Making Long Term Decision on Short Term Factors

Many times in life, we are faced with decisions that will impact us for years or even decades into the future.  In those cases, it is always good to try to “count the cost”, or look at the impact over the long term when making such a decision.  I once knew a man who decided that get to some point in your life when you are ready to marry and whatever woman you are with at that time will be the one you marry.  It sounds like making a life-long decision based upon what is happening in the short term.  It kind of reminds me of a man who fell in love with a lady who was a wonderful singer. He was completely enthralled with her voice, which as like an angel.  They married after a month of whirlwind courtship.  On their wedding night the lady proceeded to take off her makeup, pulled off her wig, and removed her girdle revealing a much different looking lady than what he married.  He looked at her and replied in horror, “For God’s sake woman, SING!”

Lenders can often get into the trap of listening to the credit applicant and looking at his short term situation in making long term financial decisions.  It makes it easy to leverage up a hotel based on the revenue in a hot market without consideration of what happens when normal times return.  While it is truly unknown what will be the new normal in the future, there may be a tendency to leverage up the client based upon today’s revenue without asking if what is going on today would be considered normal.

Many times it is hard to consider what normal is.  A few years ago, some agricultural lenders got into this trap a with grain farmers.  The lenders looked at the current escalating grain prices and considered this would become the new normal for prices in the future.  They then gave credit based upon consideration that these prices would continue and even climb further from where they were at.  Some farms were sold and lent upon at inflated prices.  Other farmers purchased new equipment, storage facilities, and made improvements based upon these high prices.

So what has happened in the past two years?  Corn prices have dropped 50%.  Wheat has fallen as well.  Cool weather and ideal growing conditions have made this a bumper year for some of the grains.  Add in a decrease in supply from some countries like China, who do not like our GMO corn and you have a perfect storm of falling prices.  The price drop will impact the top line of many farmers.  High input costs will erode profits on the bottom line.  This may lead to problem loans that just two years ago were good solid credits.

We may be facing the same issue with the livestock sector.  True, when one looks at supply and demand with the cattle population at its lowest in 60 years, the swine population is down by 5% due to the disease that is impacting the young porkers, and chicken supply is also trailing demand; all factors seem to point to higher prices for the foreseeable future.  But remember, the prices will change at some time.  The herd will eventually increase, pigs get healthier, and supply/demand factors balance out in the poultry arena.  What we don’t know is when.  It would be foolish to load up the rancher on long term debt for the next 20 years on prices that are high today, but may not last the next 5 years.

Using historical averages is a tool to help even out the dips and spikes in revenues and prices of a business.  This may help the lender approach the borrower with a more realistic approach to expected earnings for a company.  Basing a more conservative loan that can be serviced on that revenue stream will help ensure the lender reaches his ultimate goal of having the loan repaid.  Another strategy may be to shorten up the amortization in order to gain more principal reduction quicker in the early years when abnormally high revenues or prices are expected. 

On another note, contact us for more information about our agricultural finance training in Miles City, Montana on October 8-9, 2014.  We look forward to seeing you there.