"A Great Time to Be a Great Banker"

After months of uncertainty, a new trade agreement between the United States, Canada, and Mexico was announced on September 30. The new United States-Mexico-Canada Agreement, or USMCA, replaces the North American Free Trade Agreement (NAFTA). One notable change in the treaty is the end of Canada's Class 7 milk price, which had allowed Canadian producers to sell certain milk ingredients below the price charged by U.S. producers. Since Wisconsin exported $1.45 billion in agricultural goods to Canada and $412 million to Mexico in 2017, the newly minted treaty provides a not-insignificant level of stability to a market that has been in flux for a long time. 

However, looming trade negotiations with Europe and China—the latter of which received $299 million in Wisconsin agricultural exports in 2017, an increase of 27.6 percent over 2016—present a continued risk to all ag-related industries. Wisconsin's ag lenders must stay up-to-date on the trade markets and maintain sound risk management practices if they are to serve their customers well during this difficult period.

Prolonged Uncertainty

While the USMCA brings some stability back into the market, the agriculture industry faces a number of challenges in today's landscape, so producers and lenders should prepare for a period of prolonged uncertainty ahead. "The unfortunate thing is, renegotiation needed to be made, but the timing and how it was done has farmers, agribusiness, and agri-lending in a quandary," said Dr. David Kohl, professor emeritus, agricultural and applied economics at Virginia Tech. "It's hurt our long-term image and trust with some of our major countries that import our products." 

"Because of the uncertainty, pricing is all over the place," explained Jim Holte, President of the Wisconsin Farm Bureau. "Deals can strengthen or weaken prices, and it's difficult for individuals to deal with." The end result is an environment in which it is difficult for producers to be profitable. "It's really impacted margins on the farm," said Brad Guse, senior vice president, BMO Harris Bank, Marshfield. "Margins have gotten thinner. It's harder to manage for profitability right now because of the impact of the tariffs, especially in soybeans and dairy."

Further complicating matters, China appears to be planning a future push to increase its trade with most of Asia and Eastern Europe. "The one thing no one is watching is China's Belt and Road Initiative," Kohl pointed out. China's Belt and Road Initiative (BRI) is arguably President Xi Jinping's most ambitious foreign policy project. Launched in 2013, BRI is a massive infrastructure investment (roughly $150 billion per year) in 68 countries along the ancient Silk Road linking China with Europe. China's stated goal is to "enhance regional connectivity and embrace a brighter future," but the project presents more challenging implications for the West in trade and politics, extending China's influence at the expense of the U.S. While the BRI will be under development for many years before coming to fruition, it is an important future risk for ag-related industries to monitor. 

Manage Risks and Avoid Surprises

Amidst all this uncertainty, risk management is critical for ag lenders and their customers. One primary source of risk is third-party credit. "The agribusiness folks need to keep a close eye on the accounts receivable side," said Guse. "As ag bankers, we need to be aware of those open accounts, how big they are, and whether they're growing. Know who's financing the operating costs on the farm." 

Land values are another significant factor that banks must incorporate into their models. "Any significant decline in land values will impact collateral positions," Kohl warned. "Sensitivity testing for drops in assets is very critical." Another important factor for the bank to stress test is their portfolio's concentration by size of business and by enterprise (dairy, commodity crop, etc.). Knowing which areas are most sensitive to market shifts will help mitigate risk. 

On the farm side, strategic marketing practices can help reduce risk. Marketing your crop in a profitable way (selling lower for a guaranteed amount) "limits your upside, but it also limits your exposure," Holte explained. "You're not eliminating risks. You're managing them." Holte says for most producers, marketing their product effectively is far more difficult than actually producing it. "Milking the cows is the easy part, and marketing the milk is the important and difficult part," he said. "There are many examples of ag producers who recognize that and do it routinely, and they typically weather the storms better."

Another helpful resource for farm producers is the U.S. Small Business Administration (SBA) SCORE program. SCORE provides volunteer experts who work one-on-one with small business owners to offer counseling or advice to farm businesses. "We've found that when businesses use our advising program, generally their business is more likely to survive, hire people, and generate revenue," said Eric Ness, District Director of the US Small Business Administration – Wisconsin District. "It's one more resource that can help." 

