Pushing debt down the balance sheetPushing debt down the balance sheet

The elongated economic down cycle in agriculture has caused some producers to “push debt down the balance sheet,” a phrase commonly used by agricultural lenders. This idiom refers to refinancing operating losses utilizing land equity as collateral to term out the debt for 10 to 20 years.

In some cases, producers have restructured debt three times since the start of economic margin compression in 2013. What are some of the objective considerations in utilizing a refinance strategy with your lender?

First, a refinance buys the producer time for corrective action. The ability to obtain operating monies allows the producer to continue operations in the short-term. The key is in the aforementioned statement: corrective action.

Lenders have confided to me that some producers take a passive approach to corrective action, waiting for commodity prices to improve for the next wave of profits. This “wait-and-see” approach or an “aw-shucks attitude” hoping that next year will be better often leads to another refinance within two to three years.

Another objective examination must occur utilizing the term debt to EBITDA* ratio. Divide the EBITDA, which is the sum of net income, interest expense, income taxes, depreciation, and amortization, into the total term debt. If one refinances operating losses and converts them into term debt, the numerator or term debt increases. If the EBITDA does not improve, the ability to service the debt deteriorates, hindering the long-term sustainability of the business.

Related:Pricing opportunities after harvest

The business will then be drowning in term debt service as a result of not improving the bottom line. If a producer is considering a refinance, at what level does the term debt to EBITDA ratio cause concern? When the term debt divided by an average of three years of existing and projected EBITDA exceeds six to one, both producer and lender need to tap the brakes with a candid reassessment. For example, if term debt is $1 million and EBITDA is $200,000, then the ratio would be approaching the critical level at five to one.

Of course, one's ability to curtail living withdrawals or seek outside income or equity can alter the future financial picture. However, these objective, candid assessments can be valuable in the down economic cycle where refinancing is often the option of choice.

*EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization

The opinions of Dr. David Kohl are not necessarily those of Corn and Soybean Digest or Farm Progress.

The source is solely responsible for the information provided and is wholly owned by the source. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset.