Lenders: Dairies Need Caution, Even in Good Times

6/7/2014 7:00 AM
By Philip Gruber Staff Writer

With high milk prices and soft feed costs, it’s a tempting time for dairy farmers to spend, spend, spend.

That’s not necessarily what lenders want them to do, though.

“Yes, there is a lot of profit and a lot of cash coming in,” said Lowell Fry, vice president of Fulton Bank in Lancaster, Pa. “I try to cool down some of that exuberance.”

Bankers are always encouraging their clients to control costs, and be as efficient and productive as possible. “That happens irrespective of price,” Fry said.

When grain farmers were making strong profits a few years ago, a lot of them bought new equipment. “The dairy guys want to do the same thing,” Fry said.

Putting new iron in the field is not necessarily a bad thing, but now is also a good time to pay down lines of credit and put cash aside for future needs. If the milk price falls again, feed prices may not follow, he said.

Many farmers are following that advice. Fry said he is seeing farmers paying off their spring planting bills now rather than in October.

The high milk prices have not led to a spike in major dairy barn projects. Those projects take so long, often one to three years, that price changes have little effect on them, Fry said.

Accessory buildings, such as heifer barns and manure storage, have drawn more interest recently. These smaller projects could be part of expansion plans, as the new barns could allow farmers to add milking animals in their former dry cow pens, he said.

These projects may also be geared more toward efficient operation, he said.

Robots continue to draw interest from farmers, though that sector is still evolving.

Farmers with fewer than 100 cows particularly like robots as a way to manage their family lifestyle and their labor costs, he said.

Robot projects require more than just a financial commitment, though.

“You have to completely re-learn how you manage cows,” Fry said. “If you don’t relearn that, you will struggle.”

Dairies are not diversifying as much as in the past. Dairy farmers today are more likely to expand by adding cows, not broiler houses, Fry said.

Many times these diversifications are on smaller farms. The 70-cow farmers may add chicken houses with the idea that the cows will be gone in a few years.

“It may not be a diversification but a transition,” he said.

Banks are “absolutely” approaching dairy differently after the 2009 dairy downturn, Fry said.

Lenders want farmers, especially larger dairies, to have a lot more liquid cash that can be moved quickly, he said.

Some of the most successful dairies are the ones that use price tools like hedging as part of their normal operations.

Farmers who use price-protection tools are leaving some money on the table right now, “but when the price goes the other way, they should recover that, hopefully” he said. “We don’t want to see them go into the depths of that trough.”

Banks are asking for more information from all customers, including farmers. “We have to document everything,” Fry said.

“In general, agriculture has somewhat lagged the other small-business industries in their reporting,” Fry said. Most small businesses have a good grasp of their costs, though most farmers did not until recently.

As dairies get larger, Fry encourages them to switch to accrual-based accounting. It is more expensive than cash-based accounting, but it is better for showing profitability and the cost of doing business, he said.

The Dodd-Frank banking law has changed bankers’ perspective, making them more meticulous in enforcing, for instance, flood insurance rules and appraisal requirements. Those regulations make lending more costly, Fry said.

On the other hand, new Farm Bill programs like the Margin Protection Program offer ways for farmers to manage risk, he said.

Broadly speaking, dairy farmers are becoming more financially savvy. Many have always known about cows and corn, but the ones who are most prosperous focus as much on money issues as on breeding and nutrition, Fry said.

Alex Brubaker, an ag lender with Susquehanna Bank in Blue Ball, agreed with Fry that interest in lending has remained steady.

“Lines of credit are being paid to zero,” and many farmers are paying ahead, Brubaker said.

Farmers are also taking steps to increase profitability. They are looking to fill barns with cows, and managing somatic cell counts and butterfat contents to get premiums. They are also double-cropping a lot more to reduce feed costs, he said.

“Dairy farmers are looking at doing projects they might have put off for a while,” said Richard Stup, the sales manager for AgChoice Farm Credit’s northeastern Pennsylvania offices.

AgChoice is cautioning farmers not to spend all of the extra money so that they have a cushion if milk prices fall again, he said.

Many of the projects farmers are looking at are ways to increase efficiency that are not necessarily expansions, such as replacing old barns or milking equipment. “We can look at robotics that way,” Stup said.

Adding those efficiencies without adding cows can be a challenge, though, because the improvements are so expensive, Stup said. “Sometimes it’s hard to pay for them without expanding the herd at least some.”

Lending practices at AgChoice have not really changed in response to dairy’s crunch five years ago. Farmers asked that question a lot in 2009, but what really changed then was farmers’ financial situation, Stup said.

“A lot of farmers lost huge amounts of equity” because milk prices were low and feed costs were high, which made it harder for farmers to get credit, he said.

Asked if farmers are more financially savvy than they used to be, Stup said, “Oh, I think they are, and I think they have to be.”

There was a time when banks saw dairy as less risky than other types of farms. They brought in a monthly milk check, so they did not need as much liquid capital as other types of operations, he said.

That thinking has changed, though, as prices for milk and input costs have become more volatile, he said.

Reserves may be necessary for even short rough patches of a few months, he said.

Fewer farmers are settling for the price the market will give them, looking at tools to lock in prices for milk or inputs, or getting crop insurance, he said.

It is important for farmers to keep their lenders in the loop if their financial situation changes during the year, Stup said.

Lenders would rather know early on that an issue might hurt profitability rather than find out at the end of the year that a farm was not profitable when they expected it would be, Stup said.

“You build a much stronger relationship,” Stup said. “It’s so much better than having surprises.”

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