Restructuring debt in a down market: Is it the right choice for you?

With hog prices expected to hover around $30 to $40 per hundredweight into 2000, now is the time to think about how to maintain adequate operating capital.

Hopefully, you have planned ahead and saved enough money over the past few years to weather a one- or two-year downturn in hog prices. If not, or even if you want to protect the liquidity you have worked so hard to build, there are some options you may want to consider.

Most financial experts will agree that building liquidity during good times is the best defense in a down cycle.  However, consistent long-term profitability ultimately boils down to whether or not you are a low-cost producer. Efficient, well-managed operations have a built-in cushion if prices dip for extended periods or other external forces drag down returns.

Regardless of your operation’s size, it is important to know and understand the cost of production from a cash-flow and expense standpoint. Ron Saak, assistant vice president for Norwest Bank’s Agricultural Credit office in Des Moines, Iowa, works with producers to assess the financial health of their operations on an ongoing basis.

“We evaluate financial capacity and stability based on trends. A one-year balance sheet and income statement just doesn’t tell the whole story.”  Saak typically conducts a five-year financial analysis based on a three-year rolling average.

“If there’s anything we want to know, we will see it in the trends.  This information helps us provide more thorough financial advice to our  customers and make sound lending decisions. Experience tells us that a producer who has been successful in the past usually will continue to be successful in the future.” 

In light of industry production projections, University of Missouri Economist Glenn Grimes suggests producers’ whose production costs are not already below $42 per hundredweight (liveweight basis) should probably consider getting out before the anticipated period of sustained low prices. On the other hand, producers with no debt who also feed their own grain are likely in the best financial shape right now.  Operation size makes little difference in the equation.

Short-term solutions to cash flow concerns can include selling assets, third-party cash injections, loans or debt restructuring. Saak says it’s important to remember that each operation is different and financial plans should be mapped out according to specific objectives.

If you had planned to use profits from the past couple of years to fund upcoming facility improvements or pay off debt, for example, it may become more difficult to generate the cash needed to pay bills in the months ahead.  

Maybe you put up a new building in 1995 with a three-year note, expecting to pay it off this year. It might be time to approach your banker about stretching out some debt to free up your cash flow. Or, if you have reduced your liquidity and anticipate difficulties making a monthly principal and interest payment, refinancing your loan could help build in some short-term relief.

“We don’t always recommend refinancing short-term debt with long-term assets,” cautions Saak, “but it can be the correct solution for some producers. I strongly suggest getting together with your banker before there’s a problem.”  

Building a good relationship with your banker by keeping communication lines open is important when you are facing tough decisions. Most lenders are flexible and willing to work with your individual circumstances.

“We know things run in cycles. When a producer has a history of profitability, we don’t get skittish when he’s facing a year of losses,” Saak adds. “However, if we see a pattern of problems, lower prices will only exaggerate them. A high-cost producer who’s looking to stretch out his debt is only creating a temporary fix for a more serious problem.”

The bottom line is to have an accurate financial picture of your operation and your goals before jumping into refinancing or taking out additional loans. 

According to Chris Beyerhelm, chief of the Iowa Farm Service Agency’s agricultural credit division, producers who also raise crops should wait until late fall to determine which liquid assets are available. “The good news is that we don’t anticipate any serious decline in land values over the next 12 to 24 months,” says Beyerhelm.

IFSA’s Guaranteed loan program includes operating loans up to $400,000 and farm ownership loans up to $300,000. The agency’s direct loan program offers operating and farm ownership loans up to $200,000. To qualify for IFSA financing, you must be unable to obtain sufficient credit elsewhere at reasonable rates and terms to finance your specific needs.

IFSA is a combination of the former Farmers Home Administration farm loan program and the Agricultural Stabilization and Conservation Service commodity programs. Interest rates and payment terms are negotiated between the lender and the borrower. Under its Interest Assistance Program, IFSA will subsidize up to 4 percent of the interest rate on loans to qualified borrowers.

