I have worked with a number of farming businesses over the past 12 to 18 months helping them to expand, refinance or start up their farming business with farm borrowing.
During this period I have found numerous aspects that might block the stamp of approval from the lenders credit teams. We are now past the era of judgemental lending, where your bank manager would come to the farm and approve a new loan there and then.
There is instead a need for financial measurements and ratios to be achieved. In the round this makes for much more responsible lending, but in certain circumstances where you don’t know what the bank are looking for it can then feel unfair and give you the feeling your business is doing something wrong.
It is therefore important for farming business owners to ensure they understand what the right amount to borrow for their business is and the boxes to be ticked before asking for finance. It is much harder to ask a second time once it has been turned down already.
There are three key areas that you business owners should consider before approaching a lender:-
This can be a simplistic approach i.e. can my business afford £3,000 a month to finance the debt.
However on many farming businesses it is not just the one new loan to consider. The business needs to consider whether it can afford the new loan as well as its other farm borrowing commitments. For example hire purchase agreement repayments and/or existing bank debt repayments.
The lenders will assess this by taking your last or budgeted business profit adding back your finance and depreciation costs and then taking off your personal drawings (what you need to live).
This then gives the lender a figure which they call EBITDA (Earning before interest, tax, depreciation and amortisation). They will then calculate your yearly capital and interest repayments on all your finance agreements and then divide the “EBITDA” over this.
This gives the bank a “debt service ratio” – most lenders look for this to be over and around 1.5 times, i.e. you can afford the annual borrowing costs each year 1.5 times over. The margin of 1.5 times is to allow for fluctuations in the markets and prices. This is a calculation that most farming businesses can complete with help from their farm consultant or accountant.
The outcome of your calculation can often give you an indication of whether you are in a comfortable position to ask for lending or whether the change would leave your finances too tight.
When doing this calculation based on prior year performance, it is important to consider how the expansion or project will affect the financial performance. It could be that you are purchasing land that you currently rent and therefore a rent saving will be achieved. You should therefore adjust your profit to reflect this.
Many lenders also now “stress test” the lending too. This means they test whether you can repay the borrowing if the Bank of England base rate is increased. Often lenders will stress test all of your borrowings to 6%. The point of this is to see if you can still pay the annual repayments at this point.
How risky is the borrowing for the lender? In the majority of cases capital value will not be an issue. In some businesses such as a tenanted farming business security may be an issue. It is therefore important for the business to consider the level of exposure to the lender.
The easy way to look at this is by completing a “loan to value” (LTV) calculation. This is where you divide your total finance amount by your total land and property
So for example a farming business with bank debt of £1m and land/property value of £2m, would have a LTV of 50%. Lenders such as the Agricultural Mortgage Corporation (AMC) will only lend to up to 60% loan to value, whereas some high street lenders will go higher. It is therefore important before asking for finance that you consider the risk exposure to the lender.
Another important consideration is the security already given to other lenders. Some lenders will only accept a first charge on their borrowing. It is therefore important
to check which assets do have charges for security and which do not.
Often finance obtained from a lender is long term (over 10 to 15 years). It is therefore important to consider whether there is appetite from everyone involved in the business now and in the future to repay this loan.
Often the return on say changing your parlour to a robotic dairy would be over a 10 to 15 year period. It is therefore important that the next generation who may be the ones who will be responsible for repaying the debt support the investment. This is to ensure that the move is really the correct decision for the future not just the now.
Succession is often a key consideration for the lender. They will consider the future of the business and whether the profit in which they are basing their lending will still be achievable for the whole loan period.
A good example of this would be a two generation farming family where mum and dad are in there late 70’s and the son who is just starting to take control of the business is in his early 50’s. A lender may not wish to lend long term (15 years+) unless there is a potential third generation to take over. This is because in these circumstances the business is unlikely to sustain its profits for the length of the loan without employing extra labour.
By considering the above in advance of meeting a potential lender, the family should be confident that firstly the expansion or investment is right for the family business and secondly everyone is in favour of it. It will also help you to understand what the lender is looking for and whether the ask is sensible.
As I alluded to earlier when it comes to farm borrowing, it’s much more difficult to obtain a stamp of approval the second time of asking – it is therefore important to get it right the first time.