Turbulent economic times, particularly in the row crop, grain and specialty crop sectors, often prompt a refinancing request. This involves restructuring operating loans that cannot be repaid and converting them into longer-term payment plans, typically ranging from three to 10 years. Bankers often refer to this as “moving debt down the balance sheet” to the intermediate- or long-term category, with additional collateral, preferably land, often being required.
It is important to recognize that lenders providing this working capital or financial liquidity assistance are also increasing the borrower’s debt service obligations, which raises both the cost of production and breakeven levels. Interest rates that are roughly double those of the COVID-19 era often create sticker shock, as borrowing costs increased significantly in most cases.
In discussions at recent events with lenders and producers, refinancing requests have arisen under a wide variety of circumstances, usually resulting from financial stress. Some borrowers have sought quick and convenient credit through nontraditional lenders that rely heavily on credit scores for approval. However, when they fall behind on payments and are unable to reduce their lines of credit, they often receive the ultimate notice: All payments are due immediately, which creates an urgent and stressful situation.
What lenders expect
What was once easy credit is now transferred to credit administration personnel and, in some cases, special assets departments that are highly numbers oriented. These groups often require substantial financial information and supporting documentation to ensure transparency and fully assess the situation.
Similarly, when requesting restructuring from a traditional lender, expect to provide financial documentation, transparency and a written plan designed to reduce the likelihood of a repeat refinancing request. This is where relationship lenders, with their experience and understanding of the borrower, can provide a valuable bridge during the workout process compared to purely transactional lenders who may have little context for the borrower’s full situation.
Other requests to refinance operating debt are linked to excessive family living expenses or efforts to bail out family members dealing with substance abuse, sports gambling or other gambling issues, or personal family challenges. In these cases, borrowers must demonstrate that these circumstances are nonrecurring and that the business will not be adversely affected in the future through additional withdrawals or a decline in business performance.
A word of caution
A major mistake for producers is purchasing capital assets using operating funds without notifying the lender. After-the-fact refinancing requests are often viewed as a sign of potential character or management concerns and can decrease the likelihood of future financing or result in higher interest rates to compensate for the additional risk.
This winter, a banker shared an example of a 75-year-old producer with considerable land equity who requested refinancing. The banker approved the request because the producer wanted to spend the remainder of his life farming. It is a decision that’s hard to argue against.
However, had this producer been a younger family member, the decision may have been different. Approving the request could have established a poor precedent for financial management and discipline, increasing the risk of similar situations occurring in the future.
Yes, refinancing is very similar to a home equity loan. Each refinancing transaction reduces equity unless accompanied by corrective action and improved financial performance. Over time, repeated refinancing can lead to debt exceeding assets, particularly if an asset value correction occurs, or time simply runs out.