• Ag Learning Hub
• March 26, 2024
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Overview of Agricultural Loan Origination

Loan origination is the process by which borrowers apply for credit and lenders review, approve and extend credit to borrowers. Agricultural loan origination follows a similar process to general loan origination but is tailored specifically to meet the unique needs and challenges of farmers and ranchers.

Unique aspects of the process include the types of financial and non-financial information the borrower provides, as well as the decision making process used to approve or decline a loan.

When a borrower has a request for a loan, also known as “credit”, the process typically commences with an application, sometimes in person but increasingly online. What the borrower doesn’t always see is the process behind the scenes. This is where the loan officer or relationship manager should have a solid understanding of the process to held shepherd the loan through each phase.

While each financial institution may have some unique aspects and terminology in their loan origination process, there are generally eight (8) distinct phases that almost every loan goes through:

• Prequalification
• Application
• Deal Structuring
• Underwriting
• Approval
• Closing
• Funding & Disbursement
• Servicing

This guide breaks down each phase at a high-level.

Pre-qualification Phase

The prequalification phase usually starts as part of a general inquiry for a new loan or renewal of an existing loan. This could start as a casual conversation between a farmer and a banker. Alternatively, this could be part of a more involved process as part of a farm purchase or major expansion of a farming operation. Each type and size of loan presents unique challenges. Overall though, the purpose of this step to help both the borrower and the lender understand the potential loan purpose, amount and terms that may be suitable.

During the pre-qualification phase, lenders will usually ask borrowers to submit some basic information about their request for a loan. They will often also ask the applicant to submit some basic financial information to assess the creditworthiness of the borrower. This information requested could include basic information about loan, nature of the farm operation, a set of financials such assets and liabilities held by the business, employment information and possibly a tax ID or social security number.

The lender may review the requested loan and general repayment capacity of the borrower. The lender will review the summary level data and determine whether the borrower’s loan request feels like a good fit for the bank. If there is an opportunity, the lender will usually ask the borrower to submit a formal application.

Application Phase

During this step, the borrower submits a formal loan application. The purpose of this step is to provide a more comprehensive set of loan request details and initiate the request for the lender to extend credit.

Applications may still be done in the office with pen and paper. However, more commonly, applications are submitted electronically via a banker website, also referred to as an application portal.

Deal Concept in Loan Origination

One of the key terms used in loan origination is the concept of a deal. Simply put, a deal is the overall transaction in-progress during the loan origination process. This could be a collection of one or more loans which the lender may ultimately extend to the borrower.

The size and complexity of deals varies widely. In agricultural loan origination, most deals tend to revolve around a set of one or two loans extended at a time to a farmer. However, some deals can include multiple loans, each with a specific set of terms and conditions tailored to the unique needs of larger or more sophisticated borrowers. Think of deals like a container for for all of the loans, entities and collateral moving through the origination process at once.

Other common terms used to describe a deal in agricultural loan origination deal include:

• Opportunity
• Loan Package
• Lending Agreement

Most lenders can get a general sense for the overall deal during the application phase. This is usually discussed up front with borrowers during initial discussions and inquiries. However, the full deal is usually framed up on the application has been submitted during the next phase, called Deal Structuring.

See more on deal structuring and how all of this fits together below.

Common Data Collected During a Loan Application

Regardless of the method used to submit an application, it is very common for the lender to request borrower information, loan request information, and financial information. The following table shows some of the common items requested during this process.

Entities on a Loan Application

A loan application will generally ask that each applicant that has an interest or a potential obligation on a loan to provide some information.

There are three main types of applicants on agricultural loans:

• Borrower: The individual or entity seeking the loan, responsible for repaying the borrowed funds.
• Co-borrower: Another individual or entity who is equally responsible for repaying the loan. Co-borrowers share the same obligations and rights as the primary borrower.
• Guarantor: A person or entity who agrees to be responsible for the loan if the borrower defaults. Guarantors may or may not pledge collateral as security on the loan. Ultimately, guarantors provide an additional layer of security for the lender.

Specific entities and their roles may vary depending on the type of loan and the jurisdiction in which the loan is originated.

Borrowing Relationships

Borrower information and financial information is often requested for each party that is a part of the loan. The group of individuals or businesses that are responsible for fulfilling commitments on the loan are collectively known as the borrowing relationship. This could be as simple as an individual or a husband and wife. Alternatively, this could also include multiple individuals with multiple businesses when the loan is more complex.

Simple Borrowing Relationships

Simple borrowing relationship tends to have a smaller set of individuals which are a part of the borrowing relationship on a loan.

