Ag Loan 101: Insights from Texas Farm Credit’s Sarah Franklin on TSCRA Talk

Sarah Franklin, Vice President and Branch Manager at Texas Farm Credit’s Pleasanton office, recently joined TSCRA Talk host Kristen Brown to break down the fundamentals of agricultural loans. In this episode, Franklin explains the differences between long-term loans and short-term options like operating loans, while also detailing the key documentation required for the application process.

She also shares insight into the five C’s of credit—character, capacity, capital, collateral, and conditions—which are essential factors in evaluating a loan. Tune in for expert advice on navigating the ag loan process.

Listen to the full episode here: TSCRA Talk – Episode 60

Podcast Transcription

Kristen Brown, TSCRA (00:06):

Welcome to Tia, CRA talk, a podcast by Texas and Southwestern Cattle Raisers Association. I’m your host, Kristen Brown. Joining me today is Sarah Franklin with Texas Farm Credit to talk about the basics of getting an ag loan. Sarah, thank you so much for joining me today.

Sarah Franklin, Texas Farm Credit (00:22):

Well, thank you so much for having me. I’m excited to chat with ya’ll.

Kristen Brown (00:25):

Well, I think this is going to be a really great topic for our listeners. It may be something that some are super familiar with. They’re already in the process of having loans and they have been for a long time, but for those who haven’t ever had a loan, I think this is going to be great information and really, really valuable. So just diving right in. Talk to us about some of the different types of ag loans.

Sarah Franklin (00:50):

Sure, great question. So kind of to kick it off, you can really think of two big categories when it comes to agricultural loans, one being long-term and one being short-term. So in the long-term world of ag loans, really that boils down to real estate. So land loans specifically for those looking to either start their operation or expand their ag operation, or maybe even those that want to make improvements to their existing properties such as drilling a well or building a barn or things like that. And then short term, you can think of those like operating loans or lines of credit. So really it’s for those agricultural producers who have an operation who basically need capital in order to operate their short-term term notes. And so someone who’s maybe looking to buy a tractor or a trailer or maybe a certain set of cattle for their operation.

Kristen Brown (01:48):

Okay, very good to know. So how does somebody get started? Maybe we put together a scenario of somebody wants to buy some land. What if we start with that and then the things that would come with buying land, stocking it with some cattle, and then maybe they need some equipment to go with us. So that’s the scenario we’re working with. What is their first step?

Sarah Franklin (02:10):

Sure. So first step is to really determine what your financing needs are, which entails having some sort of business plan. And so what exactly are your needs? Are you in need for real estate? Are you trying to grow your herd? Do you need operating capital to do so, et cetera. So just really know what your goals are for the operation. And then after you’ve been able to identify that, your next step is to start the application process. And so typically what you’ll find with the application, and there is a little bit of paperwork that goes along with it, but I always tell people don’t be intimidated by it. We’re here to help you guys out with that paperwork. And so usually with the application, what we’re going to be looking for is a balance sheet, which basically a financial statement that lists out your assets and your liabilities, and that’ll help us determine what your financial position is.

We’ll also want to look at some kind of income documentation. So this is typically like a copy of your most recent tax return or a profit and loss statement, depending on the time of year, if we’re midway through the year and we don’t have a really recent tax return, we’re going to want to see a year to date profit and loss statement that goes along with that. And then really, we want to know about you. We want to know about your operation. Are you a cow calf producer, a stocker operator, or a feedlot? Really? What are your goals? I’d really encourage everyone to have a sit down conversation with their lender so you can get to know each other, and really, we as lenders want to understand your need. That way we can tailor a loan to fit those needs and help you reach your financial goals.

Kristen Brown (03:57):

Sure, that makes sense because y’all are taking on risk, and so you’re evaluating that, and so you obviously need to be successful in it, but you all truly want the producer to be successful too. I mean, it’s that you’re intertwined together very much so.

Sarah Franklin (04:13):

Absolutely.

Kristen Brown (04:14):

That’s just getting to know the person and probably their vision and their goals and the big picture of it all.

Sarah Franklin (04:20):

Yeah, absolutely.

