Agricultural Lending

Loan Structure

Structure is especially important in agricultural loans and should be based on the purpose for which the loan was made. When structure and purpose are not properly matched and enforced, the effectiveness of bank management’s loan supervision, including the ability to spot performance problems, can be compromised. Poorly structured loans also increase the possibility that proceeds will be used for unintended purposes. These problems might result, for example, when short-term loans for crop production are diverted by the borrower into the purchase of machinery.

Short-term Loans. Most loans for the production of crops and for livestock feeder operations are intended to be self-liquidating at the end of the growing cycle from the proceeds of product sales. Therefore, the maturities of these loans should coincide with the production cycle for the product being financed, usually one year or less. (Note: some agricultural industries such as forestry, orchards, and aquaculture may have production cycles greater than one year and require longer term financing.) As a general rule, all anticipated costs required to take a crop from planting to harvesting (fuel, labor, fertilizer, seeds, etc.) are included in a farmer’s short-term operating line. Unanticipated costs may, however, require additional short-term credit to assure that the product makes it to harvest. One well-known example of this is when heavy spring rains cause seeds to rot in the ground, necessitating a second planting. In such circumstances, the borrower comes under increased pressure to generate sufficient proceeds from the current crop to repay both the original and add-on loans and avoid a “carry over,” work-out situation. In other cases, however, short-term production credit may purposely be carried beyond the current growing cycle to enable the borrower to store or defer sale of products in anticipation of higher market prices.

Long-term Loans. More commonly referred to as “term” loans, this type of farm credit is normally associated with the purchase or development of capital assets, such as real estate, machinery and equipment, breeding herds, and orchards. Final maturities vary, depending on the useful life of the asset financed or collateral pledged, but generally do not exceed 30 years. The primary source of repayment normally is cash flow from operations, with liquidation of collateral viewed only as a contingent, secondary source.

Carry-over Debt. This refers to restructured short-term debt, such as the unpaid portion of an annual operating line, resulting from the borrower’s inability to liquidate the debt as originally planned. It essentially represents a substitute for investment capital. (Further discussion of carry-over debt appears later in this booklet.)

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