In the case of most agricultural loans, the borrowing relationship is a single individual or a husband and wife. In many cases, the farm, ranch or agricultural operation may be a sole proprietorship, however, this may also be a limited liability corporation. Less commonly, the farm may be an S-Corp.

The amount of entity and financial information may be relatively limited in these cases, usually including a simple balance sheet and an income statement or tax return. Farm production information, sometimes referred to as schedules, may also be requested. This information helps break down the revenue streams and performance of the operation.

Complex Borrowing Relationships

More complex borrowing relationships will include multiple entities. This type of setup is common in larger agribusiness deals with corporate borrowers.

In this case, there is still a primary applicant, which could be the business owner or the corporate entity as a whole. In many cases, there are co-owners that may be part owners or shareholders in the organization as well.

Corporate entities may also have a multi-tiered structure, where the corporation or holding company owns multiple individual companies. This could include full ownership or part ownership in other companies or subsidiaries.

In the case of a more complex borrowing relationship, there are often a multitude of entity documents and financial documents included in the application. It is very common for these complex borrowing structures to provide articles of incorporation, by-laws of the organization and other documents to support the legal hierarchy of the company.

Individuals may need to provide their own tax returns if they are a guarantor or personally applying on behalf of a company.

Corporations will often provide accountant prepared balance sheets and income statements with a multitude of supporting documents describing the nature of the business operation as well.

Entity Screening & KYC

Once the application has been submitted, many lenders are required to conduct entity screening. This helps verify the legality of lending and doing business with the customer. It is also an important risk mitigation factor conducted early in the process as well.

Entity screening involves the process of assessing and verifying the identity of individuals, businesses, or organizations involved in a financial transaction or seeking a loan. This process helps financial institutions evaluate the legitimacy of the entities they are dealing with and identify any potential risks associated with them.

Lenders will review documentation such as drivers licenses, passports, social security numbers and tax IDs. The lender will also check the entities against various watchlists, sanction lists, politically exposed persons (PEP) lists, and other databases maintained by regulatory authorities and law enforcement.

On of the common entity screening methods is called Know Your Customer, or KYC for short. This is a set of procedures designed to verify the identity of customers and assess their suitability and potential risks. The main objective of KYC is to prevent money laundering, terrorist financing, and other financial crimes.

Deal Structuring Phase

Once all of the preliminary application information is submitted, the lender will start the deal structuring phase. The purpose of this phase is to bring all of the information together that frames up the overall deal.

This in turn helps the lender understand how to create the loan agreement and ensure each of the proper checks and processes are followed prior to closing the loan.

This is the first part of the loan origination phase that takes place behind the scenes at a bank with little, if any, customer engagement. Typically, the lender recording all of the application and loan information into a Customer Relationship Management tool or dedicated loan origination software.

Typical components of a deal include:

Ultimately, each lending institution may track and enter different sets of data which may include potentially hundreds of individual pieces of data, depending on the loan type and size.

Loan Facilities Explained

Loan Facilities are often misunderstood and it is important to help the reader understand what these really mean. In simple terms, a loan facility is like a pool of money available for borrowing. A loan facility can indeed have multiple loans associated with it. Instead of taking out a single large loan, borrowers may choose to utilize a loan facility to access funds as needed over time. Each time they withdraw funds from the facility, it’s considered a separate loan. However, all of these loans are tied to the same facility. This approach offers flexibility to borrowers, allowing them to access funds in smaller increments as needed, rather than taking out one large lump sum.

Example Loan Facility

Take for example a young farmer that comes into a bank with an aspiration to start a new farm. The bank may review the business plan and recommend that the farmer take out:

1. A Real Estate Term Loan for the purchase of the farm.
2. An Operating Line of Credit to fund ongoing needs until the farm is operational.

The bank may be able to pool this overall request within a single loan facility, which is all tied to a general overriding agreement to between the bank and the farmer to access those fund.

This example is actually fairly common.

Loan Collateral

During the deal structuring phase, the lender will often collect and track what collateral will ultimately secure the loan. Collateral in loan origination refers to an asset or property that a borrower pledges to a lender as security for a loan. In the event of default, or non-payment, of a loan, the lender may retain the legal right to seize and sell any assets held as collateral. Usually these assets are sold at auction. The lender then retains the proceeds of the sale to recoup their losses on the loan. Collateral is a form of risk mitigation for a lender.

