By the Numbers

Check Your Farm's Vital Signs

Know the warning signs that trigger alarms among lenders. (Photo by brykmantra; CC BY-SA 2.0)

A lot of farmers are worried about whether they'll be able to get operating credit for 2017. Obviously, that's going to be your lender's decision, heavily influenced by his financial regulators. I want to take a few minutes and review some general rules of thumb for you to think about, and if the outlook is gloomy, what some of your options might be.

First and foremost, after you have done your own analysis, go talk to your lender. Putting it off will only make matters worse or cause you to lose too much sleep. For one thing, if your debt is small enough to be under the Farm Service Agency (FSA) guarantee limit, delaying will put you into a likely overload period at your FSA office and will likely delay the answer, maybe past the time for you to make a rational decision for next year. There is also the possibility FSA could run out of allocated funding.

Let's talk about several general areas of concern. The following are warning signs for any lender.

-- If, including 2016, your net farm income (accrual adjusted) has been negative for the last three years.

-- If your net worth and percent equity (net worth divided by total assets) has been declining for three years and your percent equity is below 50% (and definitely if it is below 40%).

-- If you have had carryover operating debt for the last two and possibly the last three years.

-- If your net working capital has been steadily declining.

-- If your capital debt repayment capacity (net-farm income from operations PLUS non-farm income PLUS depreciation expense PLUS interest on term debt and capital leases MINUS income tax expense MINUS family living withdrawals) DIVIDED BY (annual schedule principal and interest payments on term debt and capital leases) is less than 1.25:1 and definitely if it's less than 1.1:1 or 1:1.

-- If your cash flow coverage ratio (cash receipts minus cash expenditures) is less than 1.1:1 and especially if it's less than 1:1.

If all of these are true or even most of them, you need to be concerned about your business's viability, unless the outlook for 2017 improves considerably.

Net farm income for the sector has plunged from a high of $123.3 billion in 2013 to $71.5 billion for 2016. Another leading indicator of trouble is that the debt:income ratio was 6.1:1 after 2014, 6.6:1 after 2015 and will undoubtedly be higher after 2016. If the outlook for 2017 doesn't improve significantly, next spring is likely to see a lot of credit denials. Couple this with the fact that farmland values and used equipment values have been declining for the last two years and the outlook for 2017 could be a tipping point.

An increase in voluntary and forced sales could result in much more dramatic declines in 2017. It's simply a matter of supply and demand. If the supply on the market goes up dramatically and effective demand falls because able buyers decide to sit on the sidelines waiting to see if prices are going to continue to fall, prices will fall even further, putting even more farms in jeopardy.

So what are your options?

Sell before the crisis happens while you still have some equity remaining. Seek out a merger with a financially strong and well-managed firm looking to grow that could use your people and your assets, but not increase their leverage position by taking on a lot of additional new debt.

Consider a collaborative farming arrangement with farmers who own most of their land but are looking for ways to cut expenses.

Explore whether your lender would be willing to consider reducing your debt in exchange for a shared appreciation mortgage. It could allow you to service your debt in return for sharing some appreciation if land values improve later.

A final option would be to explore pursuing Chapter 12 reorganization bankruptcy (…).

None of these options may look desirable; but, they might allow you to make the best of a bad situation.

EDITOR'S NOTE: Danny Klinefelter is an agricultural finance professor and economist with Texas AgriLIFE Extension and Texas A&M University. He also is the founder of the mid-career Texas A&M management course for executive farmers called TEPAP. To read all of Klinefelter's recent DTN columns go to….