aving debt, repayment, and loan terms tied directly to the asset being financed is prudent for you and your lender.
Short-term loans for feed, seed, chemicals, fertilizers and feeder livestock should be treated as current operating expenses. These are self-liquidating loans (normally with terms of one-year, or less) because they are directly related to current production and are used up in the production of specified products. They should be repaid when the product they produce is sold.
Intermediate-term loans that finance machinery and breeding livestock (assets with a productive life extending over a number of years) normally have five to seven-year terms. Depreciation on this class of assets varies yearly and the expected life is uncertain, so it is a sound business practice to retire the debt on these assets before the useful life of the asset is expended. Planning accordingly will improve your chances for success.
Long-term loans for facilities, including buildings with productive lives of 10 to 20 years, and land can have longer repayment periods of 10, 15, 20 or even 30 years. However, because of the possibility of obsolescence or unforeseen loss, it is sound policy to have repayment at less than the expected useful life. In fact, many lending agencies finance only for a fraction of the useful life expectancy.
Actual Example:
We recently had an applicant who wanted to refinance an existing three-house poultry unit, plus construct one additional poultry house. The applicant wanted a 13-year term, fully amortized on the existing/new poultry house construction.
Their current lender had the three poultry houses structured on a 12-year amortization, or payback, but the loan had a three-year term and interest pricing period. The applicant’s existing $700K loan is coming due in January 2012.
Existing lender’s proposal:
1. 13-year amortization
2. 3-year interest rate of 6 percent
3. 3-year term with loan maturing in 2014
4. The loan officer offered to put a note in the borrower’s file indicating that in 2014 the rate should not renew at more than 6 percent, but the loan officer can not guarantee that the bank will be able to keep that promise in 2014.
There’s another question to consider, as well. What would the applicant do in January if their current lender opted not to renew the loan? Or if their lender decided they weren’t making poultry loans anymore? Or their lender decides to charge higher interest rates because of perceived industry and/or contract risk?
Farm Credit’s solution:
1. 13-year terms, fully amortized with loan maturity in 2024
2. A 13-year fixed rate locked for the entire 13-year period at 5.90 percent
This solution properly structures this borrower’s debt. Terms are based on the useful life of the asset and the borrower has the capacity to repay the loan well within the term.
Aaron Watson a Senior Credit Analyst for Farm Credit of Western Arkansas.
