Lending relationships: importance, insight, considerations

Narrator: The Ag View Pitch is created by Ag View Solutions to provide value to its clients and farmers like you. We'd like to welcome our new listeners today and encourage you to check out our other podcasts on The Ag View Pitch, which can be found on Apple Podcasts, Anchor, and Podbean. You can also find us on Facebook at Ag View Solutions and online at agviewsolutions.com. Enjoy.

Chris

Barron: Welcome everybody to another episode of the Ag View Pitch, and today we're gonna have a little conversation about ag lending. And we've got a special guest with us today who I've worked with for a long time in ag lending in our own farm operation, and, and somebody with a lot of experience. And so we've got Paul Schrader here with us today who works at Current Brothers Bank in Cedar Rapids, Iowa. So Paul, go ahead and give us a little introduction of yourself and kind of what you're up to this time of year, and then we'll kind of get the conversation kicked off on ag lending going into 2020.

Paul

Schrader: Thank you, Chris. I appreciate the opportunity to have a conversation with you. As you said, I work for Current Brothers. I'm the Director of Ag Banking for the bank, so I have my own portfolio that I work with and then also look at approvals coming through from some other lenders in the bank. So it gives me an opportunity to see some items and some credits both locally and then within our entire organization. So it gives me just a little bit, a little look at a pretty good spectrum of borrowers.

Chris

Barron: Okay, so talk about that, you know, tell us a little bit about when you got started at the bank and kind of what you saw when you started, what's different, you know, what's changed over the years as you've been at the bank, and how long have you been at Current Brothers now?

Paul

Schrader: I've been with Current Brothers for roughly 10 years and worked for another lending institution prior to that. I started in the ag lending field in 2002. You know, it was interesting at that time when we finally saw the prime rates start to move in the last couple years. We went for a long time, most of my banking career, if you will, where the prime rate never really moved. So that was an interesting turn and, and, uh, something new to me, if you will, as, as that started to move.

Chris

Barron: Okay, so, so basically, let's talk a little bit about, um, as we go into 2020 what is it that as farmers we need to really be paying attention to? And we're going to get into the nuts and bolts of some stuff here in a bit too, a little bit more detail. But, you know, just generally let's start with, and then we'll kind of back into this, but we've had some tough years, right? You know, we've had on the crop side of things in particular, but it hasn't been super great for any of the other commodities either. You know, the dairy has been really difficult. You know, livestock's been kind of up and down. Some good times and some bad times, and we've kind of yielded our way out of some issues in the last few years on the grain side of things in a lot of areas. But there's been some areas of some real challenges.

So I guess my question then is, having said all that, what are some of the key things as, you know, somebody that's coming to you, do we need to bring to you and to be talking to you about, and what is it that we need to be preparing for going into 2020?

Paul

Schrader: Yeah, for 2020 and the years in the past and the years going forward, I think that the biggest thing is just to have a quality set of books and the quality set of financials on your own operation. You know, that can be done internally or you can have an external partner work with you and put those together, but just to have a good quality set of books, you know, year-end financial statements, obviously the tax returns, but also internal P&Ls to work towards an accrual income statement.

Now whether that accrual is done internally by the crop year, you know, there are a number of operations that are doing that, but even if you're not to that point, even if we can get year-end balance sheets and the tax returns, we can make some accrual adjustments to do some sort of ag accrual adjustments, if you will, So look at profitability through the operation and not rely on the tax return for a profitability measure.

Chris

Barron: So if I'm understanding you right, a set of quality books would be a good clean accounting system that has for sure cash accounting, but hopefully some accrual accounting along with that, right?

Paul

Schrader: Absolutely. Even if they haven't made that step to the accrual accounting, even if they have a good clean you know, cash income—

Chris

Barron: set of cash books.

Paul

Schrader: Yep, absolutely. And the balance sheets on prior— on the— on both ends of the calendar year or the operating year, we can make some of those adjustments internally and assist them in taking a look at those accrual income and expense and profitability.

Chris

Barron: So you talked about a balance sheet, but talk a little bit to the listeners about the difference between a a tax balance sheet or a cash balance sheet and an accrual balance sheet or a market, quote unquote, market value balance sheet. You know, talk a little bit about that and why that's so important.

Paul

Schrader: Sure. What we have gone to in the bank as a whole within our portfolio is to get— we have a dual column balance sheet that's put together. On the asset side, we've got the market value of those items, and then also a cost value of those items. We do that for a couple of reasons. One, on the— using the cost column and the cost values of those items, which includes that depreciation value, we can get to what we feel like is a more true or net worth year over year over year when you're looking at profitability. The market value statement is also important because obviously, you know, if you have a piece of equipment that you bought 10 years ago, it's fully depreciated out as far as tax-wise, but still has some market value.

So that's important for, you know, when you're looking at collateralizing some loans and just to know what, what those operations have out there in their inventory.

Chris

Barron: It's probably just as important that whatever the procedure is, that that procedure is consistently used from one year to the next, right? Because isn't that an area where we could have some glitches in information if we start analyzing things one way one year and a different way another year?

Paul

Schrader: Absolutely. And we can work with those operations that do things a little differently as long as we know how those are being done. You may have a set of books that you use internally to manage the operation And when those are delivered to the bank, we may look at things just a little bit different. And as long as we know how that's being put together.

Chris

Barron: Which is kind of what we do in our operation. I give you a set of books that don't really match how you want to look at it, but it's how I want to look at it. Absolutely. So as long as we understand each other, that, you know, our set of books is so we can manage our operation and your set of books is so you can manage your operation and that we understand each other's viewpoints and perspectives and how we come up with numbers that may be different, but they're consistent from one year to the next. On both sides of the equation.

