Barry and Ellinger
Loan Pricing and Farm Performance 49
investment alternatives and liquidity require-
ments, performance measures, and the credit
scoring and loan pricing mechanism. The asset
structure of the firm’s initial balance sheet con-
tains cash, marketable securities, crop inven-
tories, machinery and equipment, securities not
readily marketable, buildings, land, and other
fixed assets. The initial debt structure is de-
termined by a specified debt-to-asset ratio,
average maturities for intermediate- and long-
term debt, and the proportions of current, in-
termediate-, and long-term debt.
Purchases of machinery, buildings, and land
can occur in any year, based on the liquidity
requirements described below. Economic de-
preciation rates are specified for machinery and
buildings. Gross returns, direct costs, and
overhead costs are entered for owned and leased
land on a per-acre basis, including any allo-
cation between landlord and tenant on share-
leased land. Growth rates can be entered for
revenues, costs and values of machinery,
buildings, and land. Costs per acre can also be
adjusted as farm size changes to reflect econo-
mies or diseconomies of size.
The model is formulated to permit land pur-
chases when a specified liquidity requirement
is met. Specifically, land purchases will occur
in integer units each year as long as the mea-
sure of accumulated fund availability exceeds
the sum of the down payment requirement on
the land purchase plus a liquidity factor or
“cushion” that is specified as a percent of the
down payment.2 Besides land, an alternative
investment is the allocation of funds to mar-
ketable securities. Thus, the model has a growth
orientation, subject to a liquidity requirement
that can be adjusted to reflect the preferences
of the decision maker. Other input specifica-
tions include the price of land and the incre-
mental size (40 acres, 80 acres, etc.) of the
purchase units.
Output measures include an annual series of
financial statements from which a set of finan-
cial ratios representing profitability, liquidity,
and solvency is calculated. Other output in-
cludes the annual credit score, credit classifi-
cation and interest rate, and other descriptive
information.
The numerical specifications of the model
follow. Initial assets include cash, $10,000;
2 Fund availability is defined as the sum of net income plus
depreciation and outside earnings minus withdrawals, down pay-
ments, and principal payments. Accumulated fund availability
equals the total of available funds carried forward from prior years.
marketable securities, $10,000; crop inven-
tory, $93,375; machinery, $100,000; retire-
ment accounts, $20,000; buildings, $30,000;
and land and other, $350,000. Operating debt,
including the current portion of intermediate-
and long-term debt and accounts payable
within the next year, is specified as 20% of total
debt. Intermediate-term debt is specified as
20% of total debt with a four-year maturity.
Long-term debt is 60% of total debt with a 20-
year maturity. The farm owns 200 acres valued
at $1,750 per acre and rents 500 acres on a 50-
50 crop share basis. Gross returns begin at
$415 per acre and cash operating costs are $228
per acre. Machinery purchases for annual re-
placements are $23 per acre. Land purchases
are accompanied by additional machinery in-
vestments of $ 180 per acre and buildings in-
vestments in the amount of 5% of the land
purchase. Family withdrawals start at $20,000
per year and grow at 3% per year, tax exemp-
tions are four, and the rate of return on mar-
ketable securities is 6%.
Credit Scoring and Loan Pricing Components
As indicated earlier, a wide variety of work-
sheets, scoring methods, and evaluation mech-
anisms are employed by agricultural lenders
ranging from relatively simple checksheet ap-
proaches based on judgment and subjective
evaluations to statistically based credit scoring
that utilizes financial data. Regardless of the
specific approach, the basic concepts are es-
sentially the same in all these evaluation mech-
anisms; that is, to identify, measure, and weight
the key variables considered to reflect a bor-
rower’s credit worthiness and aggregate the re-
sults into an overall credit score.
The credit scoring model employed here is
patterned after those currently used by the St.
Louis and Louisville Farm Credit Banks as a
basis for classifying and pricing operating and
intermediate-term loans to agricultural bor-
rowers (Farm Credit Banks of St. Louis; Bie-
ber; Tongate). The variables are essentially the
same, except a current ratio is used in place of
a collateral ratio and uniform weights are used
on each variable. In addition, the model is
applied to pricing real estate loans as well as
non-real estate loans. The variables include:
1) solvency, as measured by the debt-to-asset
ratio; 2) liquidity, as measured by the current
ratio; 3) cash flow, as measured by a debt ser-
vicing ratio; 4) profitability, as measured by