Kristen Brown (04:22):

So once they submit all the documentation, what happens next?

Sarah Franklin (04:27):

Great. So once we get a full loan application in, we begin our analysis really in the credit world, if you want to kind of boil it down, there are five Cs to credit that we look for, and I can briefly go through each one of those Cs, like the letter C. The first one is character. And what character is is really the borrower’s dependability and integrity to measure someone’s character where we look at their repayment history, which means that we’re pulling your credit report. We’re looking at that credit report to see, okay, what kind of loans have you had in the past? Have you made timely payments? What does that credit report say about you? And your character. Character can also be measured really by your business and personal references as well. The second C we look for is capacity, and this is the applicant’s financial capacity to repay the loan and meet all financial obligations.

And so this is where that tax return and profit and loss statement is going to come in handy. We want to make sure that whatever your business entails, that you have enough income to cover the debts that you owe. The next C is capital, so this is where that balance sheet comes in handy. We’re going to be looking at that balance sheet at your asset and liability position and measuring things such as your liquidity and your owner’s equity. The next C is collateral, and what collateral is is it’s the actual property that secures the note. And so if you’re buying real estate, typically the real estate that you purchase will collateralize that note. Or if you’re buying a tractor, that tractor is what’s going to collateralize that loan. And really what that does is it minimizes the lender’s risk in the event of a loan default. And then the fifth C that we look for is conditions and really what conditions are the terms of the notes and any economic factors that may impact the borrower. So you’ll put together your loan application, submit it to your lender, we’ll start taking a look at your application package and doing all the number crunching and then get back with you and let you know how everything looks.

Kristen Brown (06:48):

Well, that’s awesome. And that makes sense that there’s a lot to take into consideration.

Sarah Franklin (06:53):

Yeah, absolutely. Yeah, and we really look at everything collectively. And so something I didn’t mention earlier, we have the flexibility to structure loans different ways. And so when you’re looking to set up a new loan, you can do a loan in your personal name or in an entity or in a business name. A lot of times whenever we look at loans that are with entities and businesses, sometimes there’s multiple individuals that belong to that entity. And so we get an application package from everyone who’s going to be at the loan beyond the loan and really look at it all from a consolidated basis.

Kristen Brown (07:33):

And the thing that’s coming to mind is this is very much a relationship building process. You walk hand in hand with each other through this. Anyway, that’s just something that keeps coming to mind as the relationship that you begin to establish with your lender. So talk to us about that a little bit, if you have any thoughts there.

Sarah Franklin (07:53):

Yeah, I’m glad you brought that up. I mean, you hit the nail on the head. Relationships are something that we really value. We don’t want to be just a one-time transaction lender. We want to build relationships. We want to be relationship lenders and really grow with you in your operation. And so I would advise you if you don’t have a lender or you’re looking to expand to really think about what you look for in a lender, maybe some questions that you would consider are, does your lender have an ag background? Are they willing to go out and see your operation? Are they listening to your needs and matching them with the appropriate financing? Really, are they committed to being a partner in your success?

Kristen Brown (08:35):

Sure, sure. And on this train of thought that there are specific ag lenders as opposed to traditional banks, do you have any thoughts there of taking those things into

Sarah Franklin (08:47):

Consideration? Yeah, absolutely. So yes, I can speak to the difference really between farm credit as an ag and your traditional bank or more of a commercial bank. A lot of it really boils down to the structure, the source of funding and the scope of what the banks offer. And so your traditional commercial bank, they’re typically structured as a corporation and they can range in size from being a closely held family corporation to even being a publicly traded entity. Usually those commercial banks are depository banks, which means that they offer checking and savings accounts and also offer an array of services such as consumer loans, mortgages and business credit. Farm credit on the other hand, for we are structured as a co-op, which means that all of our borrowers are owners of the company and essentially they have a say in how we operate. So one of the biggest perks to that co-op structure is that we share our profits with our customers, and we call this our patronage program.

