Throughout the decades I have been involved as an educator in agricultural finance, an all-too-familiar pattern has emerged for large agricultural loans that has suddenly become an issue. Because of the size of these loans—and in some cases, the personalities involved—they often go beyond the agriculture press and are featured in publications such as The Wall Street Journal, and occasionally the internationally acclaimed Financial Times and The Economist. These situations are often used as real-world case studies in conferences, seminars, and schools. Today we will discuss some of the commonalities and red flags that often arise in these situations, offering observations for ag lenders to consider when evaluating similar circumstances.
“Trust but verify” was a slogan used by former President Ronald Reagan. A common issue associated with many large distressed loans is insufficient due diligence. This ranges from transparency in financial statements to inspection of assets and liabilities held as collateral. Lack of emphasis in these areas often occurs during favorable economic times, when market dynamics present advantageous profit and cash flow expectations.
Discrepancies in livestock numbers or grain and produce inventory are a frequent red flag. Perhaps the most deliberate form of deception involves what is commonly called “ghost cattle;” moving the same animals from field to field during inspections to inflate livestock numbers. Others have used deceptive methods to create the appearance of full grain bins, only to discover the corn, soybeans or other commodities were not actually there.
In some instances, the issue lies with lender practices. Inspections were skipped with the explanation that “we were too busy and we trusted the borrower.”
“Cooking the books” has been a common pattern in many of the large loan cases that went south. This will often involve two or three sets of financial records, or assets listed or co-mingled with other owners with no transparency of ownership. Often many entities are developed for tax purposes or government payment maximization. This creates a challenge in following the money and discerning cash flows and can create a nightmare of accountability.
In some instances, one of the partners is not aware of what the other is doing, particularly when one controls the finances. By the time the issues are finally discovered, it’s often difficult for the other parties involved to rectify the situation.
Today, more large customers are using both traditional sources and supplementary private equity funds to finance their businesses. These funds can be quickly diverted to pay expenses, disguising cash flow and profit issues in larger operations. This can manifest rapidly, often compounding into millions of dollars of losses or additional debt service.
In recent years, agricultural operating loans have been used to purchase lake houses, second or third homes, expensive vacations, and other expensive hobbies, such as aircraft, boats, and down payments on other business entities. These diversions typically come to light during forensic audits of distressed cases. These assets in distress are often sold at a sizable discount, sometimes as low as $0.30 on the dollar, leaving the lender with huge shortfalls to cover.
During my career I have seen all sorts of surprising ag trends explode in popularity, including llamas, emus, ostriches, catfish, hemp—even everyday commodities like almonds, wine, and grapes have seen their viral moments. The saying “if it grows too fast, it’s a weed” often holds true. In some cases, the hype and expectations do not meet the reality of the markets, the investment required, or owner expectations. This is where traditional credit and private equity’s high return expectations can set a collision course for the parties involved, resulting in large losses and deterioration of reputation.
Most sustainable business institutions have growth goals. The lure of quick growth, the home runs, along with incentive programs for relationship officers and management teams can increase the potential for credit problems. The complexity of large loan requests with multiple entities and both traditional and nontraditional sources of credit intermixed with private equity can be enticing. Some institutions split portions off to capital markets or loan pools to spread the risk. Sometimes this results in communication challenges, layered with pressures to get the deal done in a competitive environment where owners and investors with strong personalities further increase the risk. After the initial loan is made, limited monitoring and follow-up can contribute to deteriorating loan performance.
Credit analysis plays a big role in examining numbers and maintaining objectivity. However, just as the economic indicators and numbers can be lag indicators, or symptoms of bigger issues, nonfinancial factors such as fraud, divorce, diversion of funds, management or governance challenges can move a credit to financial deterioration faster than the numbers alone. Remember, financial statements and numbers do not necessarily have the answers, but they supply the questions.
One major question that analysts may want to ask is: How does the business make money? The follow-up question is equally important: Are the profits recurring or nonrecurring—in other words a “one-hit wonder”? The skill of the team initiating and monitoring these large credits, and their ability to connect the dots, is a combination of science, the numbers, and art, the human element. That combination is a top priority.
When large agriculture credits go into arrears, there is a tendency for good money to follow bad. This will often arise with the request for working capital or cash to pay expenses and accounts payable. Private investors are often promised high returns of 15-30% and things do not seem to make sense. As the old saying goes, “If it sounds too good to be true, it probably is.”
While the aforementioned list is not all-inclusive, it can serve as a good primer for analyzing not only large credits but credits across all sizes and types of enterprises.
As institutions become larger and more corporate in culture, relying on technology and quick, convenient credit scoring to satisfy return expectations, this could become a bigger issue. In the consolidating agriculture industry, focusing on home runs can lead lenders to strikeouts. A steady string of base hits throughout the game leads to higher credit quality, which equates to sustainability.
The first stop on our global economic assessment is China. China is moving full speed ahead in the manufacturing of automobiles for export markets. For perspective, China exported just under 600,000 vehicles in 2019, according to the research group Mobility Global. This year, that number has increased to 10 million vehicles, a nearly seventeen-fold jump in just a few years.
This dramatic growth has contributed to freight capacity issues globally, resulting in shipping rates increasing by as much as 65%. Much of this growth appears to be suppressing European auto sales in both domestic and export markets. Meanwhile in the U.S., tariffs, sanctions, and other restrictions have limited Chinese auto sales.
Extended electric vehicle (EV) battery life, vehicle affordability, and easy-to-use technology are very appealing to global consumers outside the U.S. and could make China a significant competitive force in the future.