Paul

Schrader: Yep. You know, those sets of books that you have internally are used to manage that operation. And our job is not to manage your operation, but to make some credit decisions. Right.

Chris

Barron: And so— To make sure that you're okay with giving us money so you can get paid back, right?

Narrator: That's right.

Chris

Barron: You want to get paid back.

Paul

Schrader: That would be nice. That would be nice. Yeah.

Chris

Barron: So, yes. So I guess talking about that, you know, a lot of times I think we see farmers, and we're gonna get into some trends here in a little bit. We're gonna talk about some trends you're seeing, but I wanna ask this question 'cause I'm thinking about it right now is on the idea of a lease versus a purchase. A lot of times farmers will ask us when we're working with them, should I lease it or should I purchase it or whatever? And a lot of times it kind of really depends on what the equipment dealer or whatever the manufacturer is of an item they're looking at. Is offering for terms, you know? So that's really what drives it. It's not, you know, not really the tax thing or whatever, but from a lending perspective, talk to us a little bit about how you guys view from a lending perspective, a lease versus a purchase, you know?

Because if a grower, let's say, goes out and leases all of their equipment, 100% of their equipment, that's something that's kind of tough for the lending side of the equation because the assets aren't really there, right? So there needs to be cash or some other sort of asset that they're borrowing against, right? So talk to me a little bit about that. I don't know if I'm asking the question right, but what your view is or what you think the lending perspective view is of a lease versus a purchase.

Paul

Schrader: Sure. How those leases should be reflected, you know, going back to that balance sheet, is how they should be reflected on that balance sheet is, you know, if you've got a 3-year lease and the terms on that lease are $25,000 a year, essentially you've got a liability out there for $75,000.

Chris

Barron: For that 3-year period, right? Yep.

Paul

Schrader: And so you would list that as, you know, just similar to a term note on the machinery that you would have for— there's a $75,000 liability out there. And then to offset that means you don't own the piece of equipment. That offsetting asset, if you will, would be listed at $75,000 or whatever the balance is on the debt for that lease. So it doesn't affect the earned net worth. Obviously will have some implications on some ratios, but the net worth isn't affected by that.

Chris

Barron: So if a grower— so I understand this right— so if a grower leased all of their equipment and put it all on the balance sheet, as long as they put the liabilities on one side, they can put the assets, the asset of the value of that machine on the other side.

Paul

Schrader: Yeah, and that, that would be fine, but the value as far as collateral to the bank is different. Yeah, it's basically—

Chris

Barron: so there needs to be collateral in another bucket somewhere is what you're saying for the, for the bank to be comfortable to loan the money.

Paul

Schrader: Yes. Okay. Yeah, and we would just look at that and go, okay, we understand. And, and that's part of that transparency and having an accurate balance sheet, that look, we do have these leases out here of X amount and for X term, and we need to know that, your lender needs to know that. But so it's not incorrectly affecting the balance sheet to go ahead and offset those with the asset. And then when you're looking at the lending or the credit decision is you're basically not including that as collateral for the loan. But there's obviously those payments need to be made. You're obligated to make those payments. And those are liabilities that operations need to take into account and lenders need to take into account.

Chris

Barron: Yeah. And the reason I bring that up, we have a client, actually just talked to him yesterday about this specific topic. He's got an operation. They lease a lot of equipment. And they do because they put so many hours on machines. And so it's a smart business move for their operation to lease their entire fleet, essentially. So then it makes their balance sheet look different than if they were to go out and buy that stuff. But from a business decision, it makes more sense for them to do that leasing because of the amount of utilization that they have. So how would a lender look at that situation or that type of a situation?— and this is a question about debt-to-asset ratio. Yeah. Okay. So what— how do you— do lenders look at debt-to-asset ratio and be comfortable? You know, is there like a hard, fast number? It needs to be 50%, you know, equity, or do you need to have 30% equity?

What's the bottom line there? And, you know, is it cash flow that affects that? Or is it a combination of several things? So talk to us a little bit about how you as a lender look at a balance sheet that, that has some other variables thrown into it like I just described. And it might be a livestock operation too that, you know, it's a startup with a lot of debt, but the cash flow looks strong. Talk about that.

Paul

Schrader: Absolutely. And all those things go into play and as far as making that credit decision. So if you've got you know, a debt-to-asset ratio that's relatively high, yet for whatever reason the cash flow has been strong and looks to continue to be strong, you're going to make a credit decision a little different than if you got high debt-to-asset ratio, highly leveraged operation—

Chris

Barron: and not very good cash flow.

Paul

Schrader: —and not very good cash flow. That's a different discussion. I don't know if there's a specific, you know, this is the number as far as debt-to-asset ratio. I think what, what I've seen over the years, whether it's right or wrong, is when things get to about maybe 60% debt-to-asset ratio, it doesn't take much for things to go bad when things go sideways. And once again, going back to if cash flow has been pretty decent, but generally if cash flow has been strong in the past, it'll probably be that leveraged, right? You know, maybe it's a case where it is a startup and, you know, they do have a lot of debt getting getting capital purchases made for the operation. And—

Chris

Barron: or it's a company that's in growth because that's what we see some of our clients doing. They're in the midst of growth. And when you're growing, it takes a lot of capital, right, for that because those assets are going up and so is your debt. And you got to really watch that equity position as those businesses are growing too.