The nation’s largest agricultural lender ù Farm Credit System ù also recommends a proactive approach to financial planning during a down price cycle. Jay Thompson, a loan officer for Farm Credit in Newton, Iowa, says the decision to refinance can depend upon where you’re at in the loan. “If you’re two years into a five-year note, you need to determine if there will be a cash flow benefit considering the additional interest you will eventually be paying, along with other out-of-pocket costs.

“On smaller loans, we offer everything from a one-year extension to rewriting a note for five or 10 years,” Thompson says. “The most important part of the decision is determining whether this is something that will help the producer get through a rough time, or are there other issues that need to be addressed. If long-term changes are necessary, we can help develop a plan of action.”

There are six regional Farm Credit Banks in the Farm Credit System, with services including real-estate loans, operating loans and rural home mortgage loans. Short-term and intermediate-term loans are generally made by Production Credit Associations, and long-term mortgage loans to farmers are financed by Farm Credit Banks, Federal Land Bank Associations and Federal Land Credit Associations.

It’s no secret that challenging times require tough decisions. How you plan to weather the storm depends on many individual factors. In most cases, the best defense is a good offense.

Loan or debt restructuring may be a viable choice to help eliminate future cash-flow concerns. With a complete understanding of your financial picture you will be better prepared to make smart, informed business decisions.

Editor’s note: Sue Bunce is a freelance writer, specializing in financial and business topics. She is located in Des Moines, Iowa.

What To Bring To The Table

Whether your goal is to protect the liquidity you have built, or you are anticipating future debt repayment problems, here are some steps to better understand all of your options and make decisions that are right for you:

  • Be proactive. Talk to your banker early in the game. This will give you more time to determine the best solution before  there’s a problem. 
  • Do your homework. An up-to-date financial evaluation will help you determine if your balance sheet is healthy enough to weather the market downturn. Also, get an objective long-term market assessment from an economist, a financial consultant or analyst. Ask yourself: What are your long-term goals for the operation? Do you plan to grow? Are your facilities already at capacity? Every situation is unique and requires different solutions to fit your specific needs.
  • Offer suggestions or solutions. If you’re planning to grow, how will you finance it? How do you plan to maintain adequate cash reserves? If you want to stretch out your debt because there may be a loan repayment problem down the road, explain why the problem has surfaced and how you plan to solve it.
  • Focus on the things you can control. You can’t control hog or grain prices, the futures market or the weather. Evaluate your own operation and determine what steps you can take to improve production efficiencies, reduce input costs, or maintain adequate cash flow to weather future uncertainties.
  • Develop an action plan. Work closely with your banker or lender and be prepared to make tough decisions. Will you need to sell any assets or borrow against assets to raise short-term operating capital? Can you postpone an equipment purchase, an upgrade to your production unit, or hiring that extra employee for another year or two? Will rewriting a loan cost you more in interest? Finally, what steps do you need to take to lower production costs long term?

Review Your Options

If you’re considering refinancing a loan or taking out a loan to generate operating capital, there are several options available. Repayment terms, interest rates and credit qualifications vary depending on the lender, the type of loan, the collateral securing the loan and your ability to repay.

  • Short-term loans: Short-term loans are made for general operating expenses such as labor, feed, seed, fertilizer, repairs and small capital purchases.  Generally the terms range from one to seven years. Operating and line-of-credit loans require crop liens and other underlying security.
  • Intermediate-term loans: Intermediate-term loans are designed for purchases of machinery, equipment, vehicles, breeding stock and real estate; farm and home improvements; livestock facility construction and debt consolidation. Terms are available up to 10 years or so depending on the lender. A down payment of up to 10 percent is generally required.
  • Long-term loans: Long-term loans are made for the purchase of farmland; to purchase, construct, remodel and refinance a home; to construct or repair buildings and other fixtures; and to develop farmland to promote soil and water conservation. Terms typically average between 15 and 30 years. A 20 percent down payment is often required (10 percent with private mortgage insurance). Your out-of-pocket costs will range from 1 percent to 2 percent of the total loan amount.