In agricultural lending, common collateral includes:

• Farm Land or Ranch Property
• Crop Inventory
• Livestock
• Equipment
• Feed, Seed, Supplies, etc

See our Overview of Collateral in Agricultural Lending guide for more information on agricultural collateral including common types, definitions, lien types and discount rates for collateral.

Collateral Liens

To secure the lenders right to seize property, a lien is usually filed. In short, a lien refers to a legal claim placed on the borrower’s agricultural assets or property as security for the loan. Lien instruments ensure that the lender has a right to seize and sell the specified assets if the borrower defaults on the loan. Liens are usually filed with the local government clerks or state/provincial offices. Where the lien is filed usually depends upon the jurisdiction and local laws.

In many cases, lenders may also look to take a blanket lien as security for the loan. Essentially, this gives the lender the right to seize any or all of a borrower’s assets if the borrower defaults on a loan.

Collateral Flood Zone Determination

All collateral has some level of risk involved. One of the key risks that lenders assess during agricultural loan origination is flood risk to collateral. This is particularly important with real estate collateral, especially those containing dwellings or structures which may be impacted by flood. However, some banks and financial institutions will assess whether any physical collateral, including equipment, livestock and vehicles are in a flood zone as well.

To assess whether collateral may be in a flood zone, the bank may order a flood certificate. In the United States, this service is provided by the Federal Emergency Management Agency (FEMA) through their flood map program.

If a specific property is located in a flood zone, lenders will often require flood insurance be placed on the property as an additional form of protection.

Unsecured Loans

In some cases, lenders may extend loans which are unsecured. This means that no collateral is taken to secure the loan. This practice is more common in personal loans, credit cards, debt consolidation loans or as part of a marketing promotion. However, loans with no collateral often entail a greater amount of risk to the lender. To compensate for this additional risk, unsecured loans almost always carry a relatively higher interest rate.

Lending Deal Structure & Hierarchy

As described above, the complexity of deal can vary widely depending on the total number of loans within the deal, the entities involved and term and conditions under which money will be lent.

However, deals are typically structured around entities, the loans and collateral securing the loan. This setup helps drive documentation, loan types, repayment and collateralization of loans being extended.

To understand the concept of a deal hierarchy, consider the following example:

A farmer is seeking funds to purchase a cattle farm in Texas. The farmer’s spouse is also applying jointly on the loan. The lender believes that the farmer will need a real estate term loan to purchase the property as well as a line of credit to pay bills while the farm operation is starting and the first herd is maturing.

The lender will structure the deal around the farmer and spouse borrowing relationship. The borrowing relationship will be primarily responsible for repaying the facility including the real estate term loan and the operating line of credit. The facility will be collateralized, or secured, by the farm real estate and the livestock being raised on the farm.

Framing the deal up with the various entities, loans and collateral will help ensure that the lender is taking the right steps to understand the deal, analyze repayment, determine risks, and ultimately secure their interest in loan repayment from the borrowers.

Underwriting Phase

Once the deal has been structured with all entities, loan characteristics and collateral identified, then begins the underwriting process.

During underwriting, the lender is ultimately answering one question: “Do we want to lend money to this?”.

This article will cover the concept of underwriting at a high-level. However, due to the depth of the topic of underwriting, AgLearningHub offers a dedicated article providing The Comprehensive Guide to Agricultural Underwriting.

Credit Score Based Underwriting

In many cases, this can be answered with a credit score. Banks often allow loans that are below a certain dollar amount to be automatically decisioned if the credit score is above a certain threshold. For example, a lenders policy may state that loans below $250,000 with a borrower credit score of 680 or higher may be auto-approved. If a borrower with a 750 credit score applies for an equipment loan of $150,000, this lender would auto-approve and bypass the more traditional underwriting process. See the section on Approval of Credit Scored Loans below.

Traditional Underwriting

Traditional underwriting is the process whereby the lender will take a deeper look at the creditworthiness of a deal. This is most always often the case where loans are more sophisticated or pose a higher risk to an organization. This is typically the case where loans may be above a certain dollar size, the borrower doesn’t have adequate credit, or the deal requires a more tailored approach to determine whether the loan is creditworthy.

In these cases, the underwriting process usually starts with a review of the balance sheet, income statement and underlying collateral.

Finishing the Underwriting Phase

Approval Phase

Once underwriting is complete, most loans are then sent through some form of approval. Based on the information gathered and analyzed during the underwriting phase, lenders make decisions about whether to approve, modify, or decline the deal.

Different types of loans will involve different levels of approval. Each lending institution sets their own loan policy on how to approve deals. Typically, the smaller and less complex the deal, the simpler and faster approval may be. Conversely, larger or more complex deals require a more involved process.

