Agriculture and Ag Lending Perspectives and Trends Dr. David M. Kohl Professor Emeritus, Agricultural and Applied Economics Member of Academic Hall of Fame, College of Agriculture & Life Sciences Virginia Tech, Blacksburg, VA (540) 961-2094 (Alicia Morris) | (540) 719-0752 (Angela Meadows) | sullylab@vt.edu Macro Clinic Video Blog: www.compeer.com/education Road Warrior of Agriculture: www.cornandsoybeandigest.com Ag Globe Trotter: www.northwestfcs.com Dave’s GPS & Dashboard Indicators: www.farmermac.com February 4, 2019

Views from the Road agriculture is in the 7th year of economic reset low margins, high volatility manage & manage around strategy Business IQ will be a requirement

Economic Radar Screen international trade USMCA China’s Belt & Road Initiative synchronized global economic slowdown China- slowest growth rate in 28 years Japan- negative growth rate Germany – negative growth rate Central Bank’s stimulus in China high debt levels in urban real estate in China

North America’s Economic Power Block 28% of the global economy’s GDP energy & oil U.S. #1 Canada #6 Mexico #8 450+ million people 47% of Mexico’s population is under 25 ag trading partners: Canada #1 Mexico #3

Lender Perspectives many institutions have more reserves toward stressed credits “4 X Rule” higher short term interest rates larger number, more zeros and commas increased consolidation, concentration risk increase in vendor and non traditional lenders agribusiness credit issues, third party counter party risk emotional stress for producers/lenders unpriced grain/livestock in inventory

Producer Cost Concerns interest rate increase impacting cost of production family living expenses leveling off- too many generations of people living out of the business off farm employment and health benefits working capital- now into equity bottom third of accounts need accrual adjustments- how quick are they to cash?

Drivers of Change on Land Values interest rates investor funds refinancing cycle baby boomer farmer relatives who inherit land supply and demand of commodities

U.S. Economy Watch real estate Federal Reserve interest rates fixers and flippers LA/Bay area Federal Reserve interest rates 2 increases/1 decrease stock market other

Top Five Economic Indicators Growth Neutral Recession LEI/Diffusion Index Positive Flat/Decline Decline 0.3% for 3 consecutive months AND >1% overall Consumer Sentiment >90 80-90 <80 Housing Starts 1.5 Million 1.0-1.5 Million <1.0 Million PMI >50 41.7-50 <41.7 Stock Market 10% increase Flat >30% decrease

Yield Curves and Recessions Source: Federal Reserve https://www.newyorkfed.org/medialibrary/media/research/capital_markets/Prob_Rec.pdf

Is the New Normal the Old Normal? Time Period Approximate Net Farm Income In Constant Dollars Era Name 2013-2017 $35,000 Agricultural Economic Reset 1996-2001 $50,000 Asian Tigers Boost Commodity Demand 2001-2005 $54,000 Pre Agricultural Super Cycle 2007-2012 $125,000 Agricultural Commodity Super Cycle Source: https://finbin.umn.edu/

Median Net Farm Income

Mega Trends 2008-2018: Technology & Production Metric Tons Increase Since 2008-2009 til 2018 Country Corn (Percent Change) Soybeans U.S. 21% 55% China 48% 1.1% Brazil 85% 108% Argentina 174% 73% Canada 36% 125% Europe -9% Paraguay 168% Source: Kirksville, MO presentation - University of Missouri

Net Farm Income, 2017

Why Some Businesses Are More Profitable Than Others These businesses are a “little” better at: production marketing cost control asset and capital efficiency utilize the 5% Rule

Business IQ: Management Factors Critical Questions for Crucial Conversations Customer Checklist Green (3-4 points*) Yellow (2 points) Red (1 point) Knows cost of production Written In head No idea Knows cost of production by enterprise Goals- business, family & personal Record keeping system Accrual Schedule F (one & done) Projected cash flow Sensitivity analysis Understand financial ratios, break evens Work with advisory team and lender Yes Sometimes Never Marketing plan written and executed Risk management plan executed Modest lifestyle habits, family living budget Non existent Written plan for improvement executed & strong people management Transition plan/Business Owner plan Working on plan Non existent/controversy Educational seminars/courses Never attend Attitude Proactive Reactive Indifferent *Extra Points: Progressive Business may receive 4 points for #2,6,7,8,14 Struggling Business attempting turnaround may receive 4 points for #3,5,8,11,12 Score Overall Analysis 35-50 Strong management rating & viability 20-34 Moderate risk & viability; will most likely show previous refinancing <20 High risk & lack of long term viability

