Almost every day the Dow and NASDAQ are hitting all-time highs. Unemployment is low and housing starts continue to be vibrant — all good news for nursery and greenhouse growers. These trends are expected to continue for the next couple of years. With the wind at the economy’s back, commercial and agricultural lending should be at an all-time high. But it’s not. What’s going on?
Banks Are Not Inclined to Gamble on Horticulture
After the 2016 election, bank stocks soared with the anticipation of an improving economy and the prospect for lighter regulation. A year later, bank stocks are growing at only half the rate of the S&P 500. The growth rate for business loans is at the lowest level since the first quarter of 2011. At Wells Fargo, total loans actually fell by 1%. This is surprising given the low unemployment rate, gross domestic product growth of 3.3%, and a rise in private business investment.
Banks suffered losses in the Great Recession from 2008 through 2011. The hangover of the recession wasn’t worth the party of the growth years that led up to it. Lenders have not forgotten. Interest rates have remained low for more than a decade, which means banks are unable to charge a meaningful spread over their cost of funds to compensate for potential loan losses. Add to that the higher reserve requirements resulting from Dodd-Frank, and banks have become even more risk-averse than usual. They aren’t making many business loans, and they really aren’t interested in making loans to agricultural producers.
Bankers See Manufacturing Companies as a Safer Bet
It is a view that is shaped by years of consolidation, shrinking profit margins, growers’ lack of preparation for the down cycles in the economy and, in some cases, it is the result of poor management practices.
These issues are not just peculiar to the green industry, they have affected agriculture more profoundly than the economy in general. As a result, many of the bankers who still refer to themselves as agricultural lenders have shifted their focus to food manufacturing and distribution, commonly known as FMD in ag lending circles.
FMD is characterized by companies that are taking raw agricultural products and making finished food items out of them. In other words, banks want to finance potato chip makers, but they don’t want to finance potato growers; former ag lenders are calling on companies that make pancake mixes, but they probably won’t call on the wheat farmers, and so on.
FMD companies have no production risk, and this is something that is attractive to those banks still trying to pretend they are involved in agricultural lending.
Greenhouse and Nursery Operations Are High-Risk Ventures
Banks perceive both greenhouse and nursery operations to have higher risk profiles. Let’s admit it, they’re right. Greenhouses remained profitable during the Great Recession, but profit margins have shrunk.
Greenhouses are, of course, specialized facilities, which banks don’t like to finance. Not that long ago, the return on investment for most new greenhouse construction was five years. That was in the days of better profit margins and before price increases in steel, glass, and concrete, not to mention increases in minimum wages and health care.
Banks are now balking at the longer payback time for new greenhouses, and don’t really care if they have a useful economic life of up to 50 years. They focus on greenhouses that have sold for less than market values under distressed circumstances, while conveniently forgetting it was their brilliant idea to put the property up for auction during the winter. It’s hard to get many interested bidders when it’s too late to produce a spring crop.
As for nurseries, inventory builds took place from 2000 through 2008 like the party was never going to end. Most were left unprepared for the housing slump. They were over-produced on inventory and slow to react. Many tried to hang onto their inventory while it kept absorbing cash for its upkeep. They couldn’t wait out the recession.
Lenders were complicit in the over-production during the growth years. They were fat, dumb, and happy looking at their borrowing base certificates, showing they were well collateralized with inventory. Most still haven’t figured out their mistake in trying to shoehorn nurseries into asset-based, meaning collateral-based, lending structures. They don’t want to try to understand the working capital and cash flow requirements and have, instead, mostly abandoned lending to these operations.
What You Can Do to Prepare
All agricultural production presents a higher risk for lenders. What complicates matters for the green industry is that you don’t grow a commodity. A farmer can produce a mountain of grain and an ocean of milk and it still is sold. It may occasionally sell for below breakeven, but there is cash returning to the farm and that can buy some time to make corrections. It’s not quite so simple for nurseries and greenhouses. A large amount of overproduction isn’t sold at any price.
For the foreseeable future, expect your bankers to be tight on the front end when you are requesting funds for expansion of inventory or facilities, and expect them to be impatient and possibly irrational if you should run into trouble. Grow slowly and carefully into your market. Leverage your long-term lending capacity to make sure you have a cash cushion. Building up long cycling nursery inventory is similar to buying a piece of equipment and, likewise, should be largely financed with current cash flow. Growing nursery inventory on a borrowing-base certificate that only considers the collateral value is a ticking time bomb for everyone.
More and more, the lending void being left by larger money center and regional banks backing away from production agriculture is being filled by community banks and non-bank banks. In many cases, they are supported by Farmer Mac and other funding sources at competitive rates, terms, and conditions. They are looking for credit worthiness in their borrowers, but it is good to know lenders still exist to support and promote production agriculture.
Disclaimer: The opinions expressed in this article are the author’s own and do not reflect the views of TS Ag Finance.