There are essentially two ways to print or create money. Debt, or Equity. Equity should be the preferred for any agricultural enterprise as it creates more value in the long run for all stakeholders, ranchers, and farmers. However, banks are in the business of lending and borrowing and lending agribusiness debt over and over and over until your credit ratings are jeopardized to the point where your cost of borrowing puts your business in a position where the bank will eventually own the business, through default.
First, you have to understand the more liabilities the bank has the more valuable it is for those who own it. A typical bank is owned by its common equity holders who garner all the residual value and earnings of the bank after paying the contractual obligations on deposits and subordinated debt. The first slice of value that equity owners of the bank lay claim to is the difference between assets and debt, also on the liability side, this slice referred to as the tangible equity or book value of the equity holders would receive if the bank assets are liquidated at fair market value and all debt is paid at par or parity.
Al larger book value of equity means a a smaller loss for depository and subordinated debt holders after liquidation hence, regulators to this as debt capital of the highest quality, the core tier 1 capital. Equity holders are also rewarded by all future earnings of the bank. The Net Present Value of the future earnings is the banks charter value, which is located on the bottom side of the asset side. Part of the earnings come from service income on deposits, but these are earnings before paying the insurance premium on insured deposits. Another part of the earnings is savings from corporate tax since the cost of debt are deductible from earnings for tax purposes., the flow of tax savings is incremental to all loans provided to borrowers, the dividend paid to equity holders is the difference between the asset cash flow and the after tax liability associated with deposits and subordinated debt, Since equity value depends on its dividend, it is affected by the liability structure. Simply put the more liabilities the bank has the more valuable its assets are, because having more liabilities allows federally regulated FDIC Insured Institutions to borrow more and more money from the Federal Reserve, making itself more money, however for the agricultural business everytime it borrows more and more funds from the bank its credit rating drops from A to C paper putting itself at risk of default and eventually allowing the bank to own the Agribusiness.
Yearly default rates are ratios of defaulted firms to surviving firms at the beginning of the year. There are arithmetic default rates and value weighted default rates. The default rates of a rating class and its volatility over time derive from these statistics. The default rates are close to zero for the best risk qualities. They increase to an average 8% a year for the lowest rating class. Actual values vary every year. The top three ratings characterize investment grade borrowers. The other three classes are speculative grade borrowers, it ranges from 0.2% to 8% a year.
We can observe the characteristic shape of average default rates of loans provided to agricultural businesses by commercial banks by detailed rating class, growing far more than the proportionally for the lowest ( riskiest) ratings. The increase in default rate when ratings decline has an exponential shape. The increase in default rate from one class to another changes drastically. In order to improve the rating by one grade, the required variation of default is around 6% for the last two classes of the scale. At the other end of the scale, a small decrease of 0.05% suffices to improve grade from Aa to Aaa. For the agricultural business with a Caa1-C rating, an analyst can observe clearly default rates are approximated at 12% to as high as 19% for a 12 month or 1 year loan.
It is important to realize for any Agricultural Business to be successful in today's environment, two options exist for the longevity of the Agricultural Business. Equity be it common or preferred or debentures and zero interest loans for the few 5 years of capital infusion. If interested in finding out if your agribusiness qualifies for these financial options, please email me at email@example.com or visit our website at www.agrilend.co