Outlining considerations for contract production

The finish line to raising hogs on contract is within reach. The initial decision-making process and commitment is complete, a pig supplier is on board, the site is selected and the permitting process and builder are secured. Financing, insurance and community outreach are the closing elements. But because you’ve paid attention to the many details along the way, these final tasks can proceed smoothly.

 

To secure financing, the contractor may offer a list of recommended lenders that are familiar with the contractor’s business. That might make the financing process a bit easier, but the requirements will be just as strict.

 

As a prospective contract grower for The Maschhoffs, Caleb Corzine received a list of three banks that had worked with the company. “The lender I chose knows the ins and outs of my pig supplier’s barns, how they cash flow, the contracting process and was comfortable with all of it,” Corzine notes. In turn, that made Corzine and his wife, Tarcie, even more comfortable with their new venture. “The lender understands agriculture, and they’ve been good to work with.” The Corzines’ 12-year loan matches their initial production contract length for the wean-to-finish facility that they run near Assumption, Illinois.

 

Because contract pork production has had a solid track record over the years, there are many lender options today. The Farm Credit System, large commercial banks, and small and local banks are all interested parties. “Contractors can’t raise pigs without the space, and contract pig growers are in a much better position than some other areas of ag,” says Kent Bang, vice president, Compeer Financial Services (formerly AgStar), Omaha, Nebraska. “They’ve been
good customers for the finance community, and we all know that.”

 

There are benefits to having a lender who’s familiar with the ups and downs of agriculture. “A decade ago these loans ran 10 years. We write a lot of 15-year, fully amortized, fixed-rate loans,” Bang points out. “That’s hard for most commercial banks to do.” Depending on the lender, they also can help with other details such as site surveying, title work and a lien review. “Those are all things you need when the loan is ready to close,” he adds.

 

The Five Cs of Credit

The loan process starts with the five Cs of credit, says Daryl Timmerman, senior swine lending specialist at Compeer Financial Services, Mankato, Minnesota. That includes character, capital, capacity, collateral and conditions, with the end goal of determining your repayment capacity.

• Character — The lender will look at the applicant’s involvement within agriculture. Does he/she have experience working with pigs? What’s the grower’s work ethic and philosophy? “Raising pigs on contract is often viewed as an added job,” Timmerman says. “But we need to be sure the person is up for the additional commitments and responsibilities and views it as their main job.”

• Capital — This targets the balance sheet, the grower’s working capital and overall equity positions. “Often growers are early in their careers, so they may be long on ambition and energy but not as rich in their overall capital position,” according to Timmerman. “This is where a solid contractor comes into play; they can provide a consistent income source.”

• Capacity — Of course your loan repayment capacity is the focal point. When reviewing your loan application, the lender will evaluate whether the contract rental income is sufficient to cover day-to-day operations as well as cover production expenses and service the debt for the 12- to 15- year loan period.

The challenge today is the downturn in other agricultural areas, such as row-crop income, and cost-of-living increases, which have squeezed cash flow. “The grower really needs to understand that the cash flowing in and out of the barn has to take care of the barn,” Timmerman says. “For the bigger picture, you have to have sufficient income streams to cover other needs, such as family living costs.”

• Collateral — Lenders require adequate collateral because it ensures a second loan-payment source should something go wrong. Be sure to talk with your loan officer to confirm the collateral requirements of your pig supplier. Typically, collateral involves the hog facility, the site/land and additional assets.The land must have a clear title and carry no debt before construction can begin.

“Because contract hog barns have a long success rate and high marketability, they have a higher loan rate than, say, bare land,” Timmerman points out. Loans can go 70 percent to 80 percent of appraised value, which means the additional collateral or down payment needs to cover 20 percent or 30 percent of the project.

• Conditions — The lender will need to review all of the conditions of the contract. In most instances, the pig supplier will send a portion of the yardage check directly to the lender. “For example, if you have a $5,000 monthly loan payment, the pig supplier will send that directly to the lender,” Timmerman says. “The grower receives the rest to pay operating expenses, real estate taxes and insurance. It minimizes the risk for everyone involved.”

 

Closing the Loan

The lender’s closing department will spell out the timeline and what documentation you will need to have completed within 100 days before closing, 60 days and so forth. “It’s not something that a grower will need to be involved with every day,” Bang says. “But it’s a process and the more detailed you are the better.”

