Lender relationships seed sustainable farm growth

America’s oldest industry offers stable returns for dilligent underwriters, reports Al Barbarino.

Bill Sciacqua walks along a dirt path between seemingly endless rows of blooming pink almond trees on an orchard in California’s San Joaquin Valley. He bends down, touching the soil to get a sense of its quality. He inspects a tree and the nuts it bears.

MetLife's Bill Sciacqua
MetLife’s Bill Sciacqua

Walking along with the farmer who owns the ranch, he poses questions about recent rainfall in the area and the irrigation methods used to water the trees. He asks what the anticipated almond production for 2016 is. About 3,000 pound of almonds, the farmer says.

Sciacqua isn’t looking to farm or even buy this land. As agricultural field representative out of the Fresno, California, office at MetLife, which is one of the largest agricultural mortgage lenders in North America, he is starting the process of determining if the life insurance company should lend this farmer money.

Sciacqua, like other lenders interviewed for this article, stresses the importance of building relationships in the agricultural industry, which is about as old as America itself. He was born into farming and to this day lives on the family vineyard in Madera, California.

“I always try to relate to the customers that we do business with,” says Sciacqua. “Anyone can throw money out, but we try to differentiate ourselves by truly understanding a client’s business and forming a partnership.”

Of course, agricultural lenders aren’t looking simply to make friends. The loans offer many benefits compared with lending on commercial real estate, experts say. They are lower leverage and offer more certainty and safety; cycle fluctuations are generally more easily anticipated and built into loan structures, and returns still offer a spread over comparably rated corporate bonds.

“It’s a great, sustainable business because farmland is always going to be there and you always need the food and grain that farmers grow,” says Neal Crapo (pronounced Cray-po), head of the Eastern Division for Wells Fargo’s Food and Agribusiness Group, the largest agricultural bank lender in the US. “A strip center will become obsolete and need to be replaced – just look at what Amazon has done to retail – but farmland is a much more stable asset.”

It’s all about the dirt. The most valuable soil allows for the growing of more expensive crops and greater diversification of crops, Crapo notes. Underwriting starts on the ground with a visit to a farm to see firsthand the type of commodity being grown or produced, the upkeep of the farm and its assets and the health of any crops or livestock raised on the land.

The geographic location of a farm is critical too. Farms in middle America, particularly Iowa, Illinois, Indiana and Minnesota, for instance, contain the bulk of the nation’s corn acreage and are thus more impacted by recent declines in grain prices. But the farms of Southern California, known to have some of the most fertile soil in the country – ideal for nuts, citrus, cherries and other more expensive crops – are more impacted by water supply, or the lack of it.

Historically, as farm income and values increased, debt rose. Income reached record levels in 2013 as high crop prices and low interest rates led to record demand. But commodity prices, grain in particular, have declined since then. The United States Department of Agriculture (USDA) is predicting a third straight year of lower net farm income and profitability in 2016. Net farm income is forecast to be $54.8 billion in 2016, just a 3 percent drop from the previous year; but also a staggering 56 percent drop from $123.3 billion in 2013.

But despite the dramatic declines, farm sector real estate debt is still forecast to increase 1.1 percent in 2016 to $207.3 billion. Why? The USDA notes that as interest rates have “remained accommodating,” agricultural lenders have continued to grow.

“At Wells Fargo we are very consistent through cycles,” Crapo says. “We consistently deploy our model, always taking into consideration what prices and values will be in the long-term. We knew that grain prices were higher than they were historically and anticipated that they would normalise.”

That’s quite a different approach compared with the recent reaction by the commercial real estate industry to prices that ticked down for the first time in six years – but by just 0.3 percent – in January according Moody’s/RCA. Although that is seemingly trivial, it has already led to widespread fears that there will be limited liquidity from the capital markets to refinance maturing loans as the CMBS market falters.

Of course, if interest rates rise, that could make high levels of farm debt riskier for both lenders and borrowers. But agricultural loans carry a heavier cushion than typical commercial real estate loans, typically long-term, averaging around a 50 percent loan-to-value and rarely peaking above 65 percent.

Real Net Farm Income

Competition to lend remains stiff, from commercial banks and the government-sponsored Farm Credit System (FCS), the two largest sources of financing; the government’s Federal Agricultural Credit Corporation (Farmer Mac); in addition to other GSEs, other life insurance company lenders, private lenders, and state-chartered savings banks and credit unions.

Because every farm, warehouse or timber yard is different, MetLife puts people like Sciacqua on the ground in order to understand those differences and to compete. Like other large agricultural lenders, MetLife also offers a variety of structures, fixed or floating rate with varying durations, tailored to the plethora of needs and nuances on individual deals. Two from 2015 for instance included a $47.55 million, 20-year floating rate loan on the Seanaria Farms nut farm in California; and an $11.2 million, 10-year fixed rate loan on a farm in south central Wisconsin that primarily produces corn and vegetables.

MetLife ended up making that almond orchard loan following Sciacqua’s visit. It was early in March and the trees were in full bloom; there was no wilting and no weeds in sight, only pink flowers. The farmer’s 3,000 pound estimate matched up with production levels of neighboring orchards. And if it wasn’t blatantly apparent from the health of the trees he stood next to, a deeper analysis of local and state-level maps confirmed the irrigation methods the farmer spoke of. A deeper underwriting analysis of the farm’s cash-flow and profitability checked out.

“I already knew it was a great area in general for those crops but it was crucial to see it all in person,” Sciacqua says. “Once I was there, I knew the farmer was giving me the right answers. Had he overshot the number regarding production expectations I would have questioned that.”

“Had I told Barry that this was a worthy borrower and then asked him to come all the way down to have a look for himself, only to find that the trees were half dead and there were weeds all over the place: that wouldn’t have gone over so well either,” he adds, referring to Barry Bogseth, the head of MetLife’s Agricultural Portfolio Unit.

Lower leverage and understanding cycles helps agricultural lending flourish

Agricultural loans are typically long-term and relatively low leverage, averaging about 50 percent loan-to-value. This does vary from one type of farm to another; dairy and poultry farm businesses for instance tend to be more leveraged, as they generally face higher capital costs. But even in a bad year, loans typically incorporate “crop lines” of credit that “should help fund all expenses,” Wells Fargo’s Neal Crapo says, noting that a real problem only occurs if some sort of unanticipated crop failure occurs that exceeds both the farmer’s insurance and the crop line.

For those in the industry long enough, that conjures memories of the declining farm income and a rapid increase in interest rates that led to a massive wave of farm bankruptcies in the early 1980s, which led many agricultural lenders to adopt stricter lending standards. But lenders say that they see commodity prices staying level this time around, at least in the short- to mid-term, which in general would keep farm income and profitability stable.

Bogseth says the average LTV of the loans in his team’s $13.2 billion agricultural portfolio declined from the 60-65 percent range in the mid-2000s to about 43 percent as he kept a keen eye on rising incomes and commodity prices that were unprecedented and proved unsustainable.

“While the agricultural industry can be volatile, if you understand its cycles and stay true to your convictions, you’ll be rewarded,” Bogseth says.