By: Robert Viering, Senior Consultant & Lending Department Manager
In our loan review practice we have seen an overall deterioration in farm financial results. However, we have noted that there are borrowers that are still providing reasonable returns and acceptable debt service coverage ratios. Our anecdotal observations have been confirmed by data from farm financial databases from farms in the Midwest. In his blog post in the December 19, 2017 Corn + Soybean Digest, Dr. David Kohl observed, “Regardless of farm size or enterprise, the gap between the top one-third of economic performers and the bottom one-third is widening. Among the most profitable, common practices include strong production, a drive towards efficiency, and an executed marketing and risk management.” My interpretation of his comment can be simplified to: Management skills count.
In our loan review client banks, management skills may be a part of the bank’s risk rating model, but how management skills are determined varies widely. All too often most borrowers are rated as having good management skills even if their financial results put them in the bottom third of financial performance. Based on my 30+ years as a banker and now as a loan review professional, management skills are what separates the top and bottom producers. The question becomes, how do we assess the management skills of our borrowers? While there are no hard and fast rules, there are several attributes that can often help in making an assessment of management skills.
The following are items to consider when assessing management skills:
- Production competency. On the production side, you will want to honestly assess how their level of production compares to others with similar operations. As an example, if they are consistently producing more bushels of corn per acre than similar farms in your market, then their skills should be rated higher than an operation with more variable results or certainly better than those that are consistently below their peers. You will want to consider if their equipment line/livestock production facilities are appropriate for the scale and sophistication of their operation.
- Financial competency. Questions for you to consider to determine financial competency include: Are you provided accurate, thorough, and timely financial information? Are the cash-flow projections reasonable and based on sound assumptions (you will need to back test borrower’s cash flows to actual results to assess this attribute)? Does the producer understand the financial implications of their decisions?
- Risk management. Risk management is about protecting what you have and limiting your downside. Among the items to assess include whether they are carrying adequate crop insurance. This can include whether they can cover the difference between what insurance pays and what they expected to produce. Other questions that are important to consider include: Does the borrower have a marketing plan? Do they make good use of hedging strategies? A good marketing plan can help pick up some additional income while limiting the downside of market volatility.
- Intangible skills. There are a few other items that should be considered that are difficult to quantify but are important to consider. Among the items to ask are: Are they willing to make tough decisions? This is often about expenses and includes the ability to reduce family living, reduce labor costs (even if it means a family member may have to leave the operation), or any other decisions that may not be popular or easy but may be required to succeed. Do they have a long-term vision of where they want to go? Even if they are not considering doing anything different, that is still a strategy that has its risks. Are they realistic in their understanding of their operation’s strengths and weaknesses? Are they open to taking advice from outside experts to improve their operation? Do they have any trusted advisors that they use? If applicable, do they have a plan to transition to the next generation? If so, do they have an understanding of the next generation’s strengths/weaknesses and the risks in their transition plan?
Agriculture is like all other types of business: good management is critical to long-term success and especially to getting through more challenging times like today. As a bank, having a good understanding of the borrower’s management skills is an important aspect of knowing the level of risk in a borrower. We encourage banks to make a thorough assessment of a farm operator’s management skills, especially today as management skills can often be the difference between long-term success and just surviving, or even the difference between just surviving and having to quit farming.
For more information on this article, contact Bob Viering at [email protected] or 1.800.525.9775.