"Hope for the weather you want, plan for the weather you get."
David Lynn says that wise saying applies to more than just planting season. It also applies to your finances.
"We've come off a period of strong commodity prices and farm earnings, and as prices decline and margins shrink against historically high input costs, we have to answer the question: how do you maintain or grow your working capital?" asks Lynn, senior vice president for financial services at Farm Credit Mid-America. He offers five ways to stay fiscally sound:
Stay liquid. In good years farmers often use capital to pay down debt. But with an extended lower outlook for commodities, it's best to preserve capital, Lynn argues. "Those with cash on hand today should hold on to it – keep a liquid position," he says. That's coming from a lender!
Staying liquid allows you to maintain a balance sheet that gives your lender options to work with you. "If you don't have fixed rate loans and you have long term debt, absolutely now is the time to fix those loans with low rates," he says. "The rates you can get today are as low as they have been since WWII. As feds continue to taper and get out of bond buying it's only a matter of time before long and short term rates rise."
Watch rates. Lynn wouldn't be surprised to see long term interest rates rise 150 to 200 points over the next 12 to 15 month period. "The bottom line is, that comes right off the bottom line for a producer."
Farmers have enjoyed historically low costs for money the past several years. On average they pay 5 to 10% of gross farm income in interest, but that figure shrunk to 2 to 3% in recent years. Meanwhile farmers have borrowed less because in many cases they've been flush with cash.
"So if you reverse those dynamics, coupled with higher interest rates, we'll see tougher times on the farm," Lynn warns.
Create an operating line of credit. Lynn believes an operating line of credit may be a useful tool for many farmers. "It does more than just finance inputs," he says. "It provides flexibility."
Create an operating line of credit in line with the crop you grow. For example, set up one in the spring for a corn crop, and one in the fall for a fall-seeded wheat crop. "It's easier to track costs of production that way and you can ensure you have funds available for crop inputs," he says. "From a lender's perspective having an operating line is more than just growing the business – it gives the lender an opportunity to sit down with the borrower and review business plans.
Write and share your business plan. "We think it's important to have a business plan where you know your goals for the year, and can share with the lender your plans and cash flow needs and how they are going to repay the loan. There's nothing a lender hates worse than to be surprised."
In times of lower commodity prices, the lender can help you fill the void or holes in your working capital position during that period when you need to buy inputs.
Watch current assets to current liabilities. Lynn says Farm Credit lenders like to have a 10 – 15% margin; with some enterprises that are highly volatile they may require more. "We haven't really seen that figure change much over the years," he adds. "We recognize that farmers will have ups and downs but we're in this for the long haul. We're not going to make decisions based on one year of results. But that's why it's important to develop that relationship with the lender.
Farm Credit believes the next few years may bring a correction to land values, and that will impact asset values. But Lynn does not believe a correction will be similar to the depression in the farm economy of the 1980s. "Today's producer balance sheets are much stronger and they aren't nearly as leveraged," he says. And lenders are smarter, too. Farm Credit's standard practice is to lend 65% loan to value. "So when we saw many land values hit $10,000 to $12,000 per acre we had lending caps established, based on what we estimate is the repayment ability of those producers," Lynn says. "We'll loan money for those purchases but the producer will have to come in with cash or collateral to support the difference. We're not going to go to 85% on $14,000 land if our land cap is not there, so we've built in a safety net for any decline."
What's the future? Lynn says investment dollars will follow the market. "As we see a recovering economy and land prices possibly decline, we think dollars may move out of farm real estate into other areas of the economy," he says. "We're working closely to educate producers and provide opportunities for financing that next generation – for succession planning. We have a new program called 'Growing Forward,' designed to work with beginning farmers who don't have an established financial position yet. For those young producers we'll have different underwriting standards that are more relaxed than we would for the typical producer, but we see it as part of our mission as a cooperative and a lender."