Dr Kohl: The Changing Face of Ag Lending
4/15/2019
Dr. Dave Kohl
grain falling into a container

Dave Kohl

At a recent conference with over 300 agricultural lenders, an eye-opening exercise revealed the dynamics impacting the agriculture industry. While speaking, I requested that all baby boomer lenders born between 1946 and 1964 stand up. A unified reaction from the crowd said it all. Less than 15 people, or 5 percent of the audience, stood up. The transition of institutional memory, leadership and brain drain from this generation of lenders who experienced the 1980s downturn and two super cycles of agriculture is now in its twilight years.

Couple this transition with an economic environment of low profit margins and extreme volatility in prices and cost, and the result has been the rapid consolidation and reconfiguration of agriculture. Layer on rapidly changing consumer habits driven by the millennials and Generation Z both domestically and internationally. In addition, venture capitalists are investing billions in the food, fiber and fuel sector through technology, blockchain and big data. All these factors have set the stage for a massive structural change in agribusiness and agriculture lending and trickle down to rural communities.

Agriculture is a cyclical industry economically, driven by global trade, weather, government programs and regulation, consumer preferences, investor habits and the motivations of farmers and ranchers. With these forces changing the face of agriculture, any strategic planning exercise must examine the shifting paradigms impacting agricultural lending in the decade of 2020 to 2030.

The commodity super cycle was a period of elongated profits from 2002 to 2012 that was fueled by a convergence of factors. Ethanol and strong demand from emerging nations for commodities increased demand for farm products. An urban real estate crisis resulted in quantitative easing and low interest rates, which in turn reduced the value of the dollar. This made U.S. farm products an attractive buy for international customers. These events led to a period of profitability replicated only three other times since 1910. Extended periods of profits and net worth growth filled the coffers of the baby boomer farmers who are in the mature stage of the business life cycle.

Eventually, demand for commodities leveled off as technology adoption accelerated the supply of farm products. This oversupply and increases in both variable and fixed costs resulted in an economic reset for many agricultural sectors and producers.

A quick assessment of the agriculture landscape finds varying degrees of financial and economic impact across the spectrum of agriculture. Smaller producers with less than $250,000 in revenue have been resilient. Many of these producers are at the size and scope that off-farm employment or revenue streams from other businesses provide stability.

Larger producers have been in a growth and expansion mode with a focus on capital and cost efficiencies. The financial outcomes of this segment are that 10 to 12 percent of the producers carry nearly two-thirds of the nation's farm debt. These larger producers are dependent on domestic and global markets and business acumen.

The midsize producer is being squeezed for profits and cash flow. Unfortunately, many of these producers are too big to “be small” and are too small to “be big.” Strong land equity has given some midsize producers the ability to refinance or restructure financial losses. Other producers are resorting to diversification, value-added businesses or scaling down the size of the operation with the realization that growth opportunities are limited by their financial and management abilities.

As the young and beginning farmers and ranchers seek to make their mark on the agriculture industry, three models appear to be emerging. Some, of course, enter through the family business; these businesses are usually in the second through the fifth generation. Others are first-generation startups often involved in value-added businesses rather than the traditional commodity route. The third group is the “highbred” or the boomerang producer. This group often worked away from the business and some even worked completely outside of the agriculture industry for a number of years. They returned to agriculture to exercise their entrepreneurial potential within or outside an existing family structure. Their motivations are often to achieve a balanced lifestyle, raise a family and use their skill base and experiences to enhance the business or processes.

The 1980s downturn eliminated many average and poor production managers. The current economic cycle is just as discriminating on the production side but is also challenging producers who lack business acumen. Recent work suggests that the economic cycle is not quite as severe as the 1980s farm crisis when measured by the debt-to-asset ratio and the number of farm bankruptcies. However, the number of debt refinances and partial liquidations may be a better gauge of the current and future financial landscape. The current economic cycle, along with the 1980s downturn, are trigger events that will have long-term implications for the agriculture industry and its lenders.

