News | Agriculture

Economist: Farmers should prepare for lenders’ questions

Operating line of credit for farmersWEST LAFAYETTE, Ind. -– When commodity prices are high and incomes are up, farmers often can borrow money to plant their spring crop with almost no questions asked by lenders. That is not the case this year, said a Purdue University agricultural economist.

As farmers approach lenders about renewing their operating line of credit they should be prepared to answer questions about their profitability, managing risk and working capital, said Michael Boehlje.

“If you look back at the last couple of years, grain farmers have had pretty good incomes — even though operating costs rose quite a bit — so lenders felt fairly comfortable with the profit margins many producers had, meaning it was not as tough getting an operating loan,” Boehlje said.

“This year a lot of lenders are increasingly concerned about risk because of the financial challenges they face from regulators and loan review committees. So most farmers should anticipate providing their lenders with concrete, definitive answers to loan-related questions. Part of your job as a farmer is to sell your credit worthiness.”

Questions about profitability could be among the first asked by lenders, Boehlje said.

“Farmers need to fully understand the profitability of their business,” he said. “If it hasn’t been profitable, they’ll need a plan for turning that around. You want to make sure before you talk to your lender that you have a solid understanding of what you’re reporting on your Schedule F tax form for profits.”

Schedule F is for self-employed farmers. Because producers often adjust their taxable income up or down through the strategic timing of crop sales, the information on the tax form can vary greatly from year to year.

“Your lender is going to ask you if you changed your strategy this year compared to last year in terms of sales,” Boehlje said. “They will want to know if you prepaid or delayed expenses.”

Managing risk questions likely will focus on crop insurance.

“Lenders may be encouraging you to up your coverage level,” Boehlje said. “Maybe you’re buying crop insurance at a 70 or 75 percent coverage level. They may say you might need to up that coverage because your input costs are up and your existing coverage won’t cover even input costs. The lender might want you to have more protection, which means it could cost you more money. There might be some sticker shock if the lender starts talking about 80 or 85 percent coverage.”

Farmers also would be wise to retain adequate working capital when seeking a new operating loan, Boehlje said.

“Probably the most important thing that a farmer can do to protect their working capital is to make sure that they don’t make any capital expenditures out of current cash,” he said. “The quickest way to destroy working capital is to say, ‘Well, I sold some grain and put some cash in the bank, but I do need to replace that tractor.’ Or, ‘I need to buy a new planter, and I’ll just use that cash to do that, and not pay down on my operating line.’

“Be really careful about destroying your working capital position. Lenders are going to be asking more and more questions about that this year.”

Boehlje said farmers should keep a few other things in mind when meeting with lenders:

Covenants – Lenders could place more restrictions or covenants on farm borrowers in 2010. A covenant is a set of conditions under which the borrower must comply and spells out the consequences for violating those conditions.

“A common covenant is a limit on capital expenditures without prior approval,” Boehlje said. “The purpose is to make sure that cash that could be used for debt servicing or buying operating inputs is not diverted to capital expenditures that do not directly contribute to the cash flow of the operation.”

Liquidating assets – While usually a smart strategy for paying down debt, selling less productive assets can result in an unintended taxable gain. “Farmers should visit with their tax accountant before liquidating any assets and using the proceeds for debt reduction,” Boehlje said.

Farm Service Agency (FSA) loan guarantees – “In some cases you and your lender may find that a FSA loan guarantee is needed to support the financing request,” Boehlje said. “If that is perceived to be a possibility, it is critical to move quickly to start the process and get the application submitted. Many commercial lenders are positioned to facilitate guaranteed loan applications and you don’t necessarily have to go to FSA to apply.”

Additional loan renewal tips are available in Boehlje’s white paper, “The Loan Renewal Season: Your Lender’s Concerns.” It is available online at

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