Organic Farms' Credit Access and Farm Lenders' Assessment of Organic Farms' Credit Risks

Organic Farms' Credit Access and Farm Lenders' Assessment of Organic Farms' Credit Risks

Summary

The project’s implementation started in August 2011 due to the delayed availability of SARE funds. During the past several months, the major proponents from Fort Valley State University and University of Georgia worked together to complete the first phase of this project that involves obtaining the organic farmers’ perspectives on the organic credit access and credit risk assessment issues. Two focus group discussions with several organic farmers were held in March 2012 in Fort Valley and Athens. These meetings produced a wealth of information and ideas from farmers that will be used to implement the second phase of the project that deals with the agricultural lenders’ perspective.

Objectives/Performance Targets

1. To provide a better understanding of the sources of credit risks peculiar to organic farming systems and compile a representative collection of issues perceived by organic farms as significantly affecting their access to credit.

2. To determine lenders’ perceptions of organic farming risks, identifying whether any preconceived notions define their attitudes towards organic farm loan requests vis-à-vis their regular farm borrowers, analyze the relevance of their existing credit risk assessment models to the organic farms’ peculiar operating environments, and elicit their opinions and perspectives in improving credit access of potential organic farm borrowers.

3. To reconcile the farmers’ and agricultural lenders’ perspectives on credit risk assessment and credit access as collected in (1) and (2), and use such findings to formulate suggested strategies to resolve any credit access issues as well as any lenders’ divergent issues in credit risk assessment not properly attuned to organic farmers’ business conditions.

4. To implement a two-pronged outreach program directed towards lenders for the sake of clarifying credit risk assessment approaches more attuned to organic farmers’ conditions and towards farmers for the sake of helping them understand lenders’ credit risk assessment methods, consider strategies to improve their credit risk ratings, and realize the role of external debt in promoting business growth and expansion.

Accomplishments/Milestones

During the past several months, the Fort Valley and UGA team worked on organizing focus group discussions among organic farmers. A database of organic farms’ contact information and their geographic proximity to the proposed locations of the focus group discussions was developed. After several e-mails sent and phone calls made, a final list of about 10 farmers for each of the two sessions was developed.

The first focus group discussion was held at the Pettigrew Center in Fort Valley State University (FVSU) on March 7. This session was attended by eight organic farmers. A couple of FVSU university officials also graced the occasion. The one-day session featured presentations by the major project proponents from UGA and FVSU to provide backgrounds on the farm borrowing process, the current credit risk assessment models, and overview of sources of farming risks for the organic farm systems. The rest of the time was spent on eliciting ideas and information from farmer participants on the borrowing issues. The morning discussions focused on farm credit access issues while the afternoon discussions dealt with credit risk measurement issues.

A second focus group discussion was held at Conner Hall in the Department of Agricultural and Applied Economics of the University of Georgia. This session is a replication of the first FVSU session in terms of agenda and structure. Six farmers attended the UGA session as some last minute withdrawals were received from those that earlier committed to attend. Nonetheless, the discussions were as productive, stimulating and enthusiastic as the FVSU discussions have been.

The wealth of information collected from the farmer participants of those two sessions are now currently being used to develop a lenders’ survey instrument. A database of agricultural lenders’ contact information is developed as the proposed lenders’ survey is expected to involve about 2,000 commercial banks, Farm Credit associations and Farm Service Agency branches in several states in the Southeast. The survey instrument will be submitted for approval by the Institutional Review Board (IRB) and should be ready for distribution to the lender participants by summer of 2012.

Impacts and Contributions/Outcomes

The two focus group discussions with organic farmers produced a number of very interesting, useful and significant issues related to their credit access and the assessment of their credit risks. The following is a summary of the major ideas contributed by the farmer participants:

1. Production Diversity

Organic farms have more diversified operations usually involving a wide array of farm commodities. While product diversity is a challenge for farmer borrowers in preparing their business projections and plans to present as support for their loan applications, it is an important and desirable business trait, especially in terms of its risk mitigating benefit. The following arguments have been made about business diversity of organic farms:

a) Lenders do not seem to put a premium on the risk mitigating aspect of business or product diversity of organic farms; some lenders even perceive it as a negative business trait.

b) Product diversity should be an argument for the relaxation of the usual insurance requirement in a borrowing transaction. The risk minimization aspect of diversification should be considered by lenders and relax the insurance requirement for organic farm borrowers.