Paul

Schrader: Yeah, you don't want to just grow for the sake of growth and make more at the building, you know, sort of building that operation. I know it's semantics, but right, growth and build are, you know, it seems like that build has a little different connotation to it than just growth, right? Like you say, we could all go out and borrow to the hilt and have all kinds of stuff, but if it has to return, yeah, absolutely. And we can leverage ourselves to the, to the point where if things go sideways on us, we're done, and nobody wants that, right?

Chris

Barron: So speaking of leverage, let's talk a little bit about refinancing and some of the trends that we've seen over the, you know, since, and I would say from our perspective, and then correct me if you, if you see a different timeline, but, you know, from 2008, things, especially on the row crop side of things, started to get a little bit stronger. You know, not that they, they were really bad before that, they were okay, but You know, we started to see some real strength in 2008 with some commodity price increases and just, you know, more storage being built and some investment in some things that had a pretty decent rate of return like tile, irrigation. A lot of those things were going on to improve the productivity. So then when, you know, we have these years that the potential for good crop is there, we really have a good crop.

I mean, people yell at the USDA because they're saying we were growing We're growing this amount of bushels and in the end, guess what? We are, you know, we're really becoming, you know, high-quality, high, you know, production growers. So as that happens, you know, and the commodity prices are affected, but we've spent money on these things and sometimes we spend them on things with a high rate of return one year, but the next year maybe they're not generating that kind of revenue. So cash flow gets tight. Working capital gets dinged or gets hammered in some cases, and an operation gets to a position where all of a sudden there's very little working capital, there's no working capital, or even worse, there's negative working capital.

Okay, so, and I know you've seen probably all three situations, and so talk to me a little bit about, about that as a whole, kind of some of the things that you've seen from a trend, and then I want to get into talking a little bit about what do we do about it. Sure. So let's, let's hit the trend first that you've seen and then we'll get into what we do about it.

Paul

Schrader: Yeah, I think your timing, your timeline is spot on. You know, in that '13 timeframe, there were a lot of operations that we were seeing that had, you know, working capital that was really strong and current assets that would cover all their debt. You know, even if they had real estate debt, it was at a level that, you know, the values, the yields have been good.

Chris

Barron: And if you were going to get out, that was the time to do it.

Paul

Schrader: That's right. Um, so yeah, you've gone from that sort of level of profitability, if you will, or working capital, to now it's just, it's, it's gone away. And some of those operations really fast, you know, in that '14-'15 time frame. I think it took a lot of operations by surprise when you'd come in and we'd sort of look at the financials and maybe they weren't looking at them as hard as they should have been because the last 4 or 5 years you just sort of walk out the door and kind of make money.

Chris

Barron: You wake up and you're making money. Yeah, you don't have to, you don't have to get really picky on accrual accounting, right? Yeah, that's not nearly as much fun as just going out and producing more. Yep, absolutely.

Paul

Schrader: And so it was a big shock when these operations came in and you'd see, you know, $200,000-$300,000 working capital losses or, you know, 50-60% working capital losses in those years. And— Right. It took a couple of years, I think, for that to really sink into some operations. And I don't know if they didn't trust the numbers or felt like maybe lenders are just being overcautious, as we all are. You know, as a lender, you're, you know, you want to be conservative because the last thing we want to do is sort of ride that operation down the hole. That's not our job and that's not what we want to do. We want to help you guys be profitable and, and if there's an issue, we want to bring that up to see if we can fix that before it becomes a major issue. So the timing on your trends, spot on, I think.

You know, at this point, there have been a number of operations obviously that that needed to do something, and you're back to your restructure conversation.

Chris

Barron: Yeah, that's my next question is now what? You know, so, okay, yeah, our working capital is bleak, you know, and we see that in a lot of operations. I mean, in full disclosure, and you know, I mean, and I'm sure you're seeing that too. It's not that we can't survive through this and work through this. Interest rates aren't that high. I mean, they're all-time low relative to, historical. And so, you know, that, that is a plus. The other thing is we have more technology and more ways to analyze things than we've ever had before. We have more access to help, you know, you know, like us working with people or really going to the lender and saying, okay, help me figure this out. Don't go dark, right? You know, don't, don't not deal with a situation. I mean, you'd rather have us call you even if it's really, really bad than not call you and have a surprise. So, so now what?

You know, we need to think about a restructure. So, you know, do we do that with, you know, with land? If you have land as an asset that's paid for, there's, there's avenues there. There's also avenues of just restructuring, taking several intermediate loans and combining some things and stretching them out a little bit longer or whatever. So talk a little bit about that. You know, what are you seeing as as an answer to now what, you know, what do we do next? If we're in that position where we need to be thinking about how do we improve working capital and then how do we not lose that working capital too? We restructure and we get that working capital in there. That's the hard part, right? It's like, okay, we've reset here. Now how do we, you know, keep that?

Paul

Schrader: Absolutely. So the restructure, I think it's really important to take a look at those restructures on a pro forma basis to see what it looks like after that's going to happen, whether that's, you know, a longer-term machinery note. We move some of that down maybe to the machinery, or we move some of that down to the real estate. And then what does that look like? What's the debt breaker after that's going to take place on the land? What is the debt break— or the, you know, the loan-to-value, if you will, on the machinery? What does that machinery payment do to the cost of that machinery on a per-acre basis or a per-bushel basis. What does that look like? Same on the real estate.

