Loan Types and the 5 Cs of Credit

Mr. Duane Hund

K-State Research and Extension Farm Analyst

Program Director

The 5 C’s

Of Lending

Duane and his wife, Dian

e, operate a

farm/ranch business located in Wabaunsee &

Pottawatomie Counties. They graze about

1000 head of yearlings each summer with

50% of those being their own. They have a

tenant who farms their ground and they raise

corn for silage and cash grain along with

soybeans.

Presenter Background/Disclosure

All business owners should know these

before they request financing.

1.

Collateral

2.

Capital

3.

Cash Flow

4.

Conditions

5.

Character

There are 5 C’s of Credit

When building a business plan,

incorporating these headings

will greatly enable you to build a

successful proposal.

Secondary source of repayment.

Equity (collateral) placed to back up the loan,

which could be tapped.

Collateral:

•

It depends upon the type of loan.

•

Liquidation is expensive.

•

Lender needs a margin.

Some lenders require a higher

percentage of collateral.

1.

A line of Credit LOC.

2.

Intermediate loans for Machinery,

Equipment and Breeding livestock.

3.

Long term loans for land and

improvements lasting 20 years or more.

3 types of loans farmers need

Different policies for the amount of

collateral required to make a loan.

The size of the bank versus the size

of the loan.

•

Lenders  require  down payment.

•

Lender has some margin in the loan.

•

Pledge additional machinery or real

estate if customer needs to borrow

100% of the purchase price.

•

Loan maximum allowed is loan to value

ratio.

•

Real estate usually has a maximum of 75%

loan of the purchase price.

•

Machinery without a down payment usually

has a maximum of 65%.

•

LOC can be 100% when using the value of

crop insurance.

Each bank has their own policies

concerning these percentages

and will vary depending upon

the borrower involved.

Capital is defined as the equity a borrower

has available in the business.

This is important for 2 reasons:

1.

It gives the farm a cushion to withstand

a temporary negative trend.

2.

Lenders like to see the borrower has

some “Skin in the Game” that

demonstrates motivation to stick it out

if the trends turn bad.

Capital:

Banks look at the owners investment

compared to their total net worth.

Banks also run debt to equity ratio analysis

which shows how much debt the farm has

compared to equity.

•

Ratios of less than 60% are preferred

and 40% or less is best.

No exact “number” for having

enough capital.

Difference between a cash flow statement and an

income statement?

•

Income statement looks at the business

income and expenses.

•

Cash flow Statement incorporates business

income and expenses along with owner

withdrawals, income taxes and required debt

principal payments.

Cash Flow:

Lenders will look at past years tax returns and

financial statements for trends.

A common ratio is term debt coverage.

•

This ratio measures the ability of the business to

cover all term debt payments each year.

•

Ratios which show more than $1.25  available for

each $1 of debt is preferred.

Looking for Trends

•

What is the environment the business is

operating in?

•

Is the competition able to operate profitably?

•

What risks are present and how can these be

mitigated?

•

Are their economic or political factors affecting

the business?

Conditions:

Be ready to discuss the primary

threats to the farm business and

how you intend to lower the risk

factors present within the current

conditions that exist.

The most important of the 5 C’s, it

includes:

•

Trust

•

Transparency

•

History

Character:

•

Lenders communicate with each other.

•

Your credit history will be reviewed.

•

A family’s history can affect the bankers

decision.

Keep in mind:

The lender wants to know

that if things go wrong you will do

whatever you can to honor your

commitments to them.