Risk-aware agribusiness financing—in both good and bad years
A strong economy does not always mean strong profits for agribusinesses— as dairy farmers know all too well. This year, the United States Department of Agriculture’s (USDA) early estimates of net income for farms in the U.S. reflects a 6.7% reduction from 2017.
The USDA also reported little growth in milk cow numbers on a nationwide basis and reduced its estimate for milk prices. Early estimates could easily get turned around over the course of 2018.
Still, any indication of economic stress is important to prepare for. From our vantage point as agricultural and commercial bankers, we have seen local agribusiness owners and managers successfully position their businesses for long-term success, even during stressed markets.
In fact, sometimes the most challenging years are the ones where risk-conscious business planning is most valuable. As local agribusiness leaders know from past experience, business cycles continue to turn, and challenges can turn into important opportunities.
In this article, we would like to share some of the ways we have seen local agribusinesses position their operations for whatever comes this year—and next.
These ideas are about risk-mitigation through financing, for the purpose of giving business owners a safety net and helping them maintain control. Ideally, agricultural and commercial bankers will help owners think along these lines as an advocate for the business to prevent future problems.
Strategic approach to lines of credit
Many agribusinesses finance much of their debt on lines of credit. It is not atypical for that line of credit to always have a balance and little availability. This situation can become a problem if additional funds are needed to support current assets such as inventory and accounts receivable. A more strategic approach is to free up line of credit funds by obtaining long-term loans for long-term assets—such as a seven-year equipment loan and a 25-year real estate loan.
Term loans vs. Guaranteed fixed-rate loans
In an uncertain environment, it’s helpful to have financing in place that you know is not going to come due—with a large balloon payment, for example—at exactly the wrong moment.
Balloon payments are an example of a loan structure that takes control away from the agribusiness leader, because the business may end up between a rock and a hard place.
For example, consider a typical real estate loan with a five-year balloon payment, a 20-year maturity and an interest rate that either floats or is fixed for a period of no more than five years. What if that balloon payment happens to come due during a downturn when operations are struggling? The owner would be forced to renegotiate with the bank at the worst possible time when it is unlikely another bank will offer financing. The lender could take steps such as increasing the interest rate, requiring the owner to put more capital into the business, or seeking additional collateral. Or worse, the lender could call the note and put the business on a forbearance agreement. These are common problems, especially for capital-intensive businesses that carry more debt on the balance sheet.
In many cases, these problems can be avoided by obtaining financing with the longest possible maturity and amortization schedule. This is where government-guaranteed financing can be an alternative to conventional bank loans. Small Business Association (SBA) loans offer longer maturities (up to 25 years) fully amortized. USDA business loans can be even longer (up to 30 years) also fully amortized. In both cases, the borrower can lock up interest rates for the entire loan period. Long-term, fully amortized loans—and especially at today’s low fixed interest rates—can contribute to business stability over time. The debt coverage is set and because there’s no balloon payment, it is a much more patient approach.
There are two main reasons why owners do not take advantage of guaranteed loan programs: these programs require more paperwork and government fees are higher. Those factors need weighing, but owners should view long-term financing as an insurance policy against potentially rougher times in the future.
Long-term financing also means lower demands on cash flow, in turn allowing businesses to reinvest more dollars back into the business and take advantage of growth opportunities as they emerge.
The following is an overview of loan programs business owners in Wisconsin should be familiar with as they consider taking on financing for a project. In some cases, loan terms are especially attractive due to government support for the program.
FSA, USDA and SBA options
Government-backed agribusiness loans are readily available at many banks and other lending institutions, but business owners often do not realize the array of options. In general, government-backed loans include Farm Service Agency (FSA) and USDA loans, along with the SBA program. In some cases, government-backed loans can be stacked with conventional loans, yielding even more options to help business owners achieve their goals.
Available information on government-backed loans in Wisconsin:
FSA Loans – Available to farmers or ranchers for operating costs, cattle, equipment and real estate. These loans can also be granted if a natural disaster, such as drought, flooding or a bad storm ruins crops or damages farm buildings or equipment. Interest rates, fees and terms for farm loans vary dependent upon the business and type of loan.
USDA Rural Development Loans – Available to agricultural businesses as well as other types of firms that meet demographic requirements (rural areas). With high loan limits and long terms, these loans are attractive to large operations. Fees are 3% of the guaranteed amount, which ranges from 60-80%, dependent on the amount borrowed, plus a 0.5% annual renewal fee. Interest rates are negotiated with the lender, and may be fixed or variable.
SBA Loan Program – SBA loans are capped at $5 million and can be used for working capital, buying equipment or property, for building construction or starting a business. CDC/504 Loans (Certified Development Company) can be used to purchase equipment, machinery or property, including buildings, for improvements such as grading and utilities or for new construction or renovation. Fees are about 3%, while interest rates are pegged to five- and ten-year U.S. Treasury issues. The project’s assets are used as collateral, but the principal owners must provide a personal guarantee. Terms are up to 20 years and some loans can be linked to job creation. General Small Business Loans 7(a) can be used to start a business or assist in the acquisition, operation or expansion of an existing business, including farms. Eligible farm expenditures include fencing, irrigation systems and construction of silos, barns, dikes, dairy and hog buildings, and buying seed or animals. Terms are up to 25 years for real estate, up to 10 years for equipment and generally up to seven years for working capital. Fees range from 0-3.75%. Interest rates may be fixed or variable and are negotiated between the business owner and lender, subject to SBA rules.
The SBA also offers a microloan program for loans up to $50,000. These are administered through nonprofit community based organizations with lending experience. The loans can be used for working capital, equipment or supplies, furniture, fixtures, machinery or equipment. Interest rates vary but are generally 8-13% for the loans, which require collateral and personal guarantee. Finally, the SBA offers a disaster loan program that features low interest, long-term loans for physical and economic damage caused by a declared disaster to businesses located within the disaster area.
Ron Markham is Market President in Monroe while Tim Hardyman serves as Market President for Platteville and Lancaster, Wisconsin Bank and Trust, Member FDIC.