Business lending is an activity that requires thorough training and experience, and in this process, lenders will learn each lending type carries with it a different set of best practices. Simply put, you cannot hold a hotel operator to the same performance measures as say a farmer, rancher, or a car dealership.
Agricultural loans are probably some of the most complicated lending to take-up. The asset conversion cycle for agriculture varies greatly, depending on the operation in question. Winter wheat is planted in the fall and harvested in the spring. Spring wheat is planted in the spring and harvested in the fall. A rancher will have calves birth in the spring and may sell them in the fall. He may not sell all those calves, keeping some back to feed until a heavier weight to sell at a later date, or he may keep some cattle to build his herd.
How are lenders supposed to get their arms around these requests? Communication is key. A good ag loan file will have detailed notes, explaining what each operating draw was for, and what each operator’s plan is going forward. The importance of this cannot be overstated, because an operator may see it in their best interest not to sell their harvest or cattle when you may expect. They may find it beneficial to wait until market conditions improve, or they may have other plans.
When a farmer or rancher has borrowed money to fund their operation, but they delay selling their crops or livestock, they will find themselves in a position of having carryover debt. Unlike other lending types, this is generally permissible. While this may seem unusual, we must consider the nature of the assets and credit administration in agriculture.
Crop inventory does not become obsolete. While its market value is constantly changing, it can be delivered to market years after it has been harvested. Cattle arguably have the same qualities if they are used for breeding, but must be delivered to market after a certain period if they will not be used for breeding. Still, cattle share another important quality with crops, which is they are a liquid asset. For these reasons, it is acceptable if carryover debt exists, so long as regular farm inspections are completed and communication is kept current, demonstrating the assets are still on hand and being appropriately managed.
While not desirable, a producer and his/her lender may find themselves in a position where they have carryover debt, but lack adequate amounts of crops and cattle to pay the debt off immediately. In this case, it is necessary to term out the debt. If fixed assets, like machinery and breeding livestock, are used as collateral, then the debt should probably be termed out between 3-7 years. If farm ground is used as collateral, then mortgage financing could justify terming the debt out 20 years like any mortgage debt.
The key idea is carryover debt should not immediately be classified as substandard credit. If collateral exists and leverage is not out of control, it is simply working capital that needs to be regularly inspected or termed out. Again, this is unique to agriculture. This is not like financing inventory and finding yourself in a situation where the inventory is useless, or like financing a contractor who manages to collect receivables but not payoff his line of credit. The financed assets are different and credit administration is different, indicating a different approach to risk management is necessary.