Character Counts Critical Questions & Observations for Customers Customer Checklist Yes No Are they honest, ethical & trustworthy? Do they report all assets & liabilities accurately? Do they use borrowed funds as agreed upon? Have they managed through adversity? Have they followed through on educational opportunities? Have they saved for lifestyle pursuits & balance with business growth? Have they had minimal surprise purchases & not obtaining credit after the fact? Have they used profits and windfalls properly for cashflow? Have they been willing to work with advisory team? Have they considered coaching and constructive advice? Totals Total Yes Character Assessment 8-10 Yes Answers Strong 4-7 Yes Answers Fair <4 Yes Answers Weak

Trouble Shooting Matrix Insufficient Repayment Capacity Cut Business Cost Reduce Four Largest Expenses: Crop, Feed, Labor, ?? Job Stability/Availability, Job Cost Job Earnings, Skills, Time Management Non-Farm Revenue Sell Capital Assets, Deferred Taxes, Increase Production, Increase Price Increase Income Cut Living Withdrawals Purchase Financial Software, Small Cost Containment Longer Term, Interest Only, Principal/Interest Deferred Restructure Debt Equity Capital, Family Capital, Supplemental Cash Flow Capital Infusion Voluntary, Involuntary, Chapter 7, 11, 12, 13 Bankruptcy

The Burn Rate – Working Capital Adversity vs. Opportunity Defensive “Adversity Oriented” Current Assets: $2,000,000 -Current Liabilities: $1,000,000 = Working Capital: $1,000,000 Projected Loss: $500,000 Working Capital = 2 Years Projected Loss Red < 1.0 Year = Vulnerable Yellow 1.0-3.0 Years = Resilient Green >3.0 Years = Agile Offensive “Opportunity Oriented” Current Assets: $2,000,000 -Current Liabilities: $1,000,000 = Working Capital: $1,000,000 Debt Service(Existing & New) Payments: $200,000 Working Capital = 5 Years Total Debt Service Payments Red < 2.5 Years = Vulnerable Yellow 2.5-5.0 Years = Resilient Green >5.0 Years = Agile

Burn Rate on Core Equity Adversity vs. Opportunity (Assume $500,000 Earnings Loss & 20% land value decline) Assets- Market Value Estimated Value Loan Maximum Collateral Position Remaining Principal Equity Excess Reserves Long Term (20% Decline on Land) $6,000,000 $4,800,000 X 70% = $4,200,000 = $3,360,000 $2,200,000 = $2,000,000 = $1,160,000 2. Intermediate $3,000,000 X 60% =$1,800,000 - $800,000 = $1,000,000 3. Current $1,650,000 X 80% =$1,320,000 - $860,000 = $460,000 Burn Rate: Land & Long Term Equity Reserves= Excess Reserves= $2,000,000 = 4.0 Years Earnings Loss¹ $ 500,000 20% Decline Burn Rate: Land & Long Term Equity Reserves= Excess Reserves= $1,160,000 = 2.32 Years ¹ Assume Earnings Loss of $500,000 Red < 4.0 Years = Vulnerable Yellow 4.0-7.0 Years = Resilient Green >7.0 Years = Agile

Bridge or Pier Concept Before: Term Debt = $1,000,000 = 4 to 1 EBITDA $250,000 After: Term Debt = $1,250,000 = 5 to 1 no improvement in EBITDA refinancing using land equity debt levels higher owner equity loss, more debt service water is deeper near the end of pier the longer the pier, then the narrower the pier

What Great Bankers Do: maintain contact with the customer for variance analysis & projected/actual analysis go out to the farm for face to face visits provide expertise in planning & monitoring of business performance provide sound counsel to preserve wealth in adverse situations provide facilitation to retain economic & emotional stability provide tools & education to assist them in preserving equity have the courage to initiate tough conversations implement the Six “C’s” of lending burn the free fuel “A.R.E.”

Questions