We don't want to go into a restructure and go, "Yeah, you've got all kinds of equity because land values have stayed strong." They're at, you know, maybe not all-time level high levels, but pretty close. I mean, they're really high. So it gives you some flexibility, some capability ability there to secure a loan like that. But at the end of the day, it needs to be repaid. So I don't think it does any good for a lender and a borrower to get together and go, okay, we're going to move this stuff down the balance sheet and put it on some real estate. And at the end of the day, we get all this done and the principal and interest payments are $500 or $600 an acre.

Chris

Barron: They can't cash flow the payments. Yeah.

Paul

Schrader: If you look at that sort of rental equivalent of that, payment, that doesn't make any sense. I mean, no one— well, I wouldn't say no one, but probably wouldn't be wise to go out in this area anyway and rent ground for $500 or $600 an acre. It just wouldn't cash flow and there wouldn't be return there. So why would you do that on the—

Chris

Barron: on your own stuff? On your own stuff.

Paul

Schrader: Right. That's right. Or even the machinery side, if you get to where your— the machinery payments, the debt on the machinery and those payments on a per acre basis gets to a level that just doesn't make any sense. It would make more sense for me to come to you and go, just, I'm just gonna sell my machine and I'm just gonna pay you, you know, whatever the going rate is to custom barn it. And I'd be way further ahead. So at some point, if that, if those losses or that working capital shortage is strong enough and there isn't cash flow to support it, unfortunately it leads to some other tough decisions, which could include selling machinery, selling real estate to sort of right-size that operation.

Chris

Barron: Sometimes downsizing is a growth strategy, which sounds counterproductive, but we've worked with a few operations since 2012 that have downsized and improved their bottom line. Right. You know, just because you're— I always tell people this when I'm doing speaking events, you know, define growth. Does growth mean more acres, more head of cattle? More milk production, what's it mean? You know, well, it might mean profitability if you want to stay doing what you're doing, you know. And so, you know, it's not about the numbers that you're producing, it's about the profit that you're producing or not producing, you know, and that's where the growth comes from.

Paul

Schrader: And I think sometimes before you go into some of those restructures is to really take a hard look at some of those contribution margin from whether it's those farms or, you know, the line of cattle that you have or whatever that is, what's really making you money on those specific farms. And maybe it's time, you know, back to your downsizing. If these farms aren't making money or the bottom, you know, 10% to just call those off, call those out of the operation. You know, obviously there's some other things that are in play there. If it's right next door, though, those things.

Chris

Barron: Right. Talk a little bit. You mentioned contribution margin, and that's something that I think is is something that is tough, you know, if you're going to downsize or if you're going to go a different direction with the operation. You know, a lot of times, you know, you look at a farmer that says, well, I've got 8 farms and 2 of them aren't very profitable, but if I kick those out of the equation, all of a sudden my machinery and equipment cost goes up $20 an acre. That's an example of contribution margin, right? Is there a better way to explain contribution margin from perspective?

Paul

Schrader: A couple of things I was looking at, you know, is if you start out by looking at those farms specifically and what the profit or loss is on those specific farms, and if you do come to that conclusion that, look, the bottom two, you know, if I cut those out, then yeah, my machinery costs go up. There may be some other decisions to be made there. Maybe it is a case of, look, we're going to sort of ride it out here. We know that these aren't the best farms that we have, but in some profitable years You know, how many of the last, how many years out of the last, say, 10 did we make money on them? You know, maybe it's a case of, yeah, we do cut those, and well, now our machinery cost is too high on a per-acre basis. Well, maybe it's time to downsize some machinery too in that scenario.

Chris

Barron: Or if you can afford it, one thing we've seen people do is say, okay, now the longevity of that machinery is better, and so, you know, I was gonna trade that tractor next year, and I was gonna trade that combine the following year. Push that stuff out. Absolutely. You know, so if you can, you know, just continue to chisel on those payments that you have on that existing fleet of equipment, you know, you call those a couple of those farms that maybe aren't as profitable and you just extend the life of that equipment. You're not wearing it out as fast either. So another piece of the equation. The other thing too, back to your restructure, one thing, one plug I want to put in there that we've seen some operations operations do to spread that equipment cost or that labor cost or any of those fixed costs that we have out over more is looking at collaboration as an opportunity.

You know, I mean, you've watched our operation. We've been collaborating since 2009. We've worked with, you know, we're pushing 30 operations now that we're working with that are at various stages of collaboration, you know. There's no one-size-fits-all in collaboration, but if you can form an alliance on, say, a combine and/or some other pieces of equipment that maybe sit in the shed a lot of the time, you know, I mean, you're using an $800,000 asset for 6 weeks, right? You know, so how do you take that $800,000 investment and spread that out over either more time, more acres, or more operations, right? So there's, there's definitely some, some ways to really mitigate cost and yet at the same time have good equipment, do a good job, and not have to run junk, you know, but do it right and, and spread that stuff out.

Paul

Schrader: Um, and that can be a real huge benefit just on the timing thing. You know, we've gone through this the last couple years where those timing, those planting windows, harvest windows seem like they're pretty narrow. Right. So if you have good quality equipment to get in and get out, that could be really beneficial.

Chris

Barron: And that's always one of the questions we get on the collaboration side is, well, how do you decide who plants first and how do you decide, you know, well, you size the equipment appropriately and the math works. I mean, it's a no-brainer when you, you know, you take, you know, even a 48-row planter, You know, look at the cost of that machine. That's a high-dollar machine, but if you can spread it out over more acres or a 24-row or even a 12, you know, whatever it is in your operation, whatever the size of that is that makes it appropriate to spread it out over those acres, you do the math and there's nothing wrong with working with somebody. You know, the only challenge we see there is the people getting along. You know, that's the key thing is making sure that that people can work together and we set that part up right.