2. Size of Business or Operations

Most organic farm businesses are significant smaller than conventional farms. The business size issue puts forth the following arguments:

a) Lenders must have separate business size considerations or standards when evaluating organic and conventional farm borrowers. A small organic farm is never equal or comparable to a small conventional farm considering the returns structures (including price premium advantages and financial efficiency differences between organic and conventional farms).

b) Organic farms usually try to keep their operation size smaller and do not aggressively consider expansion plans. This is a result of the principles that guide their business decisions. Organic farms do not necessarily farm for profit. They value sustainability more so that they want to maintain their small farm size in order to achieve sustainability. They are always aiming to operate a business of the “right size in order to do the right thing.” Lenders must realize this important motivation and should not penalize an organic farmer’s loan application for its business size (small in conventional farming standards) and lack of expansion plans.

c) Small business operations of organic farms also result in relatively smaller loan amounts required from lenders. In the past, lenders have been wary of smaller loan applications because of transaction and opportunity costs related to the resources they allocate for the processing of loan applications. However, with the success of microfinance institutions and the banks’ renewed interest in these formerly ignored (by banks) business transactions, organic farms should be considered for the banks’ microfinance programs.

3. The Hobby Farming Stereotype and the Real Nature of Farming Goals and Principles

Organic farmers have shown frustration and disappointment with the usual label others, including lenders, would ascribe to them. They do not want to be called “hobby” or “lifestyle” farmers. They want lenders to realize that they are serious farmers who do not take their businesses lightly. This also calls for lenders to be more aware of the proper labels they should ascribe to organic farmers. Organic farmers are in business for entirely different reasons that motivate conventional farmers. Organic farmers are socially responsible farmers that are bent on providing their communities with healthy food and their practices are environmentally friendly.

4. Asset Appraisal and Measurement of Equity Investments

The organic farming model involves less investment in tangible farm assets, such as machineries and large tracts of land. Organic farm operations involve more intangible assets. For instance, they spend a great deal of money on soil enhancement inputs. The soil improvement process also has a longer gestation period. Enhancing the soil cannot be done overnight. For conventional farms, however, soil enhancement is done differently with chemicals and possibly overnight. This basic difference will have repercussions on the following issues that should be addressed by lenders:

a) Land Appraisal issues – Existing methods for the appraisal of land do not consider intangible investments. Land is assessed at face value, calculated the conventional way without any regard on the real quality of the soil. Lenders should take the intangible soil enhancement investments of organic farmers into consideration when appraising land properties, especially those offered as collateral properties. A small piece of organic land is definitely worth way more than the same size of conventional farm land.

b) Existing lenders’ credit scoring models include measures on solvency (Equity-Asset Ratio) and profitability (Return on Equity). Given the intangible investments of organic farms on their farmlands, “equity” measurement should be modified for these borrowers to factor in their intangible investments that would definitely differentiate their farmland from conventional farmland.

5. Nature of Farm Operations
Organic farmers would want to clarify if lenders have discriminating treatments of different types of farms. Are certified organic farms treated the same way as uncertified organic farms? Are transitioning farms regarded the same way as conventional farms? These important clarifications should be made.

These inputs from farmers are now being integrated into a set of survey questions for various lenders in the Southeast. The survey should be able to elicit important views, ideas or opinions from lenders about lending to organic farmers. The ultimate goals of this project would be to educate lenders about the proper way of evaluating organic farms’ credit risks and assist organic farmers in improving credit access and understanding credit risk issues as lenders would and should perceive them to be.

Collaborators: