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The Collateral Factor in Farm Business Management
This article was printed in the July/August 2010 issue of the Organic Broadcaster, published by the Midwest Organic and Sustainable Education Service.
In previous articles I discussed the first three “C’s” of the “Five C’s of Credit” – Character, Capital, and Capacity. Next we will examine the fourth “C” – Collateral – as it relates to agricultural lending practices and sound farm business management.
Collateral has become an area of particular interest over the past two years as economic turbulence has rocked the banking industry and real estate markets across the country. Closer to home, exceptional volatility in farm input costs, milk prices and feed and grain prices have made commodity price prediction and selection of appropriate price protection much more challenging. When farm businesses endure challenges associated with marketplace volatility, start-up or expansion, or a course change in enterprise mix, collateral becomes a very important component of a loan contract.
Depending on the nature of the business and the volatility of the industry involved, typical loan-to-collateral values can range from 50-100% with most settling in at 65-70% for farm businesses and even non-farm businesses. In essence, the lender has a 30% cushion built in on the pledged assets, allowing for volatility in market valuation of that asset over the life of the loan. As an example, a dairy cow may be worth $2000 at one point in time, and then a year later it may be worth $1200 or vice-versa. The same can be said for most agricultural commodities, farm equipment and even real estate. Asset values can and do fluctuate over time, dependent upon market conditions and the ability to turn a profit. Thus, a lender is likely to require more collateral than the amount of the loan being requested.
Typically, adequate property insurance is required to be in place to cover the value of the assets involved. The lender may request that its name be listed on the farm owner’s property insurance policy to ensure that if something happens to the collateral, a joint discussion will occur about potential replacement of the asset or repayment on the loan. The more perishable the asset, the greater the need for insurance. Thus, cattle, crops and feed involve shorter loan repayment terms and a greater need for property insurance, particularly crop insurance. There are federal sign-up deadlines for most crop insurance policies so be sure you understand what crop insurance coverage you may need and when to sign-up. Again, when in doubt, ask your lender. Also, never sell or significantly modify collateral without first obtaining consent from your lender. Failing to do can be considered an act of loan default. Selling collateral assets typically requires an immediate payment on a loan contract (but not always), so talk to your lender first.
The collateral factor is sometimes the least discussed area at the time of a loan request, but it can be an important area to address, creating greater understanding of the lender’s and the borrower’s expectations and decreasing potential misunderstandings during the life of the loan contract. As always, communication is key in matters involving collateral and any loan contract.
Amber Bennett is Vice President- Farm & Home at Badgerland Financial, serving farmers and rural communities in 33 counties of southern Wisconsin. Amber works with a team of lenders who specialize in serving the unique, financial needs of full-time farmers, part-time farmers, and rural homeowners. She grew up on a dairy and livestock farm in southwestern Wisconsin and has 18 years of agricultural lending experience. She received a Bachelor of Science degree in agricultural economics from U.W. Platteville and an MBA from U.W. Whitewater. For more information, check out www.badgerlandfinancial.com.Return to TOP