Auto-Decisioned Agriculture Loans

The fastest and least involved form of approval are auto-decisioned deals. Usually, auto-decisioned deals are:

1. Below a Certain Dollar Amount.
2. The Credit Score of the Borrower is Above a Certain Threshold.
3. The Loan Type Can be Auto-decisioned.

Many banks will allow loans below $250,000 to bypass full underwriting, and if the borrower’s credit score is above a certain threshold (700+ for example), the bank may permit the loan to bypass human approvers.

For example, if a farmer is looking for an equipment loan of $100,000 and has a 750 credit score, the bank may auto-approve the deal and take the loan to closing. On the other hand, if the farmer has a credit score of 680 (riskier credit) then the bank may want to have a loan officer or approver review and provide approval before extending the loan to the borrower.

Overall, the auto-decision approach reduces overall costs to review and approve smaller, less risky loans while freeing up staff to review and approve the more complex deal.

Traditional Approval

Traditional approval for agriculture loans is similar to commercial lending. Depending on the size of the deal and the risk factors involved, one or more bank employees may need to get involved.

Delegated Authority

This is where the concept of delegated authority comes into play. Delegated authority is a term that describes the overall loan approval authority at a bank. This sets dollar thresholds and risk tolerances that a bank enables an individual or group of individuals to approve.

Delegated authority is sometimes also referred to as an approval authority or an approval matrix. Each bank maintains their own set of authority and tolerances.

For example, assume that a loan for $750,000 is going through final approval. If bank policy may stipulate that less experienced loan officers are not empowered to approve these, the loan must be approved by a more experienced loan officer with at least $750,000 of approval authority.

However, some organizations allow loan officers or approvers to pool their authority, meaning that the combined approval of two people can be used to approve a loan. For example, two loan officers with $500,000 in approval authority each may combine to approve up to $1,000,000.

Many organizations require that the largest or most complex loans be taken to a loan committee where a loan is reviewed and approved or declined as a group.

Decisioning

Ultimately, loans are decisioned meaning they will be either approved, declined or deferred back to deal structuring or underwriting for more information or modifications.

If a loan is declined, the lender is usually required to inform the applicant and provide some rationale related to their decision.

On the other hand, if a loan is approved, the deal will then move onto closing!

Closing Phase

The closing phase of a loan is when both the lender and applicant enter into an agreement. During this phase, there are several steps take place to ensure all proper closing procedures are set.

Closing Date Set

One a loan is approved, a closing date and location is mutually agreed upon by the lender and applicant.

Document Preparation

Loans are usually entered into contract via documentation. Documentation can be either in physical or electronic form. Documents are usually either prepared by the lenders document preparation team or an attorney who will prepare the closing documents.

Each loan may have unique documents required to enter into an agreement, however, common documents which are a part of loan closing include:

1. Promissory Note. This document outlines the terms and conditions of the loan, including the principal amount borrowed, interest rate, repayment schedule, late fees, and other relevant details. The borrower agrees to repay the loan according to the terms specified.
2. Loan Agreement. This is a more comprehensive document that outlines the rights and obligations of both the borrower and lender. This usually includes the terms specified in the promissory note and additional provisions related to default, prepayment, collateral, and dispute resolution.
3. Mortgage or Deed of Trust: This document secures the lenders legal interest real estate property. A mortgage is usually tied to a home or dwelling whereas a Deed of Trust is related to commercial property.

Once all documents are prepared, the loan can move forward to the closing ceremony.

Closing Ceremony

The closing ceremony is the final step in the closing process. This is where the lender will meet in an attorney’s office, title company office or even the borrower’s home. Documents are reviewed and documents are signed. In cases where electronic documents are used, this process may take place entirely online.

Right of Rescission

The right of rescission, also the right to cancel, is a legal provision that gives borrowers the right to cancel certain types of loans within a specified period after closing without penalty. Even after signing documents, borrowers often have the legal right to withdraw from the loan contract without penalty.

Funding and Disbursement Phase

Once closing has taken place, several steps take to ensure funds are disbursed the appropriate parties. This often times involves a specialized group of individuals at the bank that facilitate loan operations roles.

Loan Operations in Agricultural Lending

The loan operations group are usually tasked with ensuring that the appropriate steps are taken once closing is complete. This generally involves booking loans, recording collateral liens, and distributing funds. Each bank may have a unique setup or set of teams that handle these activities, however, many organization use a centralized loan operations team to handle all post-closing activities.

