Refinancing the Farm or Ranch

Situation

One of the concerns that has become obvious to many in agriculture is the rapid reduction in working capital the past few months. Operating loans for 2016 may not be paid off after harvest, especially with the rapid decline in grain prices since mid-June 2016. Refinancing or rolling forward the remainder of the operating loan is going to be an option for many farms and ranches. A lender may ask for more collateral to do the roll however or indicate there is enough to cover the additional debt. But rolling operating notes forward is a warning sign for farm and ranch operators. Why?

The incomplete payment of a current operating loan reflects a problem that farmers have experienced during the current growing season, a severe cost price squeeze. Simply rolling the debt to the next year and collateralizing it with machinery or land or cattle does not address the underlying cause. Not addressing the problem can lead to future outstanding operating loans and more debt to carry in the future. The remedy is to address the current cash flow problem.

Cash Flow Shortfall Solutions

There appears to be three cost areas that farmers and ranchers must address. Cash Rent rates are the first to deal with as these are being determined at this time. At least for the medium term, grain prices are not going to increase significantly above current numbers unless some dramatic occurrence takes place, e.g. a drought or a war. So cash rental rates need to match the income reality of the next few years.

Family living draw has increased in farm country since the ethanol boom began in 2006. In Nebraska, farm family living draw, not including taxes, doubled from 2004 to 2013 which was its peak. Since than in each of 2014 and 2015 family living draw declined by 4%. Some family living costs have increased since than which are hard to reduce such as health care and insurance and college costs. But family living will need to decline or added debt will be incurred without additional income.

Crop input costs must also be considered as well. This is the season when suppliers begin to offer pre-payment and booking incentives. How much have those prices declined since last year? Reports I have gathered indicate not much certainly compared to income from corn and soybeans. Farmers will need to indicate to suppliers their unwillingness to pay those prices before input prices are likely to drop. Don’t let emotion drive your input decision either. Products are available claiming better control or availability of an input. Farmers and ranchers should request unbiased research that shows a positive cost-benefit to the use of any input. With that research, they can analyze whether to use and how much of a product to use. Testimonials are not useful to make that cost-benefit analysis.

And then income can also be managed. Have a marketing plan and implement that plan. Of course farmers should not follow it blindly if some new information comes out which changes supply–demand of grains. At that point adjust the marketing plan. Robert Wisner, retired Iowa State University grains economist, related some of his research from more than a decade ago which showed that US corn farmers sold two-thirds of corn at a price less than the marketing year average price. Michael Swanson, Wells Fargo Chief Agricultural Economist, made the same point recently. Minnesota farmers sold the 2015 corn crop 6 cents per bushels less than the Minnesota average corn price. Most likely emotion drove farmers to wait for higher prices and eventually sell at below average prices. Following a marketing plan removes some of the emotion and can lead to more predictable income.

Summary

A proactive approach to managing the current cost-price squeeze dilemma is the way forward to improve sustainability. Farm and ranch managers have some control of the costs and income they can expect from their farm or ranch. Careful cost control, using marginal analysis, in all areas of production must be implemented first to improve cash flow. Marketing plans can have the effect of removing emotion from the selling decision and thus avoiding poor decision-making. Farms and ranches with high leverage are most at risk in the next few years and will need careful management to pull through. After those strategies are implemented, rolling current operating loans forward has a much better chance of being successful.

References:

Schnitkey, G. “The Danger of Refinancing.” farmdoc daily (6):164, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, August 30, 2016.

Swanson, M. “ True Farmers Never Sell a Rally.” https://wholesale.wf.com/food_for_thought/true-farmers-never-sell-a-rally/?contact-type=e&elqTrackId=dcac80eb4e684bc8977eb3b76e2bddad&elq=86e73390d8bc4e2d8c04ac217725a456&elqaid=9465&elqat=1&elqCampaignId=6120, Accessed 1 Sept 2016.

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