Getting Through Your Next Loan Renewal

May 2010 Issue

Published by John Ellsworth,

© Success Strategies, Inc.

This is the season when many annual loan renewals are completed in the dairy industry. Hence, it can tend to be a period of added anxiety for many producers, especially given the difficulties of the past 18 months. As if the woes of the industry and the additional debt load that many producers are carrying are not enough, most banks are under tremendous scrutiny from auditors and other regulators both inside and outside of the bank. Their anxiety can lead to terms that one might consider unusual. Some examples that come to mind include the following:


1.)    New or increased levels of loan fees.

2.)    A requirement for added collateral to secure loans or lines of credit.

3.)    Additional loan covenants required.

Of course, these items are all occurring at the same time that there are fewer banks available for you to move your loans to. Part of this stems directly from the large losses that producers took in 2009. As a result, if they added your loans to their portfolio, they would have to place a fairly low grade on it (by federal banking standards). This would require them to set aside larger loan loss reserves and/or having to charge you higher interest rates than they might normally expect.

In spite of all the current challenges in the industry, there are some items that you can complete that will help you better prepare for the renewal process. However, before we go through those items in greater detail, keep in mind that the loan approval process has become more complicated than ever. This is primarily due to the overall financial crisis we encountered in late 2008 worldwide, combined with the federal bailout of many lending institutions that followed, and the dramatic 30% drop in milk prices during 2009.

Steps to take to improve your renewal process:

Throughout this process, everything you do should be designed to increase the confidence levels of your lender, that is to boost his or her belief that making you the necessary loan is the right step for the bank to take. The minimum steps that you should take include the following:

  1. Collect your CPA prepared financial statements and make certain that they are as up to date as possible. These will provide your loan officer with a number of vital items.
    1. It will clearly show the profitability of your operation, not just last year, but for the past three years, at a minimum.
    2. It will demonstrate what type of herd growth you have experienced in the past.
    3. If the financial statement is prepared by one of the leading dairy CPA firms, it will show the production levels you have actually achieved.
    4. It will also show the trends in the amount of debt you are carrying.
    5. Finally, it will show your overall equity position, which is of particular interest to all bankers these days. This will help him calculate your “Burn Rate.” This is the amount of time that it will take to use up all of your equity if we enter a period of extended low milk prices.
  2. Your financial statement should be based, in part, on the Inventory Reports you have submitted to both your banker and your accountant. It should include:
    1. How many cows, heifers and bulls you own.
    2. What types and amounts of roughages you have on your farm.
    3. How much grain do you have stored at your dairy?
    4. Do you have any prepaid credits with feed companies or other suppliers?
    5. On the acreage you have, what are the number of acres you have, what crops are they planted to and what is the estimated current investment in crops?
  3. At a minimum, you should provide your banker a detailed 12-month Cash Flow Projection that shows:
    1. All projected revenue sources and how much each of them will amount to.
    2. A line by line projection of what your monthly expenses will be.
    3. You will also want to estimate your Owners’ Draws or what you will need to live on each month.
    4. Finally, be sure to include what you expect to be paying for loan interest to your bank and others, as well as what you believe will be required for principal repayment on each of your loans.
    5. The combination of all these items will lead you to your Net Cash Flow.
  4. Your bank may also require you to submit your business and/or personal tax returns, even if you submit CPA Reviewed Financials.
  5. They will also want a detailed plan for at least the next 12 months that show:
    1. What your expected rate of business growth will be.
    2. What your needs may be for added capital, either from your own personal sources or from lenders.
    3. If you need financing, will it come from your bank, your local farm credit office or from other sources? This is an important item to think about because if you run short on funding part way through the year, it can put a real damper on the completion of your plans and the expected increase in profitability. This would clearly be detrimental. Additionally, you will likely want to provide your banker with a Best Case, Worst Case, and Most Likely Case Scenario to show him or her exactly what the potential outcomes may be regarding your plan for the next 12 months and beyond.

What to do if you cannot convince the bank to go forward?