Basically how it works is that we are governed by a board of directors, and at the end of each fiscal year, our board of directors takes a look at our earnings, they set aside enough of our earnings to continue operating, and then they return the rest of our earnings to our customers in the form of that patronage dividend. And that’s like a physical check that you get in the mail from us, and you can do whatever you want with that check. So really farm credit, we’re focused on agriculture. Ag is really our bread and butter, it’s our area of expertise and the reason why we’re here, fun fact about farm credit, wherever you are in the United States, there is a farm credit that serves your area. And so anywhere in Texas, Oklahoma, New Mexico, I mean there’s going to be a farm credit association there to serve your needs and to serve agriculture or in rural America.

Kristen Brown (10:45):

Well, that’s great to know and so helpful. And what a cool thing that company is supported by the borrowers. So getting back into the specifics and the nitty gritty of it, talk to us a little bit about common terms of a loan. Again, it’s probably different and unique to each type of loan, but what are some things that people need to be prepared for?

Sarah Franklin (11:08):

Sure. Great question. So usually with term notes, those would be your real estate loans or even equipment loans. Well, let me back up. A term note is going to be something that we send money out for that purchase one time and then you work to repay that loan over a period of time. And so usually for real estate, what I see is that’s a 20 year payback for equipment that can be anywhere from three to five years, sometimes up to seven years depending on the size of that loan and what the equipment was for. On the other hand, you’ve got your operating loans and your lines of credit. The structure of those notes, it’s quite a bit different than what a term note is. And so basically with these lines of credit, we call them renewals, and so you’ll have a line of credit available to you for the course of a year, and we align that year with your production from when you start planting to the time you harvest if you’re a row crop farmer.

And so basically you’re drawing from that line as you need money for the inputs of your crop or for your cattle herd or whatever that might be. Once the harvest season comes around or once you start selling cattle, that’s when we expect that note to be repaid. And usually those are on one year cycles. And at the end of one year, we go through that renewal process, which means we’re basically, we want to extend that note for you another year. We just need to get updated information from you. And so usually at that one year mark, we’re working with you to get updated financials, updated tax returns, we’ll sit down with you and have a good discussion and take a look at really how your operating year worked, what were the profits and losses, what were the challenges you incurred? And then also have a conversation about what the future holds. Are you looking to expand going into next year? Are you comfortable where you are? And so is the current loan you have, is it sufficient for you and so forth. We’ll do an analysis on those updated financials and renew you for another year out.

Kristen Brown (13:22):

Well, that’s very good to know. And again, that relationship just keeps ringing in my mind of somebody that you are comfortable picking up the phone and calling and asking questions, just really walking hand in hand through all of this.

Sarah Franklin (13:36):

Yeah, absolutely.

Kristen Brown (13:37):

So talk to us about some of the common reasons that somebody might not qualify for a loan. Again, so many different types of loans and maybe different points on each of those different types.

Sarah Franklin (13:49):

So sometimes someone doesn’t qualify for a loan because one or maybe more of those five Cs that I previously mentioned aren’t met. And so again, those five Cs that we look for in a credit package, it’s character capacity, capital, collateral and conditions. And so maybe someone’s credit score isn’t good enough, they’ve got several delinquencies on their report, and maybe that’s coupled with their debt service or capacity, which means that they’re not currently showing or projected to show enough income to offset their debts. Those are tough conversations to have, unfortunately, it is just part of it, but the approach I like to take in those instances is it’s not a no forever, it’s a no right now, and this is what your financial position looks like. These are maybe the weaknesses in the file we’re seeing, but then let’s come up with a plan and let’s identify some ways to improve those ratios and then maybe come back in six months or a year and we can reevaluate everything again at that point.

Kristen Brown (14:59):

That makes total sense how great. It’s not just a no period end of subject. So again, that walking hand in hand, even if it’s not in the process immediately of that business relationship.

Sarah Franklin (15:15):

For sure.

Kristen Brown (15:16):

Now, one other thing that has come to mind that I feel like we just have to talk about when it comes to loans is interest rates. What are things that people need to know? Just it’s always evolving and changing to a certain extent, but some wisdom that you have for our listeners with interest rates?

