CHICAGO -- If you think banking will return to normal after Wall Street's 2008 financial panic, think again. The experience has been "a life-altering event for lenders and borrowers, and no one has escaped impact," Steve Hofing, managing partner in Centrec Consulting, advised a group of farmers last month. "I don't want to sound melodramatic, but this is as close to the Great Depression as someone our age could get."
The near collapse of Wall Street's money pipelines last September caused credit markets to freeze, regulators to rethink their roles and lenders to reform loose lending habits. All of this bodes major change ahead for time-honored business and credit practices, Hofing and other experts warn.
NO MORE BLANK CHECKS
Take the chilling experience of commercial cotton traders during a 10-day period in early March, 2008, when markets hit record highs and they were faced with an estimated $1.8 billion in margin calls that in many cases they couldn't meet.
One large trader had a line of credit shared by a team of lenders, since not a single one of them wanted the risk to finance such as sizable account. The trader enjoyed a net worth of at least $50 million, but successive margin calls of $100 million over several days consumed the borrower's credit lines. Some of the lenders in the club balked at granting the additional credit needed to keep the account fully hedged. Despite support from most of his bankers, the trader not only lost his position in the market, he lost much of his net worth.
The scale of the deal may seem large to farmers, but the principle is the same no matter what the size. Participation loans are a common practice in agriculture, since farmers can easily outgrow their country bank's legal lending authority. The problem is that agricultural market conditions can move too fast for a consortium of lenders to approve participation loans.
That velocity makes it critical for farmers to know all their lenders and make sure they understand agriculture, says Ken McCorkle, executive vice president of Wells Fargo's $26 billion agriculture and food portfolio. Combining the new volatility in commodities with more cautious credit trends may not mix well, he stresses.
MORE CAPITAL RESERVES
McCorkle speaks with particular authority on the topic, since Wells Fargo holds a sizable number of dairy loans and more retail farm loans than any other commercial bank in the U.S. Giants like Bank of America, Bank of the West and Rabobank trail Wells Fargo's market share by large margins in the farmer lending category.
One problematic area for farm lenders is their customers' capital levels, McCorkle says.
"Given today's industry volatility, the grain industry hasn't salted away as much working capital as it may need. In the past, they didn't have to because they had a narrower risk profile compared to other sectors, thanks to tools such as crop insurance and farm programs. But in the last year, we've seen swings in energy, fertilizer and commodity volatility that has changed that risk considerably."
McCorckle recommends borrowers perform the same stress test on their operations that banks do when assessing their loans. Assume a worst-case revenue scenario -- something with a one in 20 chance of occurrence -- and see how long it takes to deplete working capital and net worth if income stayed at that level.
If the results shock your system, think about deleveraging or at least taking full advantage of risk protection tools, such as the farm bill's Average Crop Revenue Election or crop insurance, he adds.
MORE PREMIUMS FOR RISK
Lenders aren't just treating ag borrowers more cautiously post-2008. "Our industry went into this financial crisis not pricing loans properly for risk," says McCorkle.
Some lenders treated everybody like they were a Grade A credit, he adds. "Banks acted as if housing prices would never come down. Since everyone in the system -- from mortgage brokers to marketers of the mortgage-backed securities -- were profiting, normal lending discipline suffered. During good times, things got too loose." Now lenders are correcting those oversights and differentiating for risk by charging those borrowers a higher spread.
Jay Penick, CEO of Northwest Farm Credit Services, based in Spokane, Wash., echoes the concern. Ag's profitability has deteriorated significantly in the past year, particularly in dairy and timber, he says. Given commodity outlooks, "the next 18 to 24 months will stress all farm operations," Penick adds. "The only reason the grain industry has fared so well up to now is because of crop revenue insurance, but as prices drop, the value of that coverage will change quite a bit."
The Farm Credit lender also tells farmers to expect larger interest rate premiums if they are high-risk customers. "As loans are renewed, the spreads on what you pay will widen," says Penick. "No one feels it now" because interest rates are the lowest in a lifetime, "but indexes and spreads are being put in place" that will add to the cost of borrowing money over time.
The real shock might be delayed until the economy recovers, and the Federal Reserve needs to ward off inflation or raise rates to prevent an exodus of foreign investors. In the next three to five years, Wells Fargo economists expect prime rates to jump from today's 3.25 percent to a more normal 8 percent to 11 percent. It wouldn't be unrealistic to see rates on farmland mortgages hit 9 to 10 percent again, other ag economists estimate.
Locking in attractive long-term rates might help now, but farmers' best defense is to make sure they have enough capital to weather a storm, says McCorkle. "It's not a good time to be leveraged."
