Conterra: ‘Covenants can be as varied as agriculture’

Conterra Asset Management originates loans and manages $2.2 billion in agricultural debt for US banks, Farmer Mac and other regulated institutions. Founder, president and chief executive officer Paul Erickson gives Agri Investor his views on the current credit environment for US farmers, typical loans offered and debt as an entry point into agriculture for private equity.

Is a debt strategy better than an equity strategy for fund managers looking for a way into agriculture?

At this point in the cycle, I do think so. Over the years, there’s been a lot of private equity trying to make its way into agriculture, and equity investments into farmland or agribusiness have been the easiest way. The debt side is a lot harder because there are a lot of barriers to entry. Most of the debt originated in agriculture goes onto the balance sheet of a regulated institution and they are not willing to sell it because the performance of that debt over the years is very solid and uncorrelated to most traditional private equity portfolios. The issue has been trying to amass enough loans or debt to make it worthwhile.

That is where Conterra has become very successful. We have networks of correspondents and employees that are able to generate enough volume. Right now, we are working with some BDCs, university endowments, and pension funds that all have the same aim of trying to enter that debt market.

Most of our loans are less than 50 percent loan to value, so the real estate value can decline quite substantially and we’re still well secured.  Although overall farm income has come down quite dramatically, I have a more optimistic view on agriculture cashflows going into 2017 and beyond because land rents, crop inputs and fuel costs have come down, allowing for improved cashflow.

What is the current state of the credit environment for US farmers?

Credit quality across the US has been declining, especially in the community bank sector, where there is a concentration of agricultural lending. Collateral values have held up pretty well and there’s still quite a bit of equity out there in agriculture, especially in the real estate, but what is really stressed is working capital and liquidity. We work across the US and what we’re seeing right now is lenders who are trying to figure out what to do in this declining credit environment.

Can you describe a typical loan you offer from your debt platform and your return expectations?

Our loans typically range between $1 million and $10 million and interest rates will run between 6-9 percent, priced to risk, somewhat priced to term on three to five year terms.  We will certainly consider refinancings of existing debt at about a 300-400 basis point increase over the A-quality credit.

For returns, our target is high teens for an IRR over the 10 year life of the fund. We’ll invest and re-invest and as we get to the fifth year, we will close it and let it run off, operating with a new structure, or we will just reduce the loan terms so we don’t exceed the 10 years.

What covenants do you include on agricultural loans?

Covenants can be as varied as agriculture. We start with pretty standard covenant conditions – a first lien, personal guarantee from the borrower and annual financial statements.

For loans on a larger commodity in the corn belt, where you can get federal crop insurance, we may require that they have a minimum level of federal crop support to hedge the profitability. For some permanent plantings, like patented varieties of apples for example, borrowers need to show they are in compliance with patent regulations. Water rights are also a huge issue in the [western US] and we condition loans off of water quality and quantity tests.

Do the questions from your LPs differ when talking about a debt rather than equity strategy in agriculture?

Yes. Agriculture is so varied, people think about agriculture as what comes across CNBC on a daily basis, that corn markets are down or wheat prices are up. But there are more than 200 crops just in California. Trying to understand the collateral and the cashflows [from a debt perspective] can be very difficult. The variability of the questions we get is dramatic. We’ve had to do a lot of education around historical numbers and farmland itself. It’s been a task on our end but we’ve been successful.