Resources for Farmers and Lenders

  • FSA Programs and Services – including information about the Dairy Margin Protection Plan, Farm Bill, and Farm Loan Programs 
  • SBA Lender Matchreferral tool – For any questions related to SBA lending, including getting signed up for Lender Match, contact Ellie Berg, lender relations specialist for Wisconsin, via email or 414-297-1488)
  • SBA Resource Guide details loan programs, export lending programs, SCORE locations, and more 
  • WHEDA Agriculture Guarantee Forms includes CROP and FARM information

Finally, government guarantee programs can help both producers and lenders reduce their risk exposure. "Great bankers know and understand all of the potential credit enhancement tools and deploy them appropriately to manage risk for both the bank and clients," said Guse. "Deployment early is the key." Popular programs include WHEDA's CROP and FARM guarantees, the Farm Service Agency's (FSA) many programs, and SBA loans. "When you're doing a guarantee loan you're able to hedge your risk level a little," said Ness. That doesn't negate the need for prudent lending practices, but it can provide a solution if the bank is nearing its lending limit-the guaranteed portion of SBA loans doesn't count against lending limits. Bankers should work with their customers to determine the most suitable program for their needs. "It makes sense to work through FSA if a local ag lender has an established relationship there, but SBA is another option," said Ness. "Work with who makes sense."

SBA Loan Proceeds for Farm Enterprises May Be Used For:

  • Purchasing land, buildings, and land improvements (fencing, irrigation systems, construction of dykes, silos, barns, hog, and dairy facilities, etc.); Acquisition of land beyond the needs of the farming operation is not an eligible use.
  • Construction, renovation, or improvement (including water systems) of farm buildings other than residences;
  • Purchase of farm machinery and equipment;
  • Purchase of semen and acquisition of animals;
  • Operating expenses directly related to the farming operation, excluding personal or family living expenses;
  • Refinancing of debt directly related to the farming operation, excluding personal or family debt and providing the refinance meets SBA requirements for refinancing

Ultimately, risk management in today's agriculture environment is about avoiding surprises. That requires lenders to take a more proactive approach in monitoring their portfolio.  "You can't monitor customers once per year," said Kohl. "You can't depend on tax records to give you a true estimate of where the customer is at." He cautions bankers to avoid complacency and carefully examine cash flow, working capital, profits, and collateral for their customers' operations. "Just because your defaults aren't up doesn't mean you're in the clear," Kohl warned. "Net worth is fine, but cash flow and profits pay the bills." Especially during tough times, lenders must be diligent about analyzing the information they collect from their customers. "Trust, but verify," Guse advised. "Make sure there are no surprises. Now is not the time for shortcuts."

Communication, Communication, Communication 

The silver lining to today's challenging ag environment is that difficult times are the best times for bankers to develop and solidify their relationships with their clients. "This is a great time to be a great banker," said Guse. "What does a great banker do during tough times? They're in contact with their customers, they're out on the farm, they're aware of what's happening, discussing plans, and giving sound advice."

"Sometimes, unfortunately, that sound advice could be to preserve equity and liquidate," Guse continued. It's important for bankers to understand the emotional impact those conversations will have on their customers. 

"Walking away is very difficult and very personal," said Holte. "It's more than numbers on a balance sheet." For the producer, liquidating often feels like giving up, even if it is the best financial decision for their situation. In these instances, one of the best ways the banker can serve the customer is to help them retain some economic stability and dignity, Holte stressed. "If you wait until every last dollar is gone, it's a mistake by all parties," he said. That requires the lender to take on an advisory role, according to Guse. "Help the client understand that they need to make the decision of when to preserve their equity and how far they're willing to go," he said. However, it is important for liability reasons that the financial plan for the operation belongs to the producer, not the banker. 

Bankers' conversations with their ag customers will be stressful for the foreseeable future, but no matter how unpleasant they are, bankers must have the courage to initiate them. The alternative is to let the customer down. "There's no silver bullet that will fix this," said Holte. "The easy thing is to say 'communicate, communicate, communicate,' but as debilitating as this is for farmers and agri-business, it situates the need for planning and discussion coming up to difficult points." For example, when a payment due date approaches for a borrower who may be struggling, the lender should make sure the loan doesn't need major modifications in order for that payment to happen. "Just talking about it isn't going to fix it, but having a clear understanding on both sides of what the difficulty is and what the options are can reduce the stress level for all parties," Holte concluded.