  1. First, consider what needs to be altered. Why not ask your lender what he feels would make the bank more comfortable with your loan proposal. Are there specific actions that they would like to see? The primary reason that I like to ask their opinion is that I want them to commit to some points. Otherwise, you can get trapped in what I would describe as a “moving target” situation. In this, it will not matter what you do. They still will be unhappy.
  2. Once you decide what changes need to occur, develop your strategic plan, i.e. the steps you need to take to ensure your success. In what order will these steps need to be carried out?
  3. Again, this is why you have professional advisors on board. Use the expertise that they each have in their respective areas to see if the changes you are proposing make sense from a management and operational standpoint.
  4. Ultimately, be certain that you are pleased with the new financing plan. If not, consider some other possible sources of funding. It may be a different bank or, in some cases, it may be alternative financing from a manufacturer or another selling party.

Financial Tips for Success

Again, you should have completed your 3/31/10 Herd & Feed Inventory position report. It is helpful to set a date to complete each of the Inventories that are required quarterly. If you need a format for your Inventory Position Report, simply go our “Membership Area Files” on the “Success Tools” page to download an Excel file located there for such purposes. Why? This may sound repetitious. However, I believe it is worthy of being reviewed again.

a.)    Remember, your bank likely requires you to provide them with just such a position report. If not, they should. Regardless, giving them one will keep them and their auditors out of trouble by showing that you are in compliance in terms of Loan to Values ((e.g. Less than 65% on Herd and Less than 100% on Feed).

b.)    Your CPA will, undoubtedly, need this same information to complete your year end Financial Statements. It is necessary for him or her to have these numbers to generate an accrual set of statements. There is no other way!

c.)    Finally, you should also be interested in this information, because it tells you a lot about how you are running your business. If you have a higher feed loan balance than what you have in inventory, it shows that you are probably not cash flowing. If your cash flow is short (as it has been for most dairymen in 2009), you need to find the extra dollars needed somewhere. The only two sources I know of include a personal cash injection from you or a good friend or a draw on your feed line of credit. Of course, for most of us, this is the more likely source of funds. Thus, as you use up your feed inventory, and particularly if you can’t replenish it with new feed, your LTV % will start to exceed 100%. The best way to avoid this calamity is to always manage your LTV very closely. If you measure it often, you will be in a better position to facilitate this.

Management Team Meetings (MTM) Future Topics:

As a regular part of our discussion on Management Team Meetings, I suggest that you include the following items at every meeting:

1.)    Herd Management Issues

2.)    Herd Health Update & Concerns

3.)    Herd Reproductive Performance

4.)    Nutrition Update

5.)    Financial Review, including what is happening within the dairy industry.

6.)    Ask your Management Team for their opinions of your overall operation before you meet with your banker to complete your annual renewal of your lines of credit for 2010-2011. Remember, they see many other dairy businesses and can clearly point out what you are doing well and also the areas within which you can improve. That is their primary reason for being there – to assist you to become a better operator with greater profitability. As I stated last month, all lenders will be under closer scrutiny from bank regulators going forward. Be sure you are prepared to explain why it makes perfect sense for your loan officer to complete your renewal this year. Clearly outline your step-by-step “Success Plan.”

Monthly Reminders – W.I.N.

(What’s Important Now?)

Are there any significant challenges that you are currently facing as you approach your annual loan renewal? Can your Management Team assist you with them and/or help you to find solutions? If so, be certain to include it in your MTM list of topics.

Finally, given the greater levels of volatility on all dairy prices these past several years, expect most lenders to be interested in hearing what you have done to ensure that your profit margin is positive. Sometimes, we can develop a false sense of security when temporary price spikes occur. In spite of what milk prices are currently doing, you still want to focus on your overall margin, i.e. what is left at the bottom line when all your expenses are paid. That margin is what matters more than anything else, including how high per cwt your milk price was. Next month, I will spend more time on how you can use Milk Options to deliver a stronger margin in your business.

Every suggestion in this issue of The Business Confidence MaximizerTM is intended to keep you on the leading edge of your financial relationships. Remember, stay ahead of the game and deal with any new hurdles you may face. Always focus on your overall margin and the plan that will get you to the finish line.

“Yesterday’s answer has nothing to do with today’s problem.”

Bill Gates, Cofounder of Microsoft Corporation