Borrower & Lender Perspectives

By Dr. David Kohl

The 70th annual American Bankers Association Agricultural Bankers Conference was truly the super bowl of learning, knowledge, and nuggets of wisdom. This year's event was located in Omaha, Nebraska, with over 650 bankers, government officials, vendors, and stakeholders of the agriculture industry in attendance. While the event is focused on banking, much of the information and perspectives are also applicable for borrowers. Let's journey through the information gleaned during this four-day event.

Transition is accelerating

One of the noticeable trends at the conference was a transition that is occurring in the agriculture industry. Nearly half of the participants were first year attendees with little gray hair. A notable change has been the number of female bankers in attendance and that women are increasingly holding leadership positions in the banking industry. Alignment of both borrowers and lenders with a focus on the relationship will be an accelerating trend as the agriculture industry moves toward the middle of the decade. Farms, ranches, businesses, and bankers must develop a culture to build the next generation’s talents rather than waste the next generation's talents. Each group must ask, "What is the plan to transfer assets, and what is the management transition plan?

Rocky roads ahead

Despite the fact that agricultural loan portfolios and individual borrowers are generally in very good condition, many of the attendees were concerned. Financials have been boosted by generous government payments, asset appreciation that led to paper wealth, and price and input advantages early in the cycle. Many of the agricultural lenders in attendance see rocky roads ahead with an overall economic environment that may deteriorate financial conditions.

Of course, inflated input costs are now putting a damper on profit margins. This could accelerate in the middle of the decade as possible price corrections with elevated costs cause margin compression or, in some cases, negative margins. Layer on substantial increases in interest rates and profit deterioration must be planned for. In this situation, a good set of transparent, financial records and spreadsheet projections with production, price, input costs, and interest rate stress testing is critical. This is a method both borrower and lender can use to promote objective mental discipline and provide the guardrails of business decision-making. The key will be to monitor these projections compared to actual performance data and make the necessary strategic adjustments to place the odds of success in both the borrower’s and banker’s favor.

Interest rates and inflation

The hottest topics of the conference were related to interest rates and inflation. An informal survey of leading agricultural bankers showed that many expect the federal funds rate will increase 425 to 550 basis points when it is all said and done. This equates to a prime rate between 7.25 and 8.50 percent, as historical trends find that there is about a three percent difference between the prime and federal funds rates. Of course, the borrower’s interest rate may vary depending on risk, profitability, size of loan, debt structure, etc. This interest rate increase will be noticeable on operating loans and production asset loans as they are often on a variable rate structure. However, caution needs to prevail for loans with three-, five-, and seven-year fixed rate resets. If the present interest rates continue, this represents additional costs beyond just the production loans and the real estate loans.

Financial themes

The sessions pertaining to the financials had some great reminders as we move into the renewal season. The following are some of the highlights.

  • The top 20 percent of profitable producers in the FINBIN database, managed by the University of Minnesota’s Center for Farm Financial Management, had approximately $100 lower machinery costs per acre.
  • The top 20 percent profitability segment had working capital to revenue of 60 percent when compared to 18 percent in the bottom 20 percent segment. For those that favor the current ratio, the top 20 percent had a 3.07 current ratio compared to the bottom 20 percent of producers with a current ratio of 1.3.
  • The operating expense to revenue ratio was 90 percent for the bottom 20 percent of profitable producers compared to 63 percent for the top 20 percent group.

In summary, the financials of the high profit groups showed about $200 less costs per acre, slightly better production yields, and about $100 more per acre in revenue achieved through marketing. The old adage of being five percent better in many areas of the business is a theme for sustained profits.

Other perspectives and wisdom

  • Employees typically do not leave their employers. They often leave their supervisor or boss.
  • Peak performing people often associate with and know other great people. Pay attention to the company you keep and who you network with.
  • Get ready for environmental, social, and governance (ESG) principles driven by activist investors, societal pressures, and government. The positive news is that the agriculture industry is well ahead of other industries if we proactively tell the story!
  • If you do not have land as collateral, you better build your intellectual collateral. This is particularly true for young farmers and ranchers that lack land equity. Character and resiliency with a management mindset can build agility for the future.

As we move closer to the new year, we cannot develop a game plan to produce our way to prosperity. We have to manage our way to prosperity. If so, what will be your top three strategies in the borrower and lender playbook to manage your way to prosperity?