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Is it time to consider a debt restructure?

Erica Louder for Progressive Forage Published on 30 January 2019
Debt restructure

In an earlier edition of Progressive Forage, we featured an article that compared a football team to the basics of farm finance. In that analogy, the safety position on a football team was compared to your farm’s equity.

On a football team, the safety is the “final line of defense.” On a farm, your equity is the “final line of defense.” In this article, we will explore what happens when you need to rely on your farm’s equity for loan repayment and to provide liquidity. We will explore the ins and outs of a debt restructure and how to utilize this strategy when times are tough.

State of the farm economy

In 2013, Dr. Chad Hart, associate professor of economics at Iowa State University said, “Agricultural returns tend to be cyclical in nature; a few years of good returns followed by a few years of negative returns. We should expect some negative years to balance out the recent good run.” The “recent good run” Hart was referring to were the six years of profitability prior to 2013. According to FINBIN (Farm Financial Management Database), farm profitability between the years of 2006 to 2012 was greater than the profitability of the previous 40 years.

As expected after a run like that, the cyclical nature of the industry is playing out. Here at the start of 2019, we are very likely headed into the sixth year of negative farm returns.

You may even see a correlation between the current slump and the farm disaster faced in the 1980s. However, don’t despair. Economists believe there is a reason to be optimistic. Unlike the ’80s, the value of farm ground remains valuable, and most operations came into this downturn with robust balance sheets as they built strong reservoirs during the peak years.

A robust balance sheet can make the difference between a bankruptcy filing and surviving to see the next peak in the market. If cash flow is weak, and you have used up all your working capital, it may be time to turn to your farm’s equity and consider your options to restructure your debt.

Reasons to restructure debt

A debt restructure generally involves taking short-term debt (like carryover on an operating line) or intermediate-term debt (like a three-year equipment note), consolidating those loans, collateralizing with real estate and amortizing the new note over 15 to 20 years. This scenario accomplishes a couple goals. First, by terming out operating line carryover, you are freeing up working capital and have availability to draw on your operating line. Sometimes a restructure may also include an influx of cash into the business.

Second, refinancing intermediate-term debt over a longer term lowers your payments, which lowers your breakeven. By improving your liquidity and lowering your breakeven, you will give yourself some much-needed financial flexibility. Even with these advantages, a debt restructure is not something to consider lightly.

Mark Greenwood, senior vice president at AgStar Financial Services says, “Farmers need to remember that a debt restructure isn’t a free lunch. You will pay more over the full term of the loan through higher interest costs, both from higher rates and paying the notes off slower.” On top of the interest rates, you will also have to contend with the loan fees of that refinance, which can be 1 to 2 percent of the loan amount and often higher.

From a philosophical perspective, you also need to understand that a debt restructure can mean you will continue to pay for “things” long after they have been used up. When you term out an operating line, you will pay for the seed and fertilizer from 2017 over the next 15 to 20 years. The same is true for equipment – you may “pay” for a tractor long after that tractor has been sold or traded in.

Despite these drawbacks, a debt restructure may be just what your operation needs. Before you pursue a restructure strategy with your lender, you need to really dial in to what caused the imbalance of debt, and take some definite steps to correct the tipping scales.

Causes of debt imbalance

Jackie Martinie, vice president and senior credit manager of Farm Credit Illinois says, “Some farm families may find themselves with depleted working capital and may consider debt to increase liquidity. Before approaching a farm lender, they must recognize underlying issues that got them off center and create an action plan so restructure doesn’t cause the farm further financial stress.”

It may be easy to blame poor commodity prices as the reason your balance sheet is upside down with debt. No doubt that is true, but likely there are other factors at play. Before seeking a debt restructure, Martinie advises her customers to:

  1. Cut appropriate expenses, including living expenses.

  2. Review your risk management strategies. She recommends having a consistent marketing plan and if appropriate, purchasing crop insurance.

  3. Evaluate your debt and term levels. She says, ask yourself these questions: Does the life of my assets match the terms of my loan? Are my short assets overleveraged?

No. 3 is where many people get into trouble. Rod Mauszycki, agribusiness and cooperative principal with Clifton Allen Larson says, “During the peak years, many producers attempted to reduce taxes by making significant purchases. They used cash or their operating lines to purchase equipment instead of acquiring intermediate- or long-term loans.” He adds, “Those purchases significantly pressured their working capital.”

As a word of admonition to those operations, Dr. Dave Kohl, professor emeritus at Virginia Tech University, says, “Very few businesses ever fail from paying income taxes.” In both good and bad times, it pays to have a tight handle on capital expenditures, and be cautious before making purchases on the basis of your tax liability.

Martinie says, “Once you have considered these situations and done what you can to remedy the imbalance, you are ready to approach your lender.” When you do approach your lender, be prepared with some possible strategies. Be proactive in the conversation and reassure them of your long-term plan.

Maintain a long-term perspective

In the analogy we began with, the safety position can stop the football from progressing too far up the line, but relying on the safety doesn’t mean you have lost the game. Just as relying on your farm equity doesn’t mean you failed your operation. It simply means there were some setbacks – your cash flow (defensive line) was weak and your working capital (linebackers) ran out.

When considering your farm over the long term, it pays to keep your working capital up, to continually build equity and to keep a positive outlook – agriculture is rarely easy.

Kohl reminds us that, “Good times don’t always last, and bad times don’t always last either. Challenging times give you a chance to refine your business and become a better financial manager. It is important to surround yourself with positive people because you don’t want to be so discouraged you don’t see the opportunities on the horizon.”  end mark

ILLUSTRATION: Illustration by Corey Lewis.

Erica Louder is a freelance writer based in Idaho. Email Erica Louder