The math works on the machinery and on the assets for sure.

Paul

Schrader: And one thing that I see you guys do that not every operation does is I don't think that those machines, the planters, the combines, I don't think they sit around a lot. They don't ever sit around. So whenever it's time to go, they go.

Chris

Barron: Right, right. Yeah. And that's, and that's the, that machinery and equipment utilization efficiency is a whole nother topic, but making sure that the utilization of that stuff is planned out well in advance. And, you know, back to the how do you decide who combines first or who plants first, you know, isn't as important as how do you make sure that everything gets done well. Correct. You know, and correctly. So talk a little bit about some other trends that you've seen in ag that maybe are either a concern or, you know, or an opportunity for us as farmers. So I'm throwing this question at you kind of off the cuff, but, you know, over your years of being an ag lender and watching some farmers do things that maybe don't work or that are working well and some of those trends, talk a little bit about that.

Or is there some things that we can learn from your wisdom as a lender, as farmers, to maybe do different or think differently about.

Paul

Schrader: Sure. Some of those purchases, I know we've talked about capital purchases on the machinery, those items that hopefully have some sort of return to the operation are very important and have been made. Some of those are made in the good years, some on some needs that have been made in the not so good years. But there is also some purchases of some non-returning assets that have been made, you know, homes, you know, boats, RVs, all that sort of those fun toys that are really fun to have. But at the end of the day, you know, if they aren't adding to the operation at some point, if this trend sort of continues, those things, if they haven't been gotten rid of or downsized already, that may need to happen.

That's one thing that I've seen that to just support that sort of off-farm or family living number that has, you know, through those really great years escalated and it's really hard to ratchet that thing back down. And important to do. Sometimes it isn't just the main operator manager in that operation that has to be part of that discussion, but the whole family has to be really, has to be part of that. It's a really important decision and really important to not sort of drag this big wagon on this operation that can't pull it, if you will. So that's one thing that I've seen is just the increase in the family living expenses overall that need to be adjusted and sort of ratcheted back down.

Chris

Barron: That's a tough one. And then I'll let you continue, but I'm going to throw this out is one of the things that I see is there's some advantages to operations that have, you know, healthcare is one of those big ones that I see a lot as a line item expense in a lot of farm operations that either don't have an outside source of coverage, you know, so if a spouse is working, you know, somewhere, teacher, you know, doctor, nurse, something, some other job that brings that healthcare coverage in, gives that operation strategic advantage because those costs are covered and/or other profit centers that are non-ag. And so we've got a few growers we work with that do stuff non-ag off-season. And so those things generate additional revenue and bring in and kind of help support things a little bit too.

But on the cost of living side of things, and I always joke a lot, you know, when, when we look at our cost production, we got to include everything in there, right? You know, so it's everything. It's, you know, it's the machinery, it's the land, it's all of the above. But it's also to your point that cost of living. And that's a real touchy thing because, you know, if you look at a lot of these producers and if they're pulling, say 50 or 80 or whatever the number is that they're pulling off the farm as a cost of living, it's really tough to say to those growers, you need to make less. Well, what do you mean I need to make less? You know, that's one that— so that's one I always really struggle with because they're working their butts off.

And if they can't make it, you know, making that kind of money, maybe there needs to be some other source of revenue coming into the business or whatever. Because it's not that they don't deserve that compensation, they do. Because, you know, if you look at how hard all the clients we work with anyway, and I'm sure it's the same with you. They work their butts off. So they're earning that money. They're earning that, those, whatever it is they buy, you know, but it's, it's a situation of, you know, how do you manage that? Because, you know, in agriculture, the income is up and down, right? It's, it's, it's, it's cyclical. And so it's really hard to be cyclical with your cost of living. You know, it's hard, you know, to communicate that from one year to the next. To a spouse, to your kids, to the rest of your family is a very difficult thing.

So I'm not saying I'm throwing out a solution here. I'm just saying that this is a tough area to have conversations around and to try to figure out. But the one common theme that I see where it's a little easier is, again, you know, if a spouse or somebody in the operation can bring in some healthcare coverages just to kind of offset and take some of that sting off of that cost, side of things and also maybe generated just a little bit extra revenue. So, you know, those things are there. And then, you know, and like I said, when we analyze cost of production, it's, it's looking at everything. And so to your point, you go out and, and you buy a lake house or, you know, or as I say, accidentally bought a boat that we now have a payment on. If that's coming out of the farm operation, that's part of the cost of production. And makes it that much more difficult, to your point.

But, but at the same time, I'm talking out of both sides of my mouth here because, you know, I think, I think we earned it. I think we earn what we take out. I don't, you know, I haven't seen too many operations, especially in the last 5 years, being very excessive in what they're doing. It's just that sometimes maybe there's a few things that were done in, say, '28 through 2012 that could be unwound a little bit. But it's just managing that is a tough call.

Paul

Schrader: And you, you know, you bring up those cycles in ag that we've dealt with and will continue to deal with. I think sometimes as producers in general, especially on the ag side, they don't like debt generally. So when, if they have some cash that they've built up, some working capital, they feel like they should hammer on some long-term debt. And this goes back to working capital discussion that we had earlier is that, you know, they take this cash, you've had a really good year, we're gonna pay a huge chunk on this real estate, and what they've just done is taken this working capital that was a real strength of the operation and depleted it on their own to lower some debt versus—

Chris

Barron: Put it into an equity bucket.

