more use of guaranteed loan programs.

In areas where crops thrived, growers still may be financially conservative. “I think most farmers will think that this is the chance to heal up and build liquidity,” suggests Tom Vincent, AgStar Financial in Johnston, IA. “They want more breathing room on their balance sheet. They'll probably take capital expenditures on a deal-by-deal basis.”

Lower interest

The money that growers do borrow should be at low prices. Interest costs on short-term operating loans could be 40% less due to lower interest rates, according to Cox. “This is a huge percentage change,” he says. “It will have a significant impact on their bottom line.”

His bank was offering farmers operating loans at 4.5 to 5% interest. The bank tied into a special Illinois program that provides money for farmers at deposit rates (currently 2%). Qualifying farmers borrow the money at 2.75% over the deposit rate. Otherwise, operating loans from financial institutions cost about 6.75%.

In today's financial climate, growers will find operating loans from nontraditional sources such as John Deere Credit's Finance Pro program. The program's representatives work directly on the farm with growers who need a minimum $350,000 operating loan. The program is available in a limited geographic area. But Tommy Jones, manager of marketing for JD Credit's Agricultural Financial Services Division, says the program has received a lot of interest.

“As farmers get larger and their borrowing requirements increase, they often outgrow the local community bank,” Jones explains. Plus, more banks are getting out of ag lending as banks consolidate. As a result of these trends, about four years ago, JD Credit entered the operating loan business. Jones says the business has been growing since then, and he expects continued strong growth in the future.

Shop around

“Agriculture as a whole is in a down cycle from the view of the financial community,” AgStar's Vincent says. “It is not a desirable place for banks to put money. So I expect to see some tightening in financial standards. Growers should be sure to provide a realistic gross-income-per-acre figure.”

If you are rejected for a loan, shop around for another financing deal. “Be aware of all the alternatives for financing,” Purdue's Boehlje recommends. “If you want to expand or are in need of additional credit and your current lender has decided to alter its policy, then look at the alternatives. There are new sources that are very competitive.

“But do some careful analysis of the ability to repay before borrowing,” he cautions. “That's the bottom line. If you don't have the repayment capacity, you should not get seduced by low interest rates.”

Ag lenders say that, if you do decide to borrow soon, you should consider the following options, which reflect the current trends in ag financing.

Buy rather than lease

Growers are taking a second look at buying machinery instead of leasing because of the accelerated depreciation allowed on new farm equipment. As part of President Bush's economic stimulus package, farmers may depreciate new equipment an extra 30% the first year. New equipment purchased before September 11, 2004, is eligible for the accelerated depreciation bonus. The 30% bonus is added to the usual first-year depreciation, but the total depreciation does not change.

“The bottom line is that farmers will have extra dollars in their pockets the first year,” reports Kris Harper, Case Credit communications manager. “For example, if someone is financing $100,000 and they take the additional bonus the first year, they have an extra $26,787 in depreciation.”

You must hold a contract to buy and not lease to receive the depreciation bonus, which has switched business from leasing to buying. “We do a lot of leasing business in AGCO Finance, but we're seeing a little reduction because of the tax advantages with the additional depreciation bonus for farmers,” reports Keith Large, CEO of AGCO Finance.

If you want to take advantage of the accelerated depreciation for a purchase but want the lower payments of a lease, lenders offer options. For example, AGCO Finance provides a loan with a balloon payment that replicates the buyout of a lease. Large explains, “If a customer doesn't want to lease a tractor but wants the same cash flow structure as a lease, we'll do it on a contract and make the 49% buyout as the balloon payment. So the customer owns the tractor and gets the full depreciation. But there is a higher interest charge because that final balloon payment is outstanding for the whole period.”

Lock in fixed rates

Many financial experts recommend resisting the temptation of low variable rates when looking at long-term loans. Instead, lock in a slightly higher fixed rate for protection in the long run.

“I've been in the Farm Credit System for 20 years and I remember when we used to talk about the old 5% loans on our books from 20 to 25 years before,” Stark remarks. “Now we have operators who have an opportunity to lock in rates at 6.5 and 7% — rates they've never seen before in their lifetime. Even though you can get a 5% variable rate, if you're buying real estate or taking out a loan you know you'll have for several years, why not lock in a long-term rate?”

Cox agrees. Interest rates are so low that farmers should take them and not take the risk that rates will rise in a few years on variable rate loans. “What we've seen in the last one and a half years in interest rate reductions has been unprecedented,” he adds. He recommends that if you are offered an attractive rate that works well in your operation, you should take it. Besides, Cox and other financial experts do not think interest rates will drop further.

Consider a short-term variable rate loan

But for short-term loans, take advantage of the variable rates that have dropped below 5%. Case Credit reports more interest in variable rate loans on high-tech equipment, which is traded more frequently. A grower will finance the equipment on a five-year loan but plan to trade within a couple of years. At that point, variable rates should pay off, reports Paul Rauenbuehler, Case Credit Ag marketing manager. “A variable rate loan will run 1.25 to 1.5% lower than a fixed rate loan. So farmers have to pencil it out to see if that 1.25% is going to save money,” he says.

The most popular variable rate loan for Case IH equipment is a five-year loan with interest rates tied to prime. But the amount the rate can rise over the life of the loan is capped.

“Last year, variable rate loans were less than 5% of our business,” Rauenbuehler says. “But this year variable rate loans will be 20% of our business.”

Farm Credit Services offers a variable rate loan that adjusts the interest rate each year without a cap, according to Stark. Other variable rate loans offer caps of 2% a year and 6% on the life of the loan.

If you use variable rates on long-term loans, you should not plan your cash flow based on these low interest rates, Stark adds. “If growers do that, they could be facing more challenging times in the future as rates come back to more normal levels.”

Refinance long-term loans

If you hold long-term debt at rates higher than the bargain-basement levels today, you should consider refinancing.

“There's been a tremendous amount of refinancing in the last year,” Cox reports. “I think most farmers are in pretty good shape.”

Purdue's Boehlje agrees. He's also seen a lot of activity in resetting loan rates. “If you have not looked at long-term financing rates in the last three to four years, you need to consider refinancing now,” he adds. “I know some growers who refinanced three to four years ago. They are considering doing it again.”

Check out incentive programs

Incentive programs for buying equipment, seed and crop protection products are very popular, according to Jones with JD Credit's Agricultural Financial Services. And they should be because growers can find deals such as free interest periods, low interest rates or cash discounts. Both manufacturers and retailers offer incentive programs.

“Incentives are more prolific this year than ever,” Jones says. “I think the input industry is starting to see that those financing programs help sell product. Just like car manufacturers, we offer the incentive programs on the equipment side. Now those programs are attractive to farmers when buying a bag of seed.”

JD Credit offers a variety of low-rate financing programs through alliances with more than 60 different input manufacturers and retailers for loans ranging from $5,000 up to $100,000. And for the company's better customers, many of these loans are unsecured.

The Ag Financial Services Division works with other companies to create incentive programs, Jones explains. Started in 1995, the division has greatly expanded and is a major growth area for JD Credit.

Continue to expect financing deals tied to sales. “These days, financing is very much a part of sales,” states Large of AGCO Finance. He cites the example of Gleaner combines. AGCO offered two-year, interest-free financing through dealers on used Gleaner combines, and the offer stimulated sales. Now all products lines in AGCO have special financing promotions.

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