The State of Ag Lending February 2009

Central Plains Regional Agribusiness The State of Ag Lending

February, 2009

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Overview   Share my thoughts regarding the current situation in Financial

Services, also specific to the swine industry   This is a volatile, fluid situation, getting more negative   Good chance that I will be wrong

  Discuss Ag Lenders   Background

  Lender’s perspective on Agriculture Lending

  Before we get into that I would like to put into my perspective some issues and impacts the global economy has:   Here are some quotes and predictions from the last year

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Worse Quotes of 2008   “I think this is a case where Freddie Mac and Fannie Mae are

fundamentally sound. They’re not in danger of going under I think they are in good shape going forward.”

  Barney Frank (D-Mass) House Financial Services Committee Chairman May 9, 2008

  Two months later, the government forced the mortgage giants into conservatorship and pledged to invest up to $100 billion in each.

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Worse Quotes of 2008   “The market is in the process of correcting itself.”

  George W. Bush in a March 14, 2008 speech

  For the rest of the year, the market kept correcting, and correcting, and correcting.

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Worse Quotes of 2008   Existing-Home Sales to Trend Up in 2008 – Headlines of a

National Association of Realtors press release 12/09/2007

  On 12/23/2008, the group said November sales were running at an annual rate of 4.5 million – down 11% from a year earlier – in the worst housing slump since the depression

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Worse Quotes of 2008   “I think you’ll see (oil prices at) $150 a barrel by the end of the

year”

  T. Boone Pickens, June 20, 2008

  Oil was then around $135 a barrel. By late December, it was below $40.

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Worse Quotes of 2008   “In today’s regulatory environment, it’s virtually impossible to

violate rules.” - Bernard Madoff, money manager 10/20/2007

  About a year later, Madoff – who once headed the Nasdaq Stock Market – told investigators he had cost his investors $50 billion in an alleged Ponzi scheme.

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Worse Quotes of 2008   “Never let a serious crisis go to waste. What I mean by that is

it’s an opportunity to do things you couldn’t do before.”

White House Chief of Staff – Rahm Emanuel November, 2008

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Where’s the friggin’ groceries?

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Worse Quotes of 2008:   An email from a customer in late 2008:

Dear Mr. Bang;

If I receive a returned check marked “insufficient funds” is that referring to my business or your bank?

Thank you;

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Recession   Historically, recessions occur when business over-leverages

during good times and pulls back on employment and investment when conditions turn.

  This time, over leveraged consumers caused the recession. Households are struggling with first mortgages, home equity lines of credit, student loans, credit card debt, vehicle loans and leases and other consumer loans.

  The root of the problem is the housing boom & subsequent bust

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The Housing Bubble

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The Housing Bubble

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The Housing Issue   Mark Zondi – Chief Economist with Moody’s Economist

  12 Million homeowners have mortgage debt greater than their home value at the end of 2008

  15 million “sketchy” mortgage loans made between 2005 and 2007 •  Of these, 40% or 6 million loans will go through foreclosure process

  Home values are still falling

  Mortgage Crisis Waves •  1. Flippers – 2006 •  2. Subprime with ARM’s repricing in 2007 •  3. Negative Equity and Income Disruptions

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The Housing Issue   Causes

  Everybody was doing it   Leverage   Inconsistent and inadequate regulation and oversight

•  Mortgage-backed securities   Divided so many times that securities were AAA rated.   Lender > Investment Bank > Rating Agency > Investor

  Forecast of never ending price escalation (self delusion) •  Anyone with a ruler could predict that real estate values were going

to continue to go up   Availability of Credit

•  Foreign capital •  Accommodative Monetary Policy

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Housing Crisis Causes   Investment Banks went public, adding leverage

  Solomon Brothers   Merrill Lynch   Bear Stearns   Morgan Stanley   Lehman Brothers   Goldman Sachs

Once upon a time there were brothers named Solomon and brothers named Lehman

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Additional Consumer Credit Issues