Paul

Schrader: Yeah, keep some cash around so that as we go through these cycles, whether it's that sort of depletion or just, you know, to your point with the cycles and the family living, we have some good years and those are sometimes maybe to save some things so that when we do go through some of those downturns that we don't have to pull back so hard that we have, we've tried to level this thing out within the operation.

Chris

Barron: Next question I have for you is just on from the lending perspective, talk a little bit about some of the key ratios. You know, what are things that you guys are looking at that— and I talked, I kind of started the conversation with that, you know, what are you looking at? But I want to focus on ratios for a minute and say, okay, tell me what you're looking at as a farmer. If I come into you, what ratios are really important to you as a lender? All of them, but you know, which ones are, you know, really key? Sure.

Paul

Schrader: I think that the top of that list is any sort of liquidity ratio or number. You know, cash is king, if you will. We talk about cash flow a lot, but if you look at the working capital of an operation, essentially, if you have a strong working capital, the next 12 months of payments are covered. At the end of the day. So not that the cash flow isn't important, obviously it is, and profitability, but if there's some strong working capital, strong current ratio that's there, or if that working capital to gross revenue number is strong, then you can feel pretty comfortable that, hey, this next year and then maybe the next couple years, there isn't a whole lot to worry about as long as things keep going as they as they are, and there aren't a bunch of other purchases that happen.

Chris

Barron: Explain that current ratio a little bit more in detail on your working capital for the listeners.

Paul

Schrader: Yeah, so just, you know, the total of your current assets over the total of your current liabilities. And, you know, obviously 1:1 is kind of a minimum, if you will. Right. And essentially what that would say is that We have enough current assets on hand, whether it be grain inventory, livestock, cash that we put away. Essentially, we have those current assets sufficient enough to cover all those current liabilities, would be, you know, current lines of credit, the next 12 months of principal payments on any term debt, and the accrued interest. One thing that gets kind of lost in that is the, you know, you may have a payment that's due due in July and we're sitting here at the end of December and the accrued interest is X through today, but we've got 6 more months.

Chris

Barron: You've got accrued interest up to that point.

Paul

Schrader: Yeah, that's gonna, that's gonna come out of that. The other thing that's not included in that, that working capital or current ratio is that family living that we just talked about. If that's the only source of income, is the farm operation or the operation that this balance sheet reflects, you know, we may have $50,000 of sort of family living that needs to come out of this current position as well, because the only source we have for repayment or payment is the sale of this grain or sale of this livestock or the cash we've had, these current assets. That's one item when you're looking at a current ratio or working capital, just the current position or liquidity that gets kind of forgotten in all of it is is some of those draws that come out of there that aren't reflected on the balance sheet as of, say, today.

Chris

Barron: Okay. Any other ratios that stick out that you think are key or those are kind of the top?

Paul

Schrader: I think you start with that and sort of when— if we looked at a new credit coming in, you'd look at, okay, does the— do the current assets or do the— does the grain inventory or livestock, market livestock, Are those current? Is that current inventory sufficient to cover, say, the line that they have outstanding? Mm-hmm. You know, yep, that looks good. You know, is that current, that grain inventory, is that sufficient to cover the current liabilities, you know, essentially the next 12 months? Yep, that looks good. And then you start moving down the line. Obviously, the, you know, the equity position is important because that sort of gives you, one, an idea of what they've done up to this point on the earned net worth. If they've got a very large earned net worth that's sort of increased over the years, it demonstrates that, you know what, they know what they're doing.

They've been profitable because they've built this thing from X to X plus whatever that number is. And if they do have some issues going forward, they do have some capacity, if you will, to move some things down if they need to, to to collateralize some things if they need to. So obviously, you know, the earned net worth and the net worth is important, but I don't think that as a lender you're doing anybody any favors just to lend them money against real estate and sort of be a collateral lender. So then we move on to the, you know, the debt service coverage. Obviously as a lender, that's kind of an important ratio.

Chris

Barron: You want it paid back.

Paul

Schrader: Yeah, we want this thing to demonstrate that it can be repaid and has in the past and what those trends look like. Not on the cash basis, the tax return thing. You know, you can trend them and kind of get an idea where things are headed, but you don't know where that trend started, where they're at in the tax game as far as prepaid, deferred, what that looked like back then. So unless you go all the way back to when they started farming and track it all the way through, the cash numbers don't mean a whole heck of a lot. So if you— but if you make that switch to an accrual, then you can obviously look and go, hey, the last couple years we're profitable. We've got a down year here that maybe they didn't quite get things covered like they wanted. They made some changes in the cash flow.

The projection, if you will, for 2020 looks pretty good, and we've got a debt service that's 1.5 or greater.

Chris

Barron: So what are you seeing in your area then for, you know, how your clients are doing? I mean, are you seeing, seeing some issues crop up some, or are you seeing people kind of hold their own, or are you seeing profitability? What are you seeing trend-wise?

Paul

Schrader: The last couple years have been kind of a— I would say it's stabilized where things have kind of held their own in general, with a few operations being having some profit, you know, we've had some great yields in the area, not all over but in specific areas, some great yields, and some of that grain was marketed at the right time. Mm-hmm.

Chris

Barron: Production, marketing, and cost management, those are kind of 3 key things, right?

Paul

Schrader: Yeah, they're really important, absolutely. So they've had some really good years, you know, between the yields, the good marketing, and then the Market Facilitation Program, you throw those payments on top of that.