There appears to be three types of agricultural lenders nationwide: transactional, relationship driven and a hybrid. Let’s examine the three models and the implications concerning a lender’s strategies, tactics and actions.

Transactional Lender
Transactional lenders will often use credit scoring with a focus on collateral, particularly land equity, as a basis for credit decisions. Transactional lenders often require a debt-to-asset ratio less than 50 percent to ensure plenty of equity reserves if something goes awry. These lenders often monitor credits only once a year when renewing lines of credit. Many transactional lenders will employ the “hunter and skinner” approach. The relationship or sales officer will “hunt” the deal and the credit analysts will analyze the financials, or “skin it.” Relationship officers often receive financial incentives based on loan volume production. In these institutions, there tends to be a drive toward efficiency with the lowest possible rate. In some cases, relationship officers working at community banks will work with both agriculture and commercial loans. Issues are starting to occur in this economic cycle as relationship officers are seeking greener pastures elsewhere as loan production has slowed resulting in less income from incentive plans. The customer is often left with the credit analyst, who is familiar with the account, but may lack the personal skills to work through a financially stressed situation.

The transactional model will be challenged by the fact that scoring systems and risk ratings constantly need to be validated and updated. This model is vulnerable to competitors such as nontraditional lenders participating on operating monies and one-time transaction deals where a relationship has not been established.

Relationship Lender
The relationship lender will have a balanced approach in analyzing cash flow, profit, working capital, management, collateral and character. This group will have both relationship officers and credit analysts working together to provide opportunities for value-added services such as benchmarking, additional financial services and counseling. In some cases, these lenders will exceed the 50 percent debt-to-asset ratio and will also finance non-land assets such as livestock, machinery, inventory and working capital. This model is predicated on building trust with the customer over an extended period.

For those lending institutions using the relationship model, there must be a seamless transition and development of human resources. The key for any institution is recruiting, training and retaining the new generation of millennials and Generation Z. A positive workplace culture will act as a magnet to attract and retain this group. Some critical attributes of a desirable workplace culture include flexible hours, a focus on work-life balance, educational opportunities and skill development resources. Relationship lenders must prioritize their strategic alignment with the young and beginning farmers and ranchers and midsize and large businesses experiencing a transition. This is where a new group of lenders can feel that they are making a difference in the future of the agriculture industry beyond collecting a paycheck.

Hybrid Lender
The next model is the hybrid lender, which may be prevalent at most agricultural lending institutions. This group will use transactional lending on small and midsize credits with a focus on efficiency and credit scores. The relationship lending approach will be used on larger credits, growth-oriented businesses and businesses in transition. The hybrid model is often used with young farmers and ranchers, entrepreneurial businesses, distressed producers and high-risk credits. The hybrid model faces a combination of the same challenges faced by transactional and relationship lenders.
Training programs at agricultural lending institutions need to be evaluated and tweaked. Within the context of technology, soft skills such as listening and nonverbal communication will be just as important as quantitative and financial skills. Financial and business problems and opportunities often begin outside the numbers where soft skills are needed to identify and act on said problems and opportunities. Developing and maintaining relationships needs to be a high priority training item. In addition, lenders should consider communicating with borrowers using a balance of technology and face-to-face contact.

Institutions will need to assess educational programs for producers and lenders that develop skills that are applicable to both parties and can be used to develop side-by-side relationships. Another consideration is how strategic alliances with other groups with similar value systems can enhance the lender’s model.

It is unclear whether education in the future will be delivered online, face-to-face or a combination of both called blended education. Education in the future will be in “bites” or small components that can be customized and tailored to meet one's personal needs. Will this new platform of information and knowledge delivery reinforce and enhance the brand of all parties?

These are just a few thoughts and perspectives to stimulate thinking about the challenges and opportunities in the decade ahead. This article provides some thought for the planning process for a strategic thinker who is looking for different scenarios to be sustainable and successful in the agricultural industry.

 

Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 8 million miles throughout his professional career and has conducted more than 6,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA, and regulators, as well as producer and agribusiness groups. He has published four books and over 1,300 articles on financial and business-related topics in journals, extension, and other popular publications.


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