Hoosier Banker - May June 2017

Agricultural Loans Under Stress What’s A Lender To Do?

Jim Carlberg 2017-04-29 00:49:20

The three-year decline in agriculture commodity prices, particularly in grain prices, has signaled a halt to a decade or more of increasing farm incomes. Farm incomes have been boosted since the early 2000s by steadily increasing production yields and the impact of the federal ethanol mandate. Reports indicate that all of the increase in demand for grain since 2000 has been the result of the ethanol mandate and increased grain imports by China. Ethanol currently consumes 38 percent of the U.S. corn crop. While post ethanol processed cornmeal remains a usable feed stock, it is yet to be determined what the impact on corn prices would be, if in 2021 the 10 percent fuel ethanol mandate is reduced or eliminated. The past three years have seen record or near record U.S. and world grain production, leading to increasing stockpiles of carryover grain. Additionally the 20 percent increase in the world value of the U.S. dollar over the past two years has made U.S. grains more expensive for export purposes. China is now importing grain from other markets. Grain future prices indicate that there will not be significant improvement in grain prices until at least 2019. Grain prices have rarely exceeded the cost of production during the past two years, and it now appears that trend will continue for two additional years. This level of financial stress in the farm community has not been seen since the 1980s, when an extended period of low farm incomes, following years of high crop prices, resulted in: (1) operating losses erasing working capital; (2) continued operating losses, causing increased real estate debt levels when operating loans could not be repaid; and (3) collapsing land values, as low grain prices and low incomes persisted, falling more than 50 percent. As a result, real estate debt levels exceeded land values. Today we are told that this type of decline will not occur again, because lenders have been more conservative about lending against real estate than in the 1980s; however, just as in the ’80s, there is unpaid operating debt being restructured as term debt on real estate. To date, land values have declined 15 percent from peak values, with additional declines expected. Only time will tell if future losses will continue for such an extended period of time that the problems of the ’80 will be revisited. What is a lender to do? Below are proactive steps: Review and audit loan documents – • Confirm loan documents are in proper form and properly executed; • Have a knowledgeable person or attorney review all UCC filings to verify that collateral descriptions and debtor names are correct; • Verify no UCCs have lapsed; • Perfect liens on vehicle titles; • Make sure mortgages reflect proper maturity dates and the amount of debt secured by the mortgages; determine if all loans are properly cross-collateralized. If remedial action needs to be taken with respect to loan documents or collateral, it needs to be completed at the time of this year’s renewal. When the loan becomes a problem next year, it will be too late to obtain the borrower’s cooperation to fix any deficiencies. Loan renewal or forbearance agreement – During the recent commercial real estate recession, lenders quickly utilized forbearance agreements; however, the “renew and watch” attitude that exists in the annual farm loan cycle causes lenders to fail to take the actions to protect the lender that would have occurred as part of a forbearance agreement. These steps include a loan document review and audit mentioned above, cross-collateralizing loans, obtaining additional collateral, obtaining a release of borrower claims against the lender, etc. Issuing proper notifications to buyers of crops and livestock – The UCC and the Federal Food Security Act treat security interests in crops and livestock differently than equipment and other items of collateral. Unless certain steps are taken, the borrower can sell crops and livestock free of the lender’s security interest. That is, the buyer obtains the crops and livestock free of the lender’s liens, unless the lender has provided the buyer with a notification of its security interest and lien. At the request of the lender, borrowers are required to provide the lender with a list of those entities (buyers) to whom the borrower will sell its crops and livestock. Lenders need to obtain a list of buyers of crops and livestock from their borrowers and send appropriate notices to the buyers. (The UCC was modified in 2002. Many lenders have not reviewed and updated forms since the 2002 amendments). If the lender fails to send out these notices, the borrower could obtain crop proceeds and pay all other expenses before it pays the lender. In this circumstance, the lender, rather than being treated as holding a first lien, will only receive whatever is left over after all other creditors are paid. Steps to avoid lender liability – • Have the borrower execute a pre-negotiation agreement, which clarifies that no agreement is reached until it has been reduced to writing; • Make certain that the borrowers understand that the loan officer cannot, on his or her own, make a renewal decision or offer loan terms; • Do not take actions that induce the borrower to put other creditors at risk or take advantage of other creditors; • Provide borrowers with information – let the borrowers make the decisions, and communicate with your borrower early and often; • Be aware that when the borrower has no other good or viable options, the borrower’s next option will be to sue the bank; • Use a forbearance agreement with a release of claims provision. Workout tips – • Communicate, communicate, communicate; • Make sure all owners and spouses are involved in the decision-making process; • Obtain as much information and facts about the operation as possible; • Make certain the borrowers recognize the deficiencies in their operations, and that they take ownership for the losses and deficiencies; • Work “by the numbers” – let the numbers do the talking; do not digress into history or emotional topics; • Make sure the borrowers can prepare their own financial projections, or that they can obtain help in doing so; • Identify what must be changed to make the operation viable – make certain the borrower understands that changes must be made quickly, with drastic reduction in expenses and changes in operations; • Agree on a plan of action; • Provide incentives to the borrower if he or she makes changes and meets projections – examples of incentives include reduced or waived fees and maintained or reduced interest rates; • Make the borrowers track their progress-actual versus projections – have borrowers prepare monthly cash flow statements and monthly reports; • When the borrowers fail to comply with the agreement, enforce the loan agreement requirements immediately; • Recognize borrower’s successes, as well as failures; • Discuss the alternatives if the borrower cannot comply with the workout plan; • Ensure the borrower understands the breakeven prices; • Run alternative price scenarios, so the borrower understands the effect of pricing. Understanding and implementing the steps above can help your bank, and your agribusiness customers, avoid a return to the stress felt during the 1980s. Jim Carlberg Partner Bose McKinney & Evans LLP jcarlberg@boselaw.com

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