A farmer’s financial situation tends to fluctuate from year-to-year – and sometimes even month-to-month. Most lenders are highly interested in that information as well, compiling it and benchmarking it against other loans they have made.
“Whenever you go to the bank, you’re being measured by other farmers like you in their portfolio,” said Curt Covington, executive vice president with FarmerMac, speaking at the 2020 Farm Futures Ag Finance Bootcamp Jan. 22 in Coralville, Iowa. “When you deliver your financial information to them, they want to know how you performed versus Frank down the street.”
Borrowers typically create some sort of rating system to rank their portfolio, added Paul Neiffer, CPA and Principal with CliftonLarsonAllen LLP.
“Everybody is being ranked by their bank, and you’re either coming in average, above average or below average,” he said.
It doesn’t hurt to ask your lender about your loan risk rating, Covington said. Every bank has its own particular model. FarmerMac, for example, has a 12-point scale, with most farmers falling into an acceptable risk range.
There are actually two ways that banks benchmark farmer loans, however. The first has already been described above, referred to as “peer comparison.” That is, if a bank’s portfolio includes 50 farm loans, how does your loan stack up against the other 49?
The second way banks benchmark farm loans is via an internal trend comparison. That is, how are your farm finances today, and how is your loan expected to perform moving forward?
“It helps lenders understand how you’re going to look in the future,” Neiffer said. “Is your trend going up or down?”
Lenders use benchmarking to make a bevy of important decisions that can positively – or negatively – affect your borrowing capabilities, based on your rank and risk rating, Covington said.
“Where you fit into the portfolio in that bank will drive interest rate, covenants, the amount of money they give you and any number of things.”
Covenants often address red flags on a particular loan. They come in two “flavors” – affirmative or negative. Affirmative covenants indicate something you will do, such as send your lender quarterly financial reports. Negative covenants indicate something you will not do, such as not exceeding an agreed-upon amount of monthly living expenses.
Violating covenants can bring serious consequences, Covington said.
“They are known as non-monetary defaults,” he said. “Lenders can indeed default your loan because of that.”
Click here to learn more about this year’s Farm Futures Ag Finance Bootcamp and Business Summit.