When the Traditional 5-C's of Credit Aren't Enough

If you have been attempting to secure credit for your farming operation in recent months – you likely have found bankers to be very cautious. You likely have heard the bankers indicate how carefully the government bank examiners are scrutinizing there loans and portfolios. Where were those bean counters when Freddie Mac and Fannie Mae gave out money more freely than an inebriated sailor?

Financing has really changed from the mid 1990's when the dairy industry was going through a major retooling. During the 1990's a business plan could be put together for a dairy and if the operators met the "Five-C's of Credit" the plan had a strong likelihood of being approved. Today, the Five-C's are more rigorously scrutinized than ever.

Not only is the character of the owner(s) important but the reputation of the business is also important. Does the community have a positive perception of the business and the employees that work for the company? Does the agricultural business use currently approved production practices and modern technology? What kind of environmental track record does the operation have? Have they been a good neighbor?

Capacity refers to the business's ability to meet its obligations, remain viable over time and simply make money.

Commitment is a given. Does the key person(s) in the operation have a history of overcoming challenges? I just spoke with a producer struggling to remain positive through the challenges of this wet spring. Larger operations have a distinct advantage in respect to the day-to-day struggles of operating a farm because the emotional struggles can be shared by the staff. Farms that have made it through hardships and made financial progress over the long haul are attractive to lenders.

Collateral is the fourth of the 5 C's of Credit. Collateral has to do entirely with the strength of the balance sheet. Are the assets fairly valued or are they inflated to make the balance sheet look more positive? During much of the late 90's and early 2000's, many dairy farm balance sheets were upside down. That is, the lenders owned more of the farm than did the farm. This was due to the fact that for a dairy to modernize, it took a lot of new capital. Once the dairy had retooled it's self for the future, the debt was paid down and the balance sheet recovered. When it comes right down to the nitty-gritty, can the lender get out from under the collapsed business without losing money? Most, if not all ag lenders, want to avoid a foreclosure like the plague.

Lastly, the conditions of the loan are addressed in the business plan. Conditions generally include markets, consumer trends, economic predictions and environmental considerations. We all know how global our economy has become. Farming has historically been an industry based on the production of commodities. Increasingly, more agriculture producers are vertically integrating by entering into the processing and marketing of their products to wholesalers or directly to the consumer. This takes a great deal of market research to meet the condition requirement of the loan proposal.

Most producers will not pursue direct marketing of their products but lenders are requiring prospective borrowers to come prepared with multi-year monthly cash flow projections complete with a sensitivity analysis designed with a range of product prices and cost projections. Most experienced agriculture lenders now require a marketing plan using risk management tools as a part of the cash flow projections.

In these tough financial times, the 5-C's of credit remain important but they may not be enough. When the banker rejects a strong proposal the borrower must receive honest feedback. What are the specific reasons for the rejection? Are the objections fact or does the bank lack capacity to make the loan? Is the lender technically up to date to properly evaluate the loan request? Agricultural lending has become so involved that many banks have made the decision to withdraw from the market but are reluctant to express this to prospective borrowers.

Work hard on strengthening the 5-C's of your farming business, find an agricultural lending partner that is knowledgeable regarding modern agriculture and be on top of your financial game at all times.

Greg Booher, Farm Business Instructor at Lakeshore Technical College, East Central Wisconsin provides assistance to dairy producers in the region. Greg.booher@gotoltc.edu

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