 

One of the steps prior to closing the loan is to get an “as-will-be appraisal.” Essentially, the appraiser will review all of the building, land and equipment details, as well as all bids to determine a final value. This process will take a couple of weeks.

 

At the same time, a title review will proceed to ensure there is a clear title on the property and that any liens are cleared off or paid up. Actual loan closing is a two-phase process, Timmerman says. The first phase centers on facility construction.

 

When site preparation gets underway, contractors show up and equipment arrives, instead of the grower paying bills at home, the lender issues payment directly to the vendors.

 

“During construction, a variable-interest rate is charged only on the used portion of the loan,” he adds. “Once construction is completed, that portion of your loan is fully dispersed.”

 

This brings you to phase two — the post-construction or permanent-financing phase. The interest rate will be converted from a variable rate to a long-term fixed rate. “You’ll know the exact monthly principle and interest payment,” Timmerman says.

 

A word about interest rates: You need to be aware of fluctuations and that there are restrictions around when you can lock in interest rates. “So you need to have things moving — the loan is approved, construction is underway — you don’t wait until the last day,” Bang says. And, for now, interest rates remain historically low.

 

Insure the Investment

Most lenders require builder’s risk insurance during construction. Once completed, the building and equipment inside are the contract grower’s long-term investment, so property and casualty insurance are a must. Overall, the pig supplier is responsible for the pigs, but be sure to review the contract terms to identify potential liabilities for pig-death loss within your barn.

 

“Along with the barn and equipment, I have insurance on the generator and composter, as well as on the pigs — against suffocation or freezing should the generator or fans fail or the curtain doesn’t drop,” Corzine says. “It protects me.”

 

Business-interruption insurance is not required but is a good idea for the grower, Bang points out. For example, “If the barn burns down, business-interruption insurance would help compensate you during the rebuilding period, when you couldn’t feed out pigs.”

 

Soon to be entering his second year of contract production, Corzine is not only satisfied with his business arrangement, he enjoys it. “I feel that it’s a true partnership,” he says. “Through my pig supplier I receive specific goals as well as guidance on how to reach them. Contract production gives me an opportunity to raise pigs. It reduces my risk, and it’s also rewarding.”

 

Steps to Secure Credit

Prepare for the credit-approval process early, says Kent Bang with Compeer Financial Services. Along with a signed contract spelling out the rental details and income, you will need to assemble the following:

• Three years of income taxes, a current balance sheet and cash-flow projection for the completed and operational barn.

• Construction costs and timeline.

• Water and electricity access summaries.

• Permitting documents and manure-usage intentions.

• Summary of pig-production and farming experience; labor resources that will be used within the barn.

• An outline of any off-farm income.

 

“Overall, we need to know that the farm business is viable,” Bang says, “and that it’s not a drain on the contract barn.”

 

There also may be state financing programs or grants available for young, beginning farmers through the Rural Finance Authority or Farm Service Authority. Your lender can determine whether your operation qualifies.

 

Frank’s Note

If you’re planning to build a new hog building or expanding an existing site, it’s critical to inform the public of the plans and invite questions. Whether it’s a contract unit or another type of system, it’s been shown time and again that proactively sitting down with neighbors, the county board and/or city council is a positive approach. It’s important to explain and show them what you’re planning, and then listen to and address their concerns. Open the doors, before the pigs are loaded in, to let them see for themselves, or show them the facility online or in a slide show.

 

You’d be surprised to know that your neighbors probably don’t know about modern pork production, despite living in rural areas. They don’t know how things have changed, the new technology and the animal care provided. They don’t know how your business and that building contribute to the local economy and the tax base. As a side benefit, you’ll meet a lot of folks. And, putting a face to the business helps maintain positive communications and relations in the future.

 

Communication is vital to the success of any business, whether you’re involved in farrowing or finishing out pigs or making equipment to do the work inside those barns. It’s human nature to think that successful communication hinges on the conversation, but listening is equally, if not more, important.

 

In the spirit of keeping communication lines open, remember that if you need design guidance or have questions about facility construction or equipment, give us a call at 1-800-EAT-PORK (328-7675) or use the contact form or LiveChat on our website.

 

Frank Brummer, President, Farmweld, Inc.

 

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