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Equity does not guarantee a loan

A lesson many producers need to remember is to build and maintain financial liquidity at all times.

David Kohl

November 29, 2023

3 Min Read
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“Equity does not guarantee a loan” was advice from a father to his son. This father, who is a veteran of the 1980s farm crisis, is in his 70s and his son is in his mid-40s. He also has a grandson aspiring to farm and a granddaughter who is ready to graduate from college. Both producers and lenders who remember those days are becoming fewer and far between.

Remembering when...

As both domestic and global economies are in a downward trajectory and the agriculture industry, particularly some sectors, is quite dependent on exports, this father’s advice may have more credence. In recent years, many farm loans have been made using quick credit scores from risk rating systems that are often designed and tested only in favorable economic times.

The last few years have been underpinned with government checks and increasing land values, often by double digits annually. Supply and demand shocks on prices and costs with stubbornly high interest rates may result in an extended period of profit and cash flow challenges.

Credit tightening

This situation may result in a tightening of credit to businesses by lenders and “shadow” lenders or nontraditional lenders. Government oversight by regulators will be another factor in the tightening of credit if any cracks in individual credits or agriculture loan portfolios were to occur.

Economic cycle

This father’s advice to his son, which hopefully will be passed on to his grandson and granddaughter, is great advice for tough times. Dad remembers lenders denying him and his wife an operating loan, despite having 250 acres of land free and clear of debt. This was a result of the pessimistic outlook for the agriculture industry during the tough part of an economic cycle with little hope of rebounding. This resulted in a nationwide financial liquidity issue during the 1980s.

The rescue

The good news was this producer operated a modestly large operation with the assistance of a neighbor who came to the rescue. The neighbor loaned him operating money at a 22 percent interest rate on a handshake. This provided the producer with a financial bridge to position for the positive side of the economic cycle.

Despite high interest rates, he was able to pay off the operating loan and position the business to grow. Two years later, the lenders who turned him down for the operating loan were knocking on his door for his business.

Financial liquidity

The lesson learned here is to build and maintain financial liquidity at all times. A strong current ratio above 1.5 to 1 and working capital to expenses ratio above 25 percent are solid metrics.

Be careful of quick credit based on a credit scoring system where the lender becomes very transactional. Remember, relationships matter in a downturn and you want an institution and people that know you and your business and are in it for the long term. The economic tide can turn extremely fast and one needs to be careful!

The opinions of David Kohl are not necessarily those of cornsoybeandigest.com or Farm Progress.

About the Author(s)

David Kohl

Contributing Writer, Corn+Soybean Digest

Dr. Dave Kohl is an academic Hall of Famer in the College of Agriculture at Virginia Tech, Blacksburg, Va. Dr. Kohl has keen insight into the agriculture industry gained through extensive travel, research, and involvement in ag businesses. He has traveled over 10 million miles; conducted more than 7,000 presentations; and published more than 2,500 articles in his career. Dr. Kohl’s wisdom and engagement with all levels of the industry provide a unique perspective into future trends.

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