Barry and Ellinger
and class 1 in years 7, 8, and 9. In turn, the
declining pattern of interest rates contributes
to the improved financial performance and
credit worthiness, so that the net effect is a
greater percentage change in net worth at the
end of the horizon for the higher initial lever-
age case than for the lower initial leverage case.
Land purchases are diminished and delayed
relative to the section III results, but the two
farm situations end the period with similar
leverage positions and credit classifications.
Thus, the differences in initial capital struc-
tures and credit classifications are diminished
substantially over time as the firm’s invest-
ments and financing transactions respond to
the respective patterns of the credit classifi-
cations and interest rates.
Section V of table 2 retains the initial debt-
to-asset ratio of 30%, but reflects an unfavor-
able economic environment in which farm
revenue and land values decline at a 1% annual
rate, compared to an annual growth rate of 3%
for operating and other costs and the nominal
interest rates. A 40-acre land purchase occurs
in only one year and net worth remains rela-
tively stagnant over the horizon. The reduc-
tions in investments and related financing re-
quirements help to maintain a relatively
favorable credit classification until deteriora-
tion occurs in year 10. Thus, the farm main-
tains relatively low interest rates but at the
expense of business growth and improved fi-
nancial performance.
In table 3, the focus shifts to reporting se-
lected measures of the farm’s financial posi-
tion, land investments, and credit classifica-
tions at the end of year 10 (the final year of
the horizon) for initial debt-to-asset ratios
ranging from 0% to 70% and for different as-
sumptions about the growth rates of farm in-
come and land values. In section I of the table
with the 3% growth in farm income and land
values, land purchases tend to decline as le-
verage increases, consistent with the more fa-
vorable credit conditions early in the horizon
that were demonstrated in comparing sections
III and IV in table 2. However, the ending
credit classifications and interest rates are the
same, except for the highest leverage case, and
the percentage changes in net worth as well as
the debt-to-asset ratios lie in a relatively nar-
row range, at least until the higher leverage
classes are reached. In this case, an initial debt-
to-asset ratio of 70% is high enough to keep
Loan Pricing and Farm Performance 53
the firm from attaining any meaningful im-
provement in performance over the 10-year
period.
The more favorable economic environment
in section II of table 3 indicates a larger per-
centage change in ending net worth and greater
land investments, although ending capital
structures, credit classifications, and interest
rates are very similar across the leverage po-
sitions and in comparison to the section I re-
sults. The unfavorable economic environment
in section III indicates a pattern of results sim-
ilar to section II for initial debt-to-asset ratios
of 20% or less. As initial leverage increases,
financial performance and credit classifica-
tions quickly deteriorate and eventually reach
a point of technical insolvency for the farm
business.
Other variations of the analysis (not report-
ed in the tables) considered the effects of
changes in down payment and liquidity re-
quirements, weights on credit variables, and
size increments of land investments. Lowering
the down payment from 35% to 20% of the
purchase price tended to increase land pur-
chases and leverage over the horizon and
pushed the firm into higher credit classifica-
tions with higher interest rates. Increasing the
down payment requirement had the opposite
effect. In a similar fashion, incremental in-
creases in the liquidity cushion from 50% to
200% of the down payment tended to reduce
and delay land purchases, for a given initial
leverage position, although the impacts on net-
worth growth and credit classification were
negligible.
The adjustment in the credit score involved
increasing the weight on the debt-to-asset ratio
from 20% to 50% and reducing the weights on
the other four variables to 12.5%. This change
reflects the practice of some lenders to place
greater emphasis on the debt-to-asset ratio (or
an equivalent measure of leverage). These
changes yielded minor reductions and delays
in the land investments and small reductions
in net-worth growth across the various scenar-
ios. Thus, for this particular change in the cred-
it scoring model, the levels of the variables in
the model are much more important than
changes in the weights. Finally, increasing the
size increment of allowable land purchases in
20-acre increments from 20 acres to 200 acres,
for a given leverage position, had the effect of
delaying land acquisition until sufficient finan-