Understanding water rights can get you a better farm loan
Just like any other business, farmers need to borrow money. Whether you are trying to buy property, expand your operation or keep your farm going, it is important to know about your water rights when you apply for a loan.
Bankers allocate their limited funds to borrowers based on the Five C’s of credit, and those factors can be affected by the quality of the farm’s water supply and water rights. According to Heather Malcolm at Bank of the Rockies in Livingston, Mont., those factors are Capital, Capacity, Conditions, Character and Collateral.
■ Capital, the farm’s financial position, is the most important of the 5 C’s. A strong capital position is demonstrated by cash on hand or other capital assets in lieu of cash for the down payment.
■ Capacity is determined by the borrower’s ability to generate cash flow to service the interest and principal on the loan.
■ Conditions are the overall economic conditions affecting agriculture and the intended purpose of the loan.
■ Character is indicated by credit rating and borrowing history coupled with more qualitative factors such as honesty and integrity, which support a case for a borrower’s willingness and ability to repay a loan.
■ Collateral is the asset available or offered for security. It may be land, equipment or machinery. Lenders often take a lien on borrower collateral.
The biggest asset of an agricultural operation is the land, and its value is based on productivity. Every farmer knows that irrigated land is more productive and more valuable than dry land. The higher value and productivity of irrigated land directly increase the operation’s capital and collateral. The higher production from irrigated land provides money to repay the loan and other bills, enhancing the borrower’s capacity and character.
Heather Malcolm described water’s importance to lenders this way: “When evaluating collateral, the bank looks at whether the land is used for range, dry land crops or irrigated crops. The lender looks at the availability of water for the specific needs of the operation, i.e. cropping vs. pasture. Then, the bank asks, ‘Will the land purchase enhance the operation?’”
The USDA Farm Service Agency (FSA) offers a number of loans for farmers, including Farm Operating Loans, Farm Ownership Loans and Beginning Farmers and Ranchers Loans. All FSA loan applications require the same basic forms, which include a three-year financial history, a three-year production history, a list of properties owned and leased, a balance sheet and the projected/actual income and expense. If you don’t have enough water, your production history and financial history may be irregular because production is good in abundant water years, but markedly reduced in average years.
Whether you are buying a farm or ranch, adding land to an existing operation, or financing other operational needs, it is important to find out as much as you can about the water rights used on the land. One new tool helping both farmers and bankers find out what water rights are used on the land is Water Sage (www.WaterSage.com).
With Water Sage, once you have found the water rights, you can see the abstracts, water right details, and points of diversion, places of use, ratings and check the water rights priority against other water rights from the same source. You can also save an index of the water rights and download the points of diversion to Google Earth to use as a guide for your visit to the property. If you are applying for a loan to be secured by land you currently own and operate, you can use Water Sage to make sure the water right records are correct and create an index of your water rights to submit with your property documents.
Likewise, if you are getting a loan to build stock tanks or install a pivot irrigation system, it is crucial that you have sufficient water and water rights to complete these projects. Being able to provide enough water and grow enough hay to feed a larger herd is important if you want to borrow money to increase your herd size. You can also check Water Sage to see if your property is within the boundaries of an irrigation project where you can purchase water for expansion. Perhaps you are considering converting acreage to dry land farming. Then, you may be able to add to your income by selling or leasing your water.
Water rights can also negatively impact your balance sheet if you have to spend time and money to litigate, adjudicate or secure your water rights. The best way to avoid costly and time-consuming litigation is to know about your water rights, verify the state records are correct by checking the information in the Water Right Abstracts, and be sure you operate within the limits of those rights.
Water rights matter to a borrower because they are an asset that provides value and productivity to an agricultural operation. If you have great water rights, highlight that fact in a conversation with your banker. If not, be ready to explain how you expect to meet your payment obligations in dry years. ❖
Nancy Zalutsky has over 20 years experience in water rights and is currently a Research Analyst at Ponderosa Advisors LLC, providing information about water rights used in the development of Water Sage, an interactive mapping application that integrates information about water rights, land ownership and relative priority. Learn more at WaterSage.com.
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