Chris

Barron: And some of those operations have had some pretty good years. Yeah. What we've seen with the market facilitation so far going into 2020, finishing up '19, is that number is kind of the margin. Yeah. You know, I mean, it just kind of shows that, you know, if we wouldn't have had that, I think there would have been a lot of operations, you know, that really would have been sucking wind and not doing so good. I want to shift gears here for a bit too on transition. We see a lot of farm operations that contact us and we work with them a little bit on, not a little bit, a lot on say father-son, father-daughter, you know, whatever, going from current generation to the next generation. Sometimes that's been pushed off too long. You know, it should have been done a long time ago.

And so, you know, I think it then continues to get pushed off because it's like, well, I need to do it, and you don't do it, and then I need to do it, and you don't do it. So, I mean, what are you seeing there as far as, you know, is there sufficient transition planning going on, or is there a huge need for that? And what are some of the challenges or things that are working that you see in farms that are transitioning?

Paul

Schrader: I think there is a huge need for the transition guidance, if you will. There's a lot of operations that need to come visit you, okay, and to have those conversations. Your examples of sort of pushing that off is— I see that every day, unfortunately. And as lenders, we need to do a better job of bringing that topic up. I think sometimes we get caught in the, you know, the credit decision and all the financials that are going on with this operation and really sort of looking down at the ground instead of looking out a little longer term. Look at the horizon. Yeah, absolutely. You know, we got to do a little bit of both because we don't want to trip over the wagon tongue if we're looking up too high. Right.

But I think we need to do a better job, lenders in general, myself included, is to have those conversations you know, that look at what's the plan, you know, 10 years from now, 20 years from now, what does this thing look like? And I think that we have had a bit of a downturn. And so the focus has sort of gone away from that, where in general operations are just trying to survive in time in some instances. So they're not even thinking about that. They're just, they're focused on, you know, what can we do to be profitable? Now, right? But that doesn't take away the importance of looking at those— of that transition conversation that needs to take place.

Chris

Barron: Yeah, we see a lot of that with, um, that it's been pushed off and then it gets to the point where it's like, well, I don't know if I can even do anything now, you know? And the other— another thing I want to bring up that we see happen a lot and get your take on this, but we see a lot of times if you've got multiple generations, so you have a multi-generational operation with maybe cousins even, or, or whatever, farming together, and, and mixed machinery and equipment ownership. So you've got dad owns this, son owns that, cousin owns this, the dad's brother, uncle, whatever, owns this piece of equipment. So they all have different stuff, they all kind of work together, and it all kind of works until something happens to somebody, and you find out that whoever it is you're working with isn't who you're working with.

Now all of a sudden you're working with their spouse or you're working with another family member that's connected to that person that was your partner but is really no longer your partner, something happens. The other thing is dad or uncle or whoever, the mature generation decides they're going to transition and go a different direction. And, you know, and then the younger generation starts to figure out what that equipment really costs because they've been getting a break from dad or uncle or grandpa or whoever And you try to help them, but sometimes we see in a— see situations where, you know, the mature generation's trying to help the younger generation, but that help isn't, isn't analyzed or measured. So their cost of production is sort of a pseudo number. You know, their cost is actually more than what they think it is because that equipment isn't free, you know?

And so one of the things that, that really scares me with a lot of these operations that haven't thought through transition yet is putting that equipment all into an equipment company so that everybody that has ownership and equipment can be a percentage of ownership, but then they all pay in so they know exactly what their costs are. Because, um, machinery equipment's the second largest line item expense, and it's the most misunderstood expense of all of the expenses that we deal with. I mean, it's just, it's just a guess, right? So what do you see in that area? Do you have any suggestions or anything that, that growers could, should, or be thinking about doing? Or do you see the same challenge as well?

Paul

Schrader: I do see that challenge in a number of operations, and it's oftentimes it's done so informally that, like you had mentioned, that those examples happen when dad or cousin or brother or whoever steps out or is taken away from the operation for one reason or another and it causes a holy mess. Mm-hmm. So one thing we have talked about, even if it's not going to the point of having the machinery company in the center, is to at least have a little bit more of a formal agreement so that it's clear on who's getting what and what those, you know, who's getting paid for what, what the proceeds are rather than just the barter system.. Right. And at the end of the day, the net number's the same, I think. Mm-hmm.

But I think it's important for those operators that may have a lesser item, if you will, or none, to realize what the cost of those— what the cost of that machinery is and to get a better idea of what those operating costs are.

Chris

Barron: Yeah, and the challenge is just the accounting of that. Yes. It's like, it looks like a nightmare to a lot of people. It's like, oh my gosh, how am I gonna keep track of that. It's easier just to work together, you know. But the consequences of not tracking that information are huge. And one other thing I want to throw out there, and maybe you've seen this too, but is the insurance side of it, you know. So, you know, I always make sure to try to make sure people understand how important it is if you're partnering with somebody, even if they're family, to have the same insurance provider. You have multiple insurance providers and then all of a sudden you have a loss, And the insurance companies are pointing fingers all different directions. Sure. And it really creates an issue. So that's just something I wanted to throw out there. I don't know, maybe you've seen that.

Yeah, that's a great point. Maybe you've seen that too. So I don't know really what else to ask you, Paul, but is there anything else that I haven't talked about from a lending perspective or questions I haven't asked you that you think is important that the listeners think about going into 2020? You know, what should we be doing? Back to the original question, you know, any other, any final comments or anything else that I haven't brought up?

