How to structure debt to weather tough times

Western Canadian farmers have enjoyed some great years recently and farm income statistics confirm it.

But this can lead to complacency in financing and debt structure, which can cause problems when markets or weather don’t co-operate.

You need to get your financial house in order.

Refinancing, or replacing existing debt with new loans under different terms, allows you to select the best debt structure for your needs and satisfy existing and future lenders.

With low interest rates, more borrowing options and banks aggressively seeking new clients, it’s a great time to take a look at your debt structure.

The benefits of creating a strong debt structure are three-fold.

Proper debt structure allows continued, flexible debt service in the event of a crisis.

During a crisis or economic downturn, lenders have less appetite for risk. They will require more documentation and higher down payments and will pay greater attention to repayment capacity and your risk management plan.

You should develop a customized risk strategy and the first steps are to identify your key risk factors, their probability and the impact they would have on your bottom line.

When you set up your debt repayment plans with your banker, are you in a position of having a right to pay, or are you obligated to pay?

When you borrow money with an aggressive repayment schedule, you are obligated to pay it back aggressively irrespective of what the future holds.

What might have felt satisfying when you signed the agreement could cause you a lot of pain later if you have back-to-back bad crops.

But, depending on the asset you purchase, you can extend the amortization or repayment over a longer period. Typically these loans have a clause that allows you to prepay a percentage of the original loan balance every year.

This flexibility is important in agriculture where income can be volatile.

When considering debt repayment, you should not obligate yourself to pay more than 10 percent of your debt annually.

A debt service ratio (the ratio of cash available to service principal, interest and lease payments) of greater than 1.5:1 is optimal, although which sector of agriculture you are in affects this.

The last thing to do is to test the strategy.

Pencil in a potential issue for your business. How will you manage if farm revenues decline by 10, 20 or 30 percent?

Lenders offer a lot of options these days. In addition to traditional fixed and floating rates, there is increased flexibility in loan types, rate types, amortization periods, terms and repayment options.

The borrower needs to understand the terms and conditions of the loan agreement, such as collateral requirements, prepayment penalties, reporting requirements, fees and service charges, and loan covenants. All of these impact the cost of borrowing.

Interest rates are historically low, which provides an opportunity to replace high rate debt.

Even with early repayment penalties, you could still save money in the long term.

Ask your lender to calculate the payout penalties and determine whether the fees will be more or less than the total interest saved.

These tools provide anyone looking to restructure their debt and minimize risk the options to meet their specific business needs.

The final benefit in refinancing your debt is the flexibility some of these options provide. The right debt structure will include a number of tools that will allow you to “set it and forget it.”

Matching the term of the loan with the life of the asset is an important business principle.

Don’t buy longer-term assets (land or equipment) with cash or operating lines because it can leave you short in a crisis.

Cash should be available for day-to-day business expenses and seasonal operating bulges.

The re-advanceable lines of credit and equipment operating lines act like operating loans but are designated for the purchase of longer-term assets such as land or equipment. They are like a home equity line of credit because they can be paid down and funds can be re-borrowed when needed.


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