Sarah Franklin (15:34):

Yeah, that’s a great question and it’s so interesting because the interest rate environment we’re in right now has just been a very unique one. I remember going through covid, I remember the world shut down. We were kind of on a rotation schedule with work working from home, and I remember having the news on and watching the price of oil go below zero. We were like, what is happening? And we thought from a banking and from a lending perspective that we were essentially going to shut down too. But it was so interesting because that environment that we were in also led us to have a record low interest rates. And so that was actually one of our busiest years we’ve ever had on record because interest rates were so low and because we were in an environment when the world shut down, you had people coming out of San Antonio and Houston who were just like, I need space.

I want land, I want out, or people were looking to expand their operations and so forth. And so I bring that all up to say, interest rates were record lows then. And then fast forward, we get into an environment where interest rates have just, they started increasing and they kept going up and kept going up, and luckily I think we’ve seen a plateau and they have dropped a little bit more. I’ll tell you, when those interest rates started rising, it was a little bit of sticker shock to be honest. And we had customers who they were first time buyers or first time borrowers when the interest rates were at those record lows. And so when they were looking to take out a second loan and maybe the interest rate, I mean quite honestly, it could have been double what their original loan was. There was sticker shock to it, and people were very nervous about it.

They were very scared, and it took some adjusting to it, and really our approach is the interest rate environment. It can be volatile and it is going to change. I would say though, try to be as smart as you can about it. I mean, when you’re working on your budget, I would recommend that you have some kind of budget, especially when you’re looking at making a purchase, you’re wanting to take out a loan, give yourself some cushion there and make sure if something happens, it might not be the interest rate environment, it might be some other adversity that comes up that you’ve got a layer of protection there just to provide you with a level of security if something bad were to happen. With the interest rates where they are right now, it’s been good for our operators who have operating lines of credit. Those are typically on variable rates, and so those have come down, which has tremendously helped their operations because the cost of interest, it is something you have to factor into your budget.

And so I guess all that to say in a nutshell, have a budget. Give yourself some comfort that if you were to face adversity, that you could face it and handle it. And gosh, I wish I had a crystal ball and could tell you what interest rates we’re going to do for sure, but we just don’t know. If you’re in a position where you’re going to be looking at a fixed loan, one of those real estate loans I was talking about, and you’re not as adverse to risk, I would say lock in that interest rate as long as you can just to give you that protection that like, okay, I’ve got a 20 year note. I’m going to lock in the interest rate for 20 years because I’m comfortable with that interest rate and I’m never going to have to worry about it Changing. The other side to that coin is if you are more comfortable with risk, you can certainly do a short-term fixed interest rate and ride the wave essentially. You’ll get the advantage of those lower rates when they’re low, but you do just need to be comfortable if the interest rates go up a little bit. Also

Kristen Brown (19:38):

Such good information. And it seems like there were so many black swan events, it rise back to back to back, and it’s been interesting. I mean, I think it’s probably impacted everybody’s thinking in life and just being prepared and all the different things, but it makes sense of analyzing your risk tolerance and proceeding.

Sarah Franklin (20:04):

Absolutely. Yeah.

Kristen Brown (20:06):

Well, as we wrap up, are there any other points that you think our listeners would value? Any other things that come to mind, words of wisdom that you have from your experience? Encouragement, any of the above?

Sarah Franklin (20:19):

Yeah, I would say don’t be afraid to ask questions. I mean, really take the time to find a banker or a lender that you’re comfortable with and can build a relationship with because we do want to be your partner and we want to help you succeed. And so take the time to find the right person for you and then don’t be afraid to ask questions. I promise you there are no dumb questions. The best customers we have are the ones that really take the time to understand the financials, like we’re looking at it. I mean, they’re invested in their operation, they want to succeed, and they want to understand the process also. So know there are no dumb questions. Know that we’re here to partner with you to Ag industry, as a lot of the listeners know is very volatile, and we’re here for the good times and for the bad. We get it, and we’re going to be with you hand in hand either way.

Kristen Brown (21:16):

Well, that’s wonderful. Thank you so much for your time and your insight today. Thank you so much. That’s all folks. Thanks again for listening. Be sure to join us for TSCRA talk every month to hear more stories about the industry people and issues that shape the cattle community.