In most cases, your personal guarantee rates right up alongside having the equity and financial strength to carry a loan when you walk into a bank to arrange financing for a feedlot operation.
If we are going to put our skin in the game, we need to know whether you are willing to put some in too, says Bank of Montreal (BMO) agrimanager Glen Snyder, who oversees the loan application process for feedlot financing in Saskatchewan. Snyder gave participants at this year s Western Canada Feedlot Management School at Saskatoon a rundown of the BMO s 5M process to assess agribusiness applications on the merits of men, management, markets, materials and money.
Most financial institutions have a similar review process.
Initially, there are three necessary qualifiers prior to drilling down into the 5Ms, Snyder explains. First off, you need to be able to provide the cash and, or equity equivalent necessary to back the loan. In most cases for asset term loans, it will be the lesser of 25 per cent of the cost of the asset or the appraised value. For operating loans, it s usually 25 per cent of liquid assets, those being the assets that could be easily and quickly converted into cash.
For new startups, the equity requirement is typically 40 per cent of the lesser of the cost or appraised value of the land and facilities. In Saskatchewan, the government established the feedlot construction loan guarantee to help producers address this challenge. It covers 25 per cent of the construction cost up to $750,000 for a 10-year period. Under this program, either a startup or a major renovation or expansion of an existing lot would require 20 per cent equity.
Financial strength, as measured by personal net worth and credit bureau history, is the second priority for the bank. This indicates your integrity and ability to inject cash if necessary to replace possible operating losses down the road. A new startup would need a detailed business plan, whereas an existing operation may use its financial statements from recent years. However, an in-house business plan would be required if there are special circumstances, such as a major expansion, change of ownership, or change in business structure.
The final qualifier is the willingness of the shareholders or owners to commit by providing personal guarantees. The amount of the personal guarantee is negotiable, but usually falls between 50 and 100 per cent of the operation s outstanding liabilities. Communityowned feedlot startups present somewhat of a different situation. It s not feasible to obtain guarantee commitments from the large number of shareholders, therefore, the equity requirement is 40 per cent rather than 25 per cent.
If you don t qualify, we don t just decline the application. We discuss how we can get you qualified, Snyder adds. For example, if you need more equity, we go out and do a valuation. If you still don t qualify, but have a strong financial history, we may be able to mitigate the shortage of equity with a supporting personal guarantee.
If you qualify, then it s on to the 5Ms. For an existing feedlot with good records at hand, the entire process will probably take about a month from the time of initially walking in until you have an answer. New operations should allow six to nine months to develop a business plan and arrange financing because of the time it takes for the board of directors to show due diligence.
The 5M assessment works the same way as the qualifiers. It s a process with each factor related to each of the 5Ms rated on its own merit, Snyder explains. If you don t meet a requirement, he will look at the whys and hows. A case in point is the debt service coverage ratio (DSCR) for clients coming to the BMO from another financial institution. It s an indication of profitability and the ability to cash-flow annual principle and interest payments. The BMO looks for a DSCR of around 1.25:1 ($1.25 in net income for every $1 in debt to be serviced). If it s on the low side, it could be due to high interest rates or the existing payback term being too short on some loans and it may be possible to restructure financing to achieve a reasonable DSCR.
Our preference, and that of most financial institutions, is all or nothing, Snyder comments. This means that if you need financing for fixed assets, the bank prefers to carry the equipment and operating loans as well. The main reason is that it enhances the service, understanding of the operation, and relationship between the client and lender.
Occasionally BMO partners with Farm Credit Canada (FCC), with FCC financing the hard assets and BMO financing the operating loan. Cattle purchases can be financed directly through the BMO, or through local feeder associations, regardless of which financial institution is financing the association.
For custom feeders branching out into owning cattle, Snyder generally recommends going through a broker that offers a total package of services including financing, price and foreign exchange risk management, and repurchase. Financial institutions can help with foreign exchange hedging, but not with hedging and options on cattle pricing.
Obtaining financing is a step-by-step process that requires open communication and a good working relationship between the bank and the owner, and for new startups, between the bank and the contractor, financial consultant and other major players on the project, Snyder says.
MEN AND MANAGEMENT
Of the 5Ms, men and management together constitute a large section of the application.