Beyond the auto sector, China's oil reserves, combined with reduced demand for oil and energy, may have limited the economic impact of global energy disruptions resulting from conflicts in the Middle East, providing some insulation for the world's second-largest economy from energy-related economic shocks. However, China’s economic growth has been inhibited by slow consumer sales and struggles in the housing industry.
The next stop is Japan, which has been in the news lately. The U.S. central bank and government have been involved in efforts to strengthen and stabilize the yen to dollar relationship. This action may be important in limiting the potential sale of U.S. bonds and Treasury securities. These securities help finance the U.S. record federal deficits approaching $2 trillion annually and federal debt of almost $40 trillion.
Japan is the largest foreign holder of U.S. government debt, and a significant pullback in purchases or an increase in bond sales could result in higher yields on 10- and 30-year Treasury securities, placing upward pressure on long-term interest rates.
Another potential risk is a liquidity crunch in which the current and future funding of U.S. government debt could become more challenging and expensive. This issue bears close monitoring. Japan also has a high level of government debt that requires funding internally by its citizens and institutions, as well as externally by global investors.
“Hot, hot, hot” would be the overall theme for Europe. To clarify, this refers to the weather, not the economy. Heat and drought have impacted agricultural production in parts of the continent.
However, Europe’s largest economies, such as Germany and France, have experienced sluggish export growth, particularly in the automobile and trade-related industries.
The bright spot has been strong tourism, not only in southern Europe but also in the Nordic regions, particularly from U.S. travelers
Russia and Ukraine account for approximately 30% of global wheat exports. Recent targeting of ports by both countries has resulted in limited shipping activity and the rerouting of shipments at higher costs. However, production and inventories are still available, which could help temper, rather than compound, the impact on global wheat prices.
In the Global South[LB1.1], Brazil and Argentina may be among the first major agricultural regions to experience the impact of elevated fertilizer and energy prices as they enter their planting season. Any breakdown in diplomatic efforts involving Iran, the U.S., and Israel could create additional volatility in these important input and commodity markets.
These factors, combined with inflation, appear to be contributing to margin compression among Brazilian and Argentine agricultural producers, contributing to accelerated consolidation, financial stress, and bankruptcies. The question becomes: Will these financial pressures ultimately impact overall production levels and global commodity prices?
My summer travels for speaking events and vacation would indicate that the U.S. economy is alive and well in many places. Airlines and hotels are operating at or near full capacity, with elevated rates. Restaurant activity, particularly at the upper end, also points to strong consumer demand.
The stock market, fueled in part by investments in AI and expectations of increased productivity, has accelerated to record highs. The wealth effect is evident among those at the upper end of the K-shaped economy. That is, when paper wealth increases, consumer spending can follow suit.
At the other end of the K-shaped economy, lower-income households and individuals are struggling. This may be observed in weaker sales at fast-food establishments and increases in credit card and automobile loan delinquencies.
The Leading Economic Index (LEI) trend would suggest an anemic U.S. economy, supported by mid-range diffusion numbers.
The Purchasing Manager Index is above 50, indicating growth in the manufacturing sector, driven by investments in AI, infrastructure, and the buildup of technology-related components.
The housing market continues to experience modest growth. However, demographic trends, elevated mortgage rates, and rising homeownership costs, such as insurance, fees, and real estate taxes, are becoming increasingly significant impediments to homeownership.
Factory utilization is in a modest growth stage, supported by investment in manufacturing and technology sectors.
Inflation, while moderating somewhat, continues to be an economic challenge for many Americans. While both core inflation (excluding food and energy) and headline inflation (including food and energy) have moderated, cumulative increases in prices relative to wage growth have resulted in an overall decline in purchasing power.
Persistent uncertainty surrounding the Middle East conflict and potential peace agreements, along with trade sanctions and adjustments, can result in changes in inflation rates. This uncertainty is reflected in the Federal Reserve’s wait-and-see approach concerning the direction and timing of interest rate adjustments.
Key metrics to observe during the fall months will be retail sales and consumer sentiment. Recent retail sales readings, including figures above 2.2% reported by The Wall Street Journal, suggest that the service-based economy, which represents approximately 70% of the U.S. economy, may be increasingly fragile as consumer expectations shift toward caution. The Index of Consumer Sentiment, published by the University of Michigan, recently declined from 55 to 51.
Workforce participation is declining, influenced by an aging workforce, changes in immigration regulations, and individuals remaining on the sidelines or dropping out of the workforce. The impact of AI, along with the workforce’s ability to adapt and develop new skill sets, will be a longer-term issue. These factors may ultimately influence GDP growth, productivity, and the future standard of living.
Dr. Dave Kohl is an academic Hall of Famer in the College of Agriculture at Virginia Tech, Blacksburg, VA. Dr. Kohl has keen insight into the agriculture industry gained through extensive travel, research, and involvement in ag businesses. He has traveled more than 10 million miles, delivered over 7,000 presentations, and published more than 2,500 articles throughout his career. His experience and engagement across all levels of agriculture provide a unique perspective on emerging trends and the future of the industry. Dr. Kohl is a valued and longstanding contributor to Farmer Mac's commitment to helping agricultural lenders, producers, and rural stakeholders navigate opportunities and challenges in a changing market. He writes exclusive articles for Farmer Mac that are published bi-monthly, offering timely insights on agricultural markets, rural economies, and business management strategies. In addition, Dr. Kohl regularly joins Farmer Mac's webinar program as a featured guest, sharing his expertise with audiences who are dedicated to supporting the long-term success of rural America.
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