Saturday, December 08, 2007

Heartburn behind the desk...

Despite an sector awash in cash, I suspect this upcoming lending season will be treacherous for most ag lenders. Even those borrowers at the top will be working far above old norms, making the normally unimaginative brains of credit scorers ache. Comparisons to past performance may be of less value.

Consider if:
  1. The credit crunch slowly dominoes across the economy, forcing stricter revaluations of assets now in illiquid markets.
  2. The Fed keeps lowering rates to keep the economy from pitch-poling into a deeper waters. (This will encourage refinancing - always a good way to steal a loan, but at lower margins.)
  3. Oil prices meander lower, pressuring ethanol margins even more.
  4. An increased biofuel mandate is passed.
  5. The dollar continues downward pushing [mostly imported] fertilizer even higher.
The question then becomes what combinations of prices and costs in budget projections will you deem an acceptable risk?

Keep in mind too, that consolidation is on fire in the industrial grain sector, and if your horse is less than competitive, you could lose large chunks of portfolio in a hurry by being too conservative. Fewer customers borrowing more is like farmers renting from fewer owners of larger tracts - the increments of success (and failure) are significantly harder to mitigate.

Complicating this even more is the complex government "solution" to the subprime lending mess. If those lending contracts can be abridged later by government whim, how much has lender risk increased on say, farmland loans? How do you price that risk into your products?
On the macroeconomic issues, there is a real chance of a cascading credit crunch in the next few months. Having the federal government arbitrarily rewrite legally binding loan contracts will, if anything, make that problem worse rather than better. It will hurt bank capitalization, plus it will weaken confidence that future loan agreements will be left intact. Uncertainty is the enemy of lending. Further side effects include the savaging of the subprime loan market (currently most subprime loans are being repaid without incident, thus putting deserving borrowers into homes) and seriously curbing floating rate lending in the future. [More]
I think it is wishful thinking to consider ag lending isolated from the larger credit markets. And any resultant change in regulator attitude about lending for assets like real estate will likely be echoed in our loan provisions.

The numbers on my 2008 and 2009 budgets are encouraging but a quantum level larger than last year. The variance of outcomes for different scenarios has never been so wide, despite a stronger financial position that ever before. To be sure, most are happy outcomes, but I have discovered when good news is the forecast, my competitors ramp up the pressure to expand.

I suspect real estate lending will see tightened underwriting, even with land prices screaming upward and cash rents remaining around 5%. (Data on rent is rarely presented accurately IMHO, since old, multi-year contracts - not to mention less-than-truthful operators - skew the averages. It would appear $6000 ground can get close to $300 rent, for example).

In fact, the borrower trait that could weigh most heavily is how strong is his/her control of rented ground. We need longer term rent instruments, but I doubt we will get them until rents start heading downward.

Another perverse view would be that this is the time to consider vendor financing since inputs like seed are inflating wildly and the loan risk would rest with the guys partly responsible for it.

All in all, ag bankers have their work cut out for them.

1 comment:

reedark said...

I was an ag banker in Arkansas (also had Oklahoma customers)for 2/3 of my 35 years in banking; I retired in 1998.
Most of the serious problems in my ag credit experiences were in the mid 80s when PCA and FLB loans became "asset based" loans, not based realisticaly on "cash flow" (which is required to pay debts as agreed).
Farmers and ranchers were my passion; I went to a lot of FFA/4H banquets and bought for our bank at a lot of premium sales.
Fred Reed
Springfield, Ohio 45503