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Loan-Loss Reserves in Billions (FDIC)

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Impact of Economic Recession   Consumers are deleveraging

  Lower purchases – increase savings   1st time in 50+ years household debt declined in Q3 2008   Combination of bank conservatism and declining credit worthiness   Defaults increasing   Non-bank providers (e.g. mortgage companies) exit as market refuses to

fund

  Corporations reduce borrowing   Choice   Capital Markets less accessible   Combination of bank conservatism and declining credit worthiness

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Latest Economic Indicators Survey Actual

Non-Farm Payroll -540K -598K Manufacturing Payroll -145K -207K Initial Jobless Claims 620K 627K Continuing Claims 4,830K 4,987K Unemployment 7.5% 7.6% Consumer Credit -3.5B -6.6B Housing Starts 529K 466K

Lowest Housing Starts since before 1970

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Impact of the Economic Recession   Think about this!

  The nation’s largest credit card issuer (MBNA)   The nation’s largest home mortgage company (Countrywide)   The nation’s largest investment house (Merrill Lynch)

  Were all recently acquired by a large US Bank

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Focus on Agriculture   Beef Feedlot

  Cattle Fax indicates that feedlot losses were record large in 2008, near $150 per head, with current losses near $250 per head, assuming no risk management

  Dairy Producer   $10.78 class III Milk in January, USDA forecasts $9.70 to $10.40 for

2009 vs. $14.65 average in 2008. (Predicts lowest prices since 1978)   Broiler Industry

  Cleveland Research indicates broiler processors made a profit in three weeks during 2008. The industry is bloodied, but reduction in inventory has produced some margins in early 2009.

  Swine Industry   Significant losses in 2008 amounting to $21.51 per head (Lawrence –

ISU)   Using the same data, in the three years (2006-2007-2008) producers lost

money - $0.77 per head

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Macro View of Animal Agriculture (Lawerence – ISU)

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Macro View of Animal Agriculture (Lawerence – ISU)

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Macro View of Animal Agriculture Meat and poultry production

Total Total Meat & Beef Pork Meat Chicken Turkey Poultry Poultry

2007 26.421 21.943 48.683 36.126 5.958 42.582 91.265 2008 26.564 23.348 50.228 36.864 6.263 43.687 93.915 2009 26.110 22.980 49.401 36.175 6.040 42.740 92.141

2009/2008 98.3% 98.4% 98.4% 98.1% 96.4% 97.8% 98.1%

Meat and poultry prices Choice Live Steers Hogs Chickens Turkeys

2007 $ 91.82 $ 47.09 $ 76.40 $ 82.10 2008 $ 92.27 $ 47.84 $ 79.70 $ 87.50 2009 $ 89.00 $ 47.50 $ 84.00 $ 85.50

Source: World Agricultural Supply & Demand Estimates

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Who Lends to U.S. Production Agriculture?   Direct Lenders

  Farm Credit System •  99 Farm Credit Associations in the U.S. •  5 Farm Credit Banks

  Commerical Banks •  National Banks •  Regional Banks •  Community Banks

  Non-Banking Entities •  Suppliers •  Insurance Companies

  Secondary market for agriculture mortgage loans   Farmer Mac

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Farm Credit System

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Commercial Banks   Top 5 U.S. Agricultural Commercial Banks

  Wells Fargo   Bank of America   Bank of the West   US Bank, NA   Rabobank   Many others

  Largely funded by:   Deposits   Fed fund borrowings   Bank to bank loans

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Farmer Mac   Federal Agricultural Mortgage Corporation

  Farmer Mac is a stockholder-owned instrumentality of the U.S. chartered by Congress to establish a secondary market for:

•  Agricultural real estate •  Rural housing mortgage loans •  Rural utilities loans

  Total assets (loans) of about $3.0 billion   Farmer Mac I – Secondary lending to agricultural loans originated by:

•  Commercial Banks •  Farm Credit System institutions •  Credit Unions •  Insurance Companies •  Mortgage Bankers

