Common collateral monitoring mistakes in ag lending

This blog is part of the ongoing series on common agricultural lending mistakes for lenders to avoid. This part focuses on some best practices for monitoring collateral.

Lenders often encounter a version of the same problem. A lender will obtain a balance sheet from a particular borrower. The balance sheet will look good: plenty of collateral to secure the debt. However, when a lender decides it’s time to enforce its rights against the collateral, the lender discovers the collateral is (1) not as numerous, (2) not the expected quality, or (3) not there.

There are several simple steps that lenders can take to minimize the risk that collateral is not able to cover the borrower’s indebtedness.

First, lenders should be prepared to do onsite inspections. While this may seem like an obvious suggestion, many lenders do not make the effort to inspect a borrower’s operation. Inspections, more often than not, happen after the borrower is already in crisis. Lenders then discover things are not as the lender expected. An onsite inspection can reveal a number of problems with a borrower’s operation before a crisis starts.

For example, borrowers may report on the balance sheet that they have a certain quantity of grain in storage. An onsite inspection may reveal that that the grain is of poor quality, or that it is exposed to the elements.

A borrower’s balance sheet may also show that the borrower has a large number of livestock. An onsite inspection may reveal, however, that the livestock are sickly or not as numerous as the borrower reports.

A borrower’s balance sheet may also show that the borrower has a certain number of acres planted in corn or soybeans. The lender may make an assumption about the yield that a particular number of acres will generate. Walking into a borrower’s fields may reveal problems with pest or weed management. With information about the quality of the crop, the lender can take a hard look at its collateral position.

While these may seem like easy steps to take, all of the examples identified above are based on actual cases attorneys at this firm have encountered. Once a loan is moved into collection status the warts on a borrower’s operation become apparent, so it is a good idea to have a clear idea about what those problems will be before extending additional credit or foreclosing.  

Second, lenders should take a minute to evaluate the collateral and consider whether it is properly described. For example, lenders may identify an error in a legal description. Attorneys in this firm have encountered situations where lenders moved too quickly in preparing legal descriptions, and found out later they only had a lien against a 50% interest in a borrower’s real estate.

Lenders also need to carefully check that they have identified the borrower’s name correctly on UCC filings. As this blog has previously reported, having the debtor’s name correct is crucial.

Third, lenders should determine whether a livestock borrower’s operation is falling behind on paying its feed supplier. This blog previously reported on a decision from the Iowa Supreme Court that an agricultural feed supplier’s lien on livestock can take priority over a previously recorded bank lien. Then, recently, this blog reported on the Iowa Supreme Court’s decision that in a farrow-to-finish operation, a feed supplier that files a UCC financing statement within 31 days of supplying feed – and does so for all feed supplied – has a lien with priority over the bank’s lien for the entire value of the livestock.

As a result, when a substantial portion of the lender’s collateral is livestock, the lender needs to be actively involved to determine whether the borrower is paying his feed suppliers. If feed suppliers are not timely paid, the lender may need to consider whether to advance funds to pay feed suppliers in order to protect its priority position.

Lenders don’t necessarily have to have the same level of oversight of all of their borrowers. Rather, lenders can prioritize the borrowers that have historically had problems or who have a high risk score. Early evaluation of the borrower’s collateral may help a lender to decide when it’s time to end its lending relationship with a borrower.

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.

- John Lande