Editor's note: Each month in Wallaces Farmer magazine, the Timely Tips panel answers questions sent by readers. Members of the Timely Tips panel are William Edwards and Michael Duffy, Extension economists, Iowa State University; Leslie Miller, Iowa State Savings Bank, Knoxville; and Rob Stout, Master Farmer, Washington, Iowa. Following are two questions sent to us this month and the answers from our panel.
Our locally owned bank was taken over by a large banking firm several years ago, and they now have new loan officers. I asked the one I dealt with last year what he looks for in a client. I didn’t get a straight answer. I’d like to know what the new lenders are looking for in farmers, as I make my case when trying to secure a loan. Any ideas?
Duffy: Basically a lender looks at what kind of person you are, what collateral will you put up for the loan, and can you repay it. Be prepared to show what kind of operation you have; how your operation has been doing financially over the past several years; how much money you’ll need; why you’ll need it; and how are you going to pay it back. Have your records, dress appropriately and be professional. The lender is loaning you money and you have to convince them why they should.
Stout: I’m not sure I know what your banker is looking for, but most lenders will look for at least some of the following. First and foremost, in this economic climate, especially when your lender has no history with you, is repayment capacity. A good cash flow budget, with adequate working capital, is likely more important than net worth in securing an operating loan. Good character, honesty and a good work ethic are also important. Also important is a proven ability to make sound business decisions and good marketing prowess, or willingness to hire help in that extremely important aspect. A good relationship with others in your farming operation and landlords is also important. Being willing to diversify or take off-farm employment if needed would also be a positive trait.
Miller: This is where lenders start talking about the three C’s of credit or the five C’s or the seven C’s — or whatever number of C’s they use. What lenders are trying to tell you is that they want to be sure you have good character and you have paid past obligations on time. They want you to have collateral to secure your loans, and they don’t want to loan 100% of that value. So, you need to have some capital to invest in your operation along with the borrowed money. They want you to have capacity or cash flow to show you can pay back the loan they make, and they want you to have some cushion in that cash flow. They want you to have the conditions that permit you to operate, and they want you to have coverage (as in risk coverage) to protect your investment and the banks.
Many big banks will try to define their “desired borrower” by looking for certain ratios or performance measures. Often, your information is sent to a centralized loan analysis center, and the local lender does not know what these numbers are; he just gets an approval or denial. If the lender is willing to ask, you both might be able to learn what ratios are being used (debt coverage ratio, debt to asset ratio, return on assets, current ratio, etc.) and what minimum values are desired. A good lender should also be able to provide some ideas on how to improve your ratios if needed.
I was gloating just a bit as I attempted to explain to Dad and Grandpa some of the more complicated risk management strategies I learned at school this year. Grandpa listened patiently and then said, “Sonny, there is only one true risk management strategy. That is, have something stashed away in the sock.” Dad chimed in, “Always have something in position to sell.” Exactly what are they talking about? And are they right?
Edwards: There are two general approaches to risk management in farming. One is to have enough financial resources in reserve to stay afloat when bad things happen. The suggestions your dad and grandpa give fall into that category. The second approach is to take measures to avoid the bad results in the first place. Purchasing crop insurance and forward-pricing grain would fall into that category. A total risk management plan includes both types of strategies. Holding onto grain until you need the cash may not be the best marketing strategy. Developing a bimonthly cash flow budget and coordinating a marketing plan to fit with it will avoid having to make forced sales. Keeping cash in reserve has to be balanced against the need to earn a return on it at the same time. Putting funds in a money market account that can be easily liquidated may be preferable to a low-interest savings account, for example.
Stout: Your grandpa was probably talking about having some money saved for the proverbial rainy day, which might be a little unrealistic if you are just starting farming, but still sound advice. Your dad is likely talking about being in a good working capital position so you can always pay off any short-term debts with available cash, and grain or market-ready livestock to sell. So yes, they are right in what they say as being sound advice, but you can add to that with additional risk management strategies you have learned, which should complement their plan.
Miller: Grandpa and Dad may have heard the old adage “Cash is King.” For farmers, it could mean a big balance in a checking or savings account. A more likely scenario is there is grain in the bin that can be sold, and the money does not have to go to pay off an operating loan or make land and machinery payments. The advantage of having some extra cash or grain is if you have a short crop, or cattle prices are lower than what you wanted, you have some money available to cover the shortfall. Also, in tough times like these, there will always be opportunities that come your way. The extra cash gives you a chance to take advantage of those opportunities.