Farmer Reserve Fund

Slow Money Northwest and Viva Farms have helped beginning farmers access and build credit through three simple steps:

  1. Beginning farmers connect with a business training program like Viva Farms.
  2. A representative of the training program fills out a checklist certifying that they have reviewed the borrower’s financial information, and believes that they will be able to repay the loan.
  3. The loan application and checklist are combined and submitted to the North Coast Credit Union.

The entire process can be done in less than a day, making it easy to do what you do best: growing healthy food.

Why it works
Banks and credit unions don’t like to make small, unsecured loans of this kind because the combined costs of reviewing the loans, the potential risks of default and the cost of servicing a small loan are often larger than the potential income from the interest on the loan.  It’s not that they don’t want to lend to farmers; it’s just that they can’t figure out how to make money on it.  By reducing the risk to the bank with our loan loss reserve fund, and helping verify the viability of the borrower’s business, the cost of providing these loans is reduced, and the bank or credit union can better serve their community by extending credit to those who need it most.  A longer description of the program can be found here.

Full Description
In 2010 SMNW considered creating a direct loan program. We knew we did not want to administer the loans so we worked to identify the best regional partners who already do that work. Along the way we discovered that there are enough funds available in the region via current funding outlets (banks, credit unions, farm credit, etc.) but no real microloan programs below $20,000. Credit unions were perfectly aligned as they are not only cooperatives and therefore more value-aligned than other entities, credit unions were the beneficiaries of much of the Move your Money efforts to move money away from Wall St. to Main St.

We narrowed our focus to a few specific credit unions and worked with one in particular: North Coast Credit Union (NCCU) in Skagit and Whatcom counties who was very interested in helping out their community. We wanted to reduce their risk so that they would deploy their funds to those in need. We honed in on a loan guarantee program that would cover a portion of the loan, and we would secure promissory notes from individuals and foundations that were called in as needed.

NCCU then offered an even better idea that seamlessly fits their current operations: a loan loss reserve fund where we cover the expected default rate for loans and lines of credit.  Below is an explanation of that program.

The Opportunity 
All farm businesses need access to credit for seed, equipment, soil amendments, and to pay operating costs between planting and harvest. Beginning farmers may not have the credit history or assets to qualify under conventional bank guidelines, and therefore represent a greater risk for lenders.  The Farmer Reserve Fund reduces the risk to lenders by providing technical assistance to the borrowers, performing additional due dilligence on the borrower, and enhancing the existing loan loss reserves of the lender.

For a conventional loan program, financial institutions set aside a portion of their funds for losses under this program.  To over simplify the risk assessment, the higher the risk of non-payment of loans, the larger the amount of the loan loss reserve.  As the risk increases (i.e. borrowers with fewer assets, shorter credit history, and low incomes), the costs of administering the program plus the estimated losses becomes greater than the amount that will be earned in interest, and the credit union can no longer responsibly lend.  By enhancing the loan loss reserve amount from the normal ~4% to ~20% of the total loan portfolio, the risk to the credit union is dramatically reduced, and they can comfortably lend to beginning farmers at competitive or reduced interest rates.

Building on the credit union’s internal system of risk management we are able to leverage small foundation grants and non-profit technical assistance to provide a pool of capital to help new farm businesses succeed while assisting the credit union in it’s ability to invest in it’s community. What we do is cover the potential default rate for the whole program of high risk micro loans. In this early stage we have agreed to work with a conversative (high) default rate of 20%. This means that for every dollar deposited at NCCU they will make up to $5 dollars in loans they would not have been able to do otherwise. The
initial donation of $5,000, from regional two impact investors, creates a loan portfolio of $25,000.

For this, SMNW has teamed up with Viva Farms and NCCU to provide credit to beginning farmers. As the loans and lines of credit are repaid, the borrowers build assets and credit history and banking relationships with the credit union and will be able to transition away from this program into other lending programs, creating a more stable and sustainable food system. As more data is gathered and loans are repaid, the goal is to bring the default rate down below 10%. This means the $10,000 may underwrite $100,0000 or more in loans.

Below is a diagram and explanation of how this works:

frf2

The producer or food business approaches NCCU for a small operating loan. NCCU does their due diligence. If they say yes, the business gets the loan and nothing else is needed.

If NCCU finds the applicant too risky they turn to SMNW to see if we have interest in using our fund as a backstop for the potential loan default. SMNW does an additional layer of networked due diligence and looks to it’s business development partner in NCCU’S territory, Viva Farms, to see if the applicant has gone through their production and business planning program. If Viva Farms recommends the applicant then SMNW approves the use of the reserve fund to backstop the loan for NCCU.

NCCU and the applicant then continue to negotiate the terms of the loan or line of credit. The loans will most likely be under $20,000 with a 6-8% interest rate and a term of between 6 months and three years.

SMNW secures reserve funds for this work in one of two ways. The first method is as a grant/donation from individuals, foundations, or other organizations to SMNW (via it’s parent Growfood) who then deposits the funds in an interest-bearing account at the credit union. The second method is helping an entity make a direct deposit from either their PRI/grant or investment programs directly in to the credit union.

In both cases a key component is engagement of a regional business development program like Viva Farms who helps identify their best candidates for success. Different counties have different programs like this farm incubator, many of them attached to extension services, CDFIs, or small business development centers.

VivaFarmsViva Farms is the ideal program as it assists farmers with both production knowledge and business planning. Viva Farms helps to mitigate the risk by pooling large equipment purchases, providing improved farmland, business education and resources, and direct marketing of produce.  In addition, the personal and professional relationships developed between the Viva Farms staff and the farm incubator participants gives additional insight on the borrowers’ ability to repay loans that a financial institution will not know from a credit application.

North Coast Credit Union, like many other credit unions, has seen a surge in deposits as people have moved their money away from large banks and back into their communities. The have plenty of funds, but are unable to make small loans to beginning farmers because of the relatively higher risk and unknown credit history of the borrower.  This is where the partnership with Viva Farms makes all the difference.  Knowing that the borrower is engaged in a technical assistance program and has an existing support relationship with Viva Farms, NCCU can more easily lend to these farmers.

SMNW provided the technical assistance and impact investors to bring this all together.

For more information contact us at info@slowmoneynw.org.