Paul

Schrader: Sure. You know, the general comment I think going into 2020 is there's no magic bullet. If there was, we'd all have it, if you will. So to make sure that you're taking a look at those line items again, you know, line item by line item, and make sure that the, not necessarily just cutting the cost, but that the return on investment is where it needs to be. It doesn't do any good to, you know, back fertilizer off, if you will, and then lose out on the big end. We, you and I have talked before about, you know, sort of yielding yourself out of some problems. And so without that, that goes away. So just make sure that those line items are returning for you, being able to lower those costs when you can. Be conservative in purchases, you know, look at needs versus wants.

We all want the latest and greatest and newest, and there are times when that makes sense when, if you can, you know, in the machinery thing, back to the planter situation, if you can spread that thing out over enough and keep that thing rolling, that return is sufficient to warrant that. But oftentimes I think we look at some wants to get taken care of versus just some needs and right-sizing some operations, right?

Chris

Barron: One thing while I'm thinking of it too, we talked about the balance sheet. I just wanted to bring up because it popped back into my mind, but, um, you know, when you do that market value balance sheet and, you know, we definitely want to make sure, and I think people already know this, but I just want to throw that out there, is that the land is a constant number, right? So on that market and that earned equity number, when you're bringing that stuff forward either have— you have your dual column, you can have your market value, but you need your cost value, which is really should be a number that's not changing. Absolutely.

Paul

Schrader: That cost value or that cost column is what it says, it's at cost. So we bought it 30 years ago for $900 an acre. It's, it's— and that cost column, it's $900 an acre, right, from when it came in. Now the market value today obviously could be tenfold Right. And, but I think it's important to have both of those in there, you know, same with the machinery, same with any other improvements that come into the operation.

Chris

Barron: One thing we do, and you've seen that in ours, but, and we do this with a lot of our clients, but we'll build a constant number. So we'll just select a number in time and then just, that'll be the land value number that carries out over time. And just, and it seems like it's nice to kind of look at the balance sheet from a couple of different perspectives. To your point, the market, you know, to your point, the cost, but also maybe even kind of an average in there. Because if the cost is as low as you said, that might not be as relevant as a normalized price, maybe, especially if the land was bought 30 years ago, you know, normalizing a price and using that as a constant.

Paul

Schrader: Yeah, you'll utilize that cost value within your own operation to look at year over year over year. If you start taking your operation and then comparing it to peers, then it's almost impossible to do that just because, right, it could have been bought 10 years apart. So then you start looking at market value, whether it's market value, equity, you know, solvency, liquidity, all those things. So they sort of serve two different masters, if you will.

Chris

Barron: Another quick question there too. I mean, we're going to wrap this up, but I keep thinking of questions, so we'll just ask. But, um, another one is on the tax side of things. You know, you have taxes that aren't paid. So what's the term for that? I'm trying— I'm not thinking of the term, but, you know, taxes that are bulldozed forward, and that on the balance sheet, you know, you really— if, if that whole operation were liquidated, what what's tax consequence there, you really technically almost need to take that number off of it as an analysis thing on a balance sheet too, don't you?

Paul

Schrader: It can be done. It most oftentimes is not. But yeah, most definitely it needs to be considered.

Chris

Barron: Yeah, because if you have a $10 million balance sheet, net worth balance sheet, but there's $4 million worth of taxes bulldozed forward, you got a $6 million net worth, not a $10 million net worth. So if you've got multiple owners in that, on that balance sheet, that's another thing to consider. You know, if this, if this operation is ever sold, that's the value. It's not what, it's not what we're giving, you know, showing the bank, you know, as the numbers. And that's where I'm wondering if that's taken into account when you start looking at debt service and you know, debt repayment capacity and all that stuff, if that factors into any of that, maybe not.

Paul

Schrader: I think in the— not specifically, and it's not generally listed on the balance sheet, but always needs to be considered as an ongoing concern and where is that operation in its sort of its life, if you will.

Chris

Barron: Right. And, you know—

Paul

Schrader: That comes back to the transition, right? Yes, absolutely, yep. And is it a case where, you know, at some point, we're done and the operation's done and it's being liquidated and then those tax consequences hit. Or is it a case where over some time that operation is going to be transitioned whether, you know, into another family member or to another third party coming in and then that tax liability can be managed a little bit more versus just all of a sudden we're getting hit.

Chris

Barron: Yeah, the tax The tax implications of not planning that versus planning that are massively different. Absolutely. So there's a lot of opportunities out there for people to manage that. I think we're getting to the end. One final question. Anything else that I haven't brought up that you can think of for now? I don't think so.

Paul

Schrader: I appreciate the opportunity, Chris, and I always enjoy our conversations.

Chris

Barron: Yeah, I do too. Appreciate all that you've done and you putting up with me and our operation and dealing with us. Hopefully that relationship continues for a long time to come and appreciate all you've done for our operation and appreciate you taking the time to have a conversation with our listeners. Thanks everybody for listening and we will be back again with some more conversations with lenders as we go through the season and work towards 2020 planning and wrapping up 2019. So again, thanks everybody for listening and we'll catch you next time on the Ag View Pitch.

Narrator: Thanks again for listening, everyone. If you would like to hear more content from Ag View Solutions, listen to our other podcasts such as Dad's Wisdom or our Current Harvest series. Ag View Solutions works as an integral part of operations like yours, side by side for farm profit management, business collaboration and structuring, facilitating industry-leading peer groups, and coaching and consulting tailored to your farm's unique needs. We know that no two farms are the same, and we are here to help make your farm be the best it can be. You can learn more at agviewsolutions.com, email us at agviewpitch@gmail.com, or call Chris Barron at 319-533-5703. We really look forward to talking with you.