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Farmer Mac Programs   Farmer Mac I – Secondary lending to agricultural loans

originated by:   Commercial Banks   Farm Credit System institutions   Credit Unions   Insurance Companies   Mortgage Bankers

  Farmer Mac II – Secondary lending on the USDA guaranteed portion of loans   FSA – Farm Ownership and Farm Operating guarantees   Rural Development’s Business and Industry guarantees

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Farmer Mac Underwriting   Loan to Value

  New Facilities <75%   Existing Facilities <65%

  Maximum Exposure - $15 million   Total Debt Coverage - >1.10   Current Ratio - >1.00   Leverage <60%   Term: 10 or 12 years   Amortization: 10 or 12 years   Other

  Must be contracted with a processor for the term of the loan   Must be non-cancelable and assignable to FAMC   All FAMC underwriting standards must be met   Operation must conform to all environmental rules and regs

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Ag Lender Issues   Impact of “deleveraging” US balance sheets will impact all

  Consumer spending declining sharply •  Inability to service current debt load •  Reduction of net worth (home value / investments) •  Fear of future

  Business spending has dramatically fallen in an attempt to deleverage their balance sheet

  Bank balance sheets •  Tier One Capital (Tangible Equity / Risk-based assets) •  Lender’s are attempting to guard and build capital

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Ag Lending   It is a new world

  Syndicated loan market •  Dramatically reduced in the 4th Quarter of 2008

  Participation in “club deals” has been made significantly more challenging •  Reflects the changing strategy in the lending world •  Capital preservation to make sure you can take care of clients

  Customer lending •  Fewer or no exceptions to loan policies

•  Change from growth model to risk management model

  Challenges in getting a lender to take on a new customer when most are trying to figure out how to take care of their current customers needs.

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Typical Swine Financing   Biggest changes:

  Larger deals over > $30 million aggregate are harder to get done •  Participating lenders are harder to find

  Exception to lending policies are going to be rarer •  Working capital •  Owner Equity •  Debt Service Coverage Ratio •  Personal liability

  Interest Rates •  Prime rate adjusted loans are probably history (for a while) •  Spread to Libor is up about 100 to 150 basis points over a year ago

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Pork Industry   Strengths / Opportunities

  Efficient low-cost pig production relative to the rest of the world   Efficient low-cost pork processing relative to the rest of the world   Reduced trade barriers, growing exports   Strong U.S. per capita demand through recession, historically

  Weaknesses / Threats   Reduced disposable consumer dollars   Difficulty in controlling pork supply   Ethanol production’s demand for grain   Environmental / Political pressure on the industry   Threat of foreign animal disease that may interrupt exports

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Defensive Strategies   Continually update your budget / projections

  Analyze liquidity and equity after projected losses   Review loan covenants and communicate with your lender   Take action early – soon – now!

  Watch for opportunities to lock in profits   Reduce risk exposure if you cannot afford the exposure   May be behind us, locking in a loss is always difficult

  Analyze Debt Structure   Leverage or re-leverage fixed assets   Structure for “worst case” as it may be difficult once there

  Sell underutilized assets   Or reduce contract payments

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Watch for indicators   Demand, domestic and imports   Sow liquidation in North America

  Canada 1/01/09 •  Breeding Herd down 107,000 sows (7.1%) •  Market Inventory down 1,302,000 head (10.6%)

  United States 12/01/08 •  Breeding Herd down 152,000 sows (2.4%) •  Market Inventory down 1,317,000 head (2.1%)

  North America •  Breeding Herd down 259,000 sows (3.3%) •  Market Inventory down 2,619,000 head (3.5%)

  Packer / Processor profitability   Slaughter capacity changes   Cold storage reports   Imports of Canadian Pigs

  Feeder imports are 516,115 through 2/07/09, down 31% from 2008   Market hogs and sows are 141,036 through 2/07/09, down 66% from 2008

Thank you!

Financing the livestock industry