Klinefelter: By the Numbers

When Can a Lender Call My Loan?

A shortfall in collateral after the 1980s land crash turned current loans into under-secured loans. (Photo by ctj71081, CC BY-SA 2.0)

Problem farm loans have been rare since the 1980s but are on the uptick now. Last week lenders in the Chicago Federal Reserve district reported 5% of their farm borrowers were having "severe" or "major" repayment problems. Worried about a potential repeat of the last credit crisis, several farmers have inquired recently if a lender can call their loan, even if they are current.

I asked four major agricultural lenders, two commercial bankers and two Farm Credit Chief Credit Officers, and found out what I was already pretty sure was operating procedure. The answer is "yes" in specific instances.

On term loans, intermediate loans and mortgages, there is usually language in the note that allows a loan to be called if the lender deems himself insecure. Usually, this is when a borrower is highly leveraged and asset values fall significantly. This may be equipment, livestock or land used as collateral. In serious economic downturns, devaluation often happens to all three, compounding the problem faced by the borrower. The other case is where the borrower has been losing money and eating equity and liquidity for an extended period.

The other case where loans can be called is when there is a loan agreement with specific restrictive covenants. If a borrower violates the covenants, he is subject to having his loan called unless he immediately rectifies the problem.

Besides covenant violations, a lender in good faith can deem himself insecure or under-secured and call a loan due to misrepresentations or false statements (material dishonesty); death or insolvency; or credit or forfeiture proceeding by another lender or other party. In most cases, laws require that default must be material to the borrower's ability to repay.

A case-in-point would be where a borrower was current with his primary lender, but has acquired substantial debt and payables to other creditors, including landlords and suppliers, which he is unable to pay.

In the case of operating loans, a lender is most likely just to not renew or extend the borrower's loan(s).

In the case of Farm Credit and the Farm Service Agency, a borrower rights laws passed in the 1980s give borrowers the right to challenge the decision if they can offer a viable restructuring plan. This may include qualifying for a Farm Service Agency (FSA) guarantee. However, FSA is not as likely to bail the lender out of a loss situation, as was the case with its predecessor in the 1980s farm financial crisis, the Farmers Home Administration.

Restructuring applies only in cases where no fraud has been committed by the borrower. This is something no lender takes lightly from both a public image and a legal standpoint. For one thing, the lender can't publically defend his actions except in court, while some borrowers have made it a point to tell their side of the story to anyone who would listen, even if their lender had told them repeatedly of the potential consequences of a deteriorating situation.

Lenders are likely to feel caught between a rock and a hard place if the condition of their portfolio and the ag sector deteriorate significantly. On one hand, they have laws like Dodd-Frank, which make them hesitant to be very aggressive. On the other hand, there are the Basel III Accord and financial regulators, which are very concerned about the institution's safety and soundness. That will force them to be less flexible in working through today's problems loans.

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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. Paid subscribers can access all of his DTN columns online using the News Search feature under News.

(MZT/CZ)