Loan Boarding

Loan boarding, sometimes referred to as the booking group, is responsible for ensuring that loans are properly recorded in the bank’s accounting systems. After loan closing, this group will usually receive instructions to record the new loan in the bank’s software accounting system.

These accounting systems (often referred to as core) are the ultimate system of record for loan records, loan payment frequency, outstanding loan balances and loan payoffs. These systems usually require hundreds of individual data points be accurately captured. A bank’s core loan accounting system is generally regarded as the most important information technology asset in the organization.

Collateral Management

Once loan closing takes place, collateral liens are often recorded. This group will typically file liens with the local government jurisdiction to ensure that the proper paperwork is in place. Should the loan go into foreclosure, the collateral liens help ensure the bank can take possession of the collateral for resale.

Collateral lien recording can usually take place at the same time that boarding takes place (see above).

Disbursement

Once all other post-closing activities to record the loan and ensure the proper paperwork has been completed, funds are ultimately distributed or to appropriate party. Banks may wire funds to escrow accounts or other banks involved in the transaction. In the event that funds are distributed directly to the borrower, these funds may be routed to the borrower’s bank account.

Servicing Phase

Once the loan is originated, then the loan servicing phase begins. The servicing phase lasts for the lifetime of the loan. Several important steps take place during this process:

Payments Collected

The most obvious activity taking place during the life of the loan is receipt of payment. This is the principal and interest that the borrower repays. For term loans, this usually takes place at a predefined interval or point in time. As payments are processed, the outstanding loan balance is reduced.

Loan Covenant Monitoring

Many types of agriculture loans stipulate that borrowers abide by specific covenants. These covenants are agreements to perform certain actions or to keep the financial performance of the operation within specific parameters.

Specific examples include keeping a certain level of insurance coverage on a building or not engaging in prohibited business activities. An example of a financial covenants would be to maintain a specific level of operating expenses or maintain a specific current ratio.

At a set frequency, the bank will usually test covenants during the servicing period. For example, the bank will require proof of insurance once a year be submitted by the borrower. Another example includes requiring quarterly financial statements be sent to verify financial performance is within the loan agreement.

If the covenants are within the terms of the loan agreement, the covenant is said to have “passed”. If the covenant is not within the terms of the loan agreement, then the lender may take putative action, up to and including closing the loan and requiring repayment (this is known as “calling the loan”).

Loan Payoff

Ultimately, the loan is expected to be repaid at a certain point and time in the future. Once the full outstanding balance has been paid or the loan agreement has been fully met, the loan will then start the payoff process.

This usually includes the bank closing the loan record on their core system, releasing collateral lien records, and sending some form of written documentation to the borrower that the loan has been paid in full and is now considered closed and fulfilled. Certain collateral, such as stock certificates held in a vault will be returned to the borrower.

Loan Delinquency & Default

The servicing phase also includes handling of any delinquent loans or loans in default. This is most commonly the case when the borrower ceases loan payment.

A loan is considered delinquent when a borrower doesn’t make a payment under specified terms within the loan agreement. Delinquency can occur after missing a single payment or multiple payments. Lenders often classify delinquency based on the number of days past due, such as 30 days, 60 days, or 90 days delinquent.

Loan default occurs when a borrower fails to repay a loan according to the terms agreed upon in the loan contract. This usually happens after a loan has been delinquent for an extended period, typically 90 days or more. Defaulting on a loan can have serious consequences, such as damage to the borrower’s credit score, legal action by the lender, and potential loss of collateral.

Loans which are delinquent or in default will usually undergo a very rigorous process to collect outstanding loan due (sending to collections), seize and foreclose on collateral at auction and reporting to the credit bureaus.

In most cases, banks lose money on the loan when loans go into default and it is a lose-lose for both parties. Borrowers should do everything in their power to maintain on time payments and contact their banker as early as possible to alert them that a payment may be missed. Banks are often best advised to work closely with borrowers to help make timely payments and get the farmer back on track if there are issues.

Summary

The agricultural loan origination process is methodical series of steps that helps to bring opportunity to both the borrower and the lender. Lending is a partnership. In this partnership, both parties stand to benefit if approached properly.

Lenders should work closely to understand the nature of the loan request and carefully evaluate the risks and opportunities associated with extending credit. Borrowers should also carefully assess the terms offered and their ability to repay.

Even in the best of circumstances, a certain level of risk is present in lending and both take adequate steps to mitigate these risks and improve the prospect of fulfilling their obligation to one another.

Further Reading

• https://www.fema.gov/flood-maps