Taken into consideration are the board of directors and, or owners trustworthiness, education and employment background, level of experience in the cattle industry and managing people, level of success in their own businesses, along with industry and community connections and involvement as well as whether any conflicts of interest exist. As it relates to management, the focus is on the key positions of general manager and chief financial officer.
The organizational structure, operations manuals, employee policies, labour availability and competing industries in the region, use of professional consultants, such as veterinarians, nutritionists and commodity and foreign exchange brokers for risk management, are also important.
Of course, financial and production management are crucial. The use of computer software for accounting, payroll, inventory control, monthly statements, rolling projections and real-time foreign exchange management is noted. Preferably, it will be linked to the production software program, with the capability to do summary reports of pen closeouts, monthly summary reports and benchmarking reports.
Risk management is another key factor. In the general business area, a financial institution will require you to carry policies on the income-producing assets, third-party liability, environmental risk, and loan insurance. Other types of policies to be considered include business interruption, contract frustration, key-man life insurance and personal death insurance. Production insurance categories that may be applicable are crop and forage production, hail, livestock transportation, and inventory insurance. Income insurance is recommended through the use of tools such as AgriStability, provincial livestock insurance plans, hedging on the futures market, foreign exchange insurance, break-even software, and contracts to mitigate feed supply risk.
BMO s guideline for equity percentage is 50 per cent. Your equity, or net worth, is the market value of your assets less existing liabilities against those assets, while your equity percentage is your equity divided by your assets.
The guideline for the debt-to-equity ratio is 1:1 (one dollar in equity for every dollar in debt).
The DSCR is your earnings before interest, tax and depreciation (EBITA) divided by your existing principle and interest payments. The guideline is 1.25:1 for the past three to five years. If any one year is less than 1.25:1, the reason for the variance is determined by reviewing individual income and expense items.
Your future cash flow viability is analysed by rolling your existing debt, new debt and future money needs into an average year in the future budget to determine whether a 1.25:1 DSCR exists. Likewise, your balance sheet is recalculated factoring in the proposed financing to determine your equity position, which should be no less than 50 per cent.
The margin conditions, or loan-to-value ratio guideline, is a maximum of 75 per cent for fixed assets and equipment. For operating loans, the loan-to- value ratio shouldn t exceed 75 per cent of your inventory value plus accounts receivable, minus accounts payable of more than 30 days and previous charges against inventory. However, the loan-to-value ratio requirement will vary subject to the level of government guarantees.
Commonly, financial institutions will ask you to agree to maintain certain financial standards known as covenants, such as annual capital expenditure maximums, maximum debt-to-equity at year end, DSCR minimums, and dividends or cash withdrawal guidelines.
A financial institution will look at whether the land base for feed production and manure disposal is owned or leased and if, leased, the terms of the agreement. Other considerations include the percentage of feed produced versus feed purchased, whether the operation meets provincial permitting requirements, expansion potential given the existing permit and the water supply.
With regard to the facility itself, the quality of construction materials, state of repair of the existing lot, a user-and animal-friendly layout, and backup water and power supplies are important considerations.
Also noted are the condition of equipment, maintenance records, on-site repair capability, capacity of feed mill and availability of licensed cattle, batch and truck scales.
If you are a custom feeder, the financial institution will look at the number of clients, whether you are backgrounding and, or finishing cattle, and the type of feeding contract (weight gain, cost-plus, or a combination).
If you own the cattle, you will need to show a procurement plan that takes into consideration break-even calculations, transportation costs, and terms of sales contracts with packers.
ROLL IT UP
The 5Ms are rated on their individual merits, then rolled into a single rating. Your application is then risk-rated according to the overall rating. If approved, the interest rate charged will be influenced by your risk rating.
The general health of the beef industry is always a background consideration, Snyder adds. As of July, the cattle industry was rated as outperforming the broad market on the strength of the declining cow herd and short beef supply in North America relative to increasing global demand with U.S. beef exports on the rise due to the weakness of the U.S. dollar. Looking ahead, trade barriers, foreign exchange rates and interest rates are factors that will affect the cattle industry s outperform rating.
Going forward, markets are bullish for finishing cattle in Canada, versus bearish for feedlot demand and finishing cattle in the U.S.
USDA long-term projections for cow-calf operations see producer margins above cash expenses to increase from $94.97 per cow in 2011 to $144.48 per cow in 2020.