Financial publications such as the Wall Street Journal have been running articles on rising distress among agricultural producers. Many turnaround professions, particularly those in the Midwest, have seen an uptick in the number of farm bankruptcies and foreclosures. While it does not appear this cycle will be as bad as the late 1980s farm crisis, a number of factors have come together that indicate producers could be in for a prolonged downturn.
The typical agricultural producer usually funds operations on an annual basis with loans from lenders. These loans are often used to pay input costs, such as seed, fertilizer, and other chemicals, and ground rent, labor, and other annual operating expenses. Given the growing season, many of these loans are secured in the late winter or spring. The producer may also have longer-term loans to cover land or equipment purchases. Many times, some or all of the equipment may be financed or leased by lending arms of equipment manufacturers.
By and large, producers seem to have managed to continue operations so far because lenders have been willing to provide working capital loans to them each year, even in the face of prior year(s’) losses. But when the lender says it will not renew or provide new working capital, many producers do not know what to do.
While each loan workout is unique, with its own set of facts and circumstances, professionals advising producers should focus on a few core considerations to deal effectively with the lender when negotiating over a problem loan or when working with their clients. They include:
Understanding the problem from the lender’s perspective. Many lenders, such as commercial banks, are highly regulated in terms of their lending capacity and requirements. Banks are subject to regular audits by state or federal regulators who review the bank’s loans to make sure they do not pose an undue risk.
In addition, lenders are in the business of loaning money and making money on those loans—not foreclosing on collateral. Thus, having adequate collateral for a loan does not automatically mean the lender will continue to lend. The lender must be convinced there is a reasonable capacity to pay the loan back as well.
Clients who have had long-term lending relationships often do not understand why the lender is suddenly changing the terms of the lending relationship or even worse, cutting them off from additional loans. Clients need to be counseled on what to expect when a commercial bank is facing what it considers a problem loan.
Understanding the producer’s situation. Professionals advising the producer need to understand the facts of the lending relationship and the producer’s operations. How has the producer performed in the past compared to past operating projections? Is it time to get updated land or equipment appraisals? Is land being leased at current market prices, and what are the trends? Are there any special government programs or benefits available to the producer? Are there any problems in the financial reporting to the lender, such as faulty or incomplete record-keeping? If the trend line has been to lose money in the last several years, what can be changed in the operations to turn that around? What noncritical assets may be sold?
In addition, the lending documents should be examined to determine what collateral the lender has a lien on and whether there are any technical defects in the lien perfection. Reviewing lending documents is useful for understanding loan maturities, default provisions, and the timing and type of remedies the lender may exercise.
Understanding and analyzing legal options and negotiating tactics. Not all borrowers with defaulted loans should file a bankruptcy case. But understanding whether bankruptcy is a viable option is crucial for the professional and client to know while negotiating alternatives to a defaulted loan.
For example, bankruptcy might be a credible concern for the lender if there is a possibility of the lender being crammed down in a bankruptcy reorganization plan—that is, having its debt termed out over a period of time. Moreover, under certain circumstances, a bankruptcy filing may allow for the producer to suspend interim debt payments to the lender or other secured creditors, allow access to cash to continue to operate, and suspend, at least for some time, payments to equipment lessors.
These and other implications of a potential bankruptcy filing may provide a producer and its advisors a baseline from which to negotiate. In addition, many states with significant agriculture sectors have special protections for producers that provide alternatives to foreclosure or bankruptcy, such as mandatory mediation provisions or special rights of redemption from foreclosure sales. (Many of these laws were enacted as a result of the 1980s farm crisis).
Understanding how these remedies and procedures affect the lender’s ability to foreclose on collateral is important for any negotiation to restructure the loan with the lender. Moreover, understanding the tax consequences of asset dispositions from voluntary sales or foreclosure sales is critical to coming up with solutions or at least not exacerbating the problem unknowingly. At times, these tax considerations may provide sources of financial review such as tax refunds that may be obtained by carrying back current year losses to prior tax years.
Presenting a realistic plan to the lender. Many lenders are conservative and risk-averse by nature. These characteristics are exacerbated when a borrower is in trouble. In addition, when a loan becomes troubled a new bank officer, such as someone from the special assets group who has no prior relationship with the borrower, may become involved in the matter. Therefore, any plan a producer presents to the lender must be credible and realistic.
Consider steps that may be difficult to take but will be meaningful to the lender, such as liquidating excess equipment or selling some land, and using the proceeds to pay down debt. Are credit enhancements such as guarantees from third parties or cash infusions available? Could some lifestyle changes be made? (These usually do not have a big financial impact but can be symbolically important to the lender). Is it possible to obtain credit terms with input suppliers that could reduce the amount of cash needed from the lender to fund operations for the upcoming year?
Once an agreement is reached with the lender, it must be reduced to writing and signed by the lender to be enforced. Any written agreement must reflect all terms agreed upon, especially if the lender is agreeing to act or not to act by committing to make new loans or forbearing from remedies. Under the laws of many states, a verbal agreement with a lender is unenforceable (subject to certain equitable exceptions). Therefore, get the agreement in writing signed by the parties.