BY Tina Vierra

Inspired by sessions with bankers at a recent wine industry financial seminar, PWV obtained the help of lenders experienced in the wine and vineyard industries to research and report on the process of vineyard lending and analyze its attendant risk.

Types of vineyard loans
Risk assessment is relatively simple for lenders when it comes to the most common type of vineyard loan: the self-liquidating, single-season loan. In such loans, growers apply for money to get a crop from pruning to harvest, then repay the loan at harvest when the crop is sold. In this instance, a lender has only to review the grower’s grape contracts for that season, or the winery’s projected use and sale of the grapes, in order to assess risk for a short-term loan.

Analyzing the risk of long-term vineyard loans is very different. For vineyard development, redevelopment, and acquisition financing, loans of up to 20 years in length are requested, and they must be carefully assessed and written by lenders.

Covenants and conditions
Covenants and conditions are lender terms pertinent to risk analysis of a loan. A covenant is a circumstance of the borrower’s financial health upon filing, which must remain viable for the life of the loan. Examples of a covenant might be a vineyard capital ratio of 1.5 to 1, a debt-to-net-worth ratio not exceeding 1 to 1, etc. Covenants can alert the lender to a decline in the strength of the borrower’s business as the loan term progresses.

Conditions are requirements that attach to a loan and must be present and correct for the acquisition and continuing health of the loan. Prime examples of vineyard loan conditions are pre-existing grape contracts, maintenance of insurance, timely filing of tax payments, and annual financial reports.

Is there a checklist, then, of covenants and conditions? Not according to lenders. “Covenants and conditions are too specific to each case for us to offer any kind of blanket checklist,” says Bill Rodda, vice president at American Ag Credit (Santa Rosa, CA). “One failed condition in an applicant might be countered by another condition which is very strong for them. In commercial banking like this, some risk elements in a grower’s business plan will be countered by other strengths. Loans themselves can then be tailored to the risk — amount loaned, interest rate, term length.”

Matt Tucker, senior vice president and division manager at Banner Bank (Walla Walla, WA) reports, “A winery or grower can fail some covenants and still expect to be granted a loan. It isn’t the number of covenants failed, but the severity of covenant failures that needs to be assessed.

“It is certainly possible for a borrower to fail a covenant in a technical sense while the bank does not see associated credit risk, and therefore may not declare a loan default. On the other hand, failure in even one covenant allows the bank to declare a loan default, and therefore exercise its rights under default, which could include refusal to loan more money.”

Generally, banks will try to work with a borrower who has broken a covenant, so long as the failure was not a willful event on the part of the borrowers and does not represent a significant threat to loan repayment. Covenants, then, can be flexible, while conditions are terms which must continue to be met in an ongoing loan.

Cash flow impact
The vineyard industry is presently experiencing over-production, which has resulted in lower pricing and depressed cash flow. Banks anticipate downward trends in cash flow as lower grape prices impact growers in the short term. Long-term grape contracts at set minimum prices mitigate this problem for some growers.

“All of this depends on where you are in the hierarchy,” maintains Travis Foxx of Merchant Capital (Portland, OR). “If you have prime Napa Valley vineyards with limited production, your case is very different than if you are located in the Central Valley of California and have more fruit than you can sell.”

Rob McMillan of Silicon Valley Bank (St. Helena, CA), agrees: “In the higher volume vineyards, there is widespread price compression and some vine removal. In the best vineyards, prices are holding and even rising still. The middle, though, can have virtually any number of possibilities, including growers trying to replant while prices are soft.”

Washington state shows similar cash-flow-by-growing-region statistical variations. “In Walla Walla, pricing has held relatively well, and good quality vineyards continue to show positive cash flow (at least at vine maturity),” reports Tucker. “In the greater Columbia Basin, cash flow has suffered as pricing has become depressed.”

Lindsay Wurlitzer, regional vice president at American Ag Credit (Santa Rosa, CA), sees soft wine sales as exacerbating growers’ cash flow problems. At the winery level, sales and pricing are down, and this flows down to growers. Given market conditions, wineries want to pay less for grapes. Wurlitzer estimates conservatively that more than 50% of existing grape contracts were renegotiated this year, but the figure could be as high as 75%.

How does a bank write loans against grape contracts that are likely to be renegotiated? “Industry knowledge and asking lots of questions to assess the risk,” Wurlitzer replies.

Interest rate factors
All lenders in this report expressed astonishment that interest rates continued to decline in 2003. “I never thought they would go as low as they have today. We are at historic lows,” says Tucker. “With Fed funds at 1.0% today (August 2003), there simply isn’t any way for rates to get much lower before they are so close to zero that they mathematically can’t fall further.”

Thus, all lenders felt safe in predicting interest rate hikes, albeit slowly, over the next five years. “If you believe the Forward Yield Curve,” says McMillan, “the rate forecast is mixed for the next year and then shows increases of roughly 1/2% thereafter.” (See Table I, the Forward Yield Curve.)

Wurlitzer and Rodda offer separate advice for short-term, seasonal vineyard loans compared to long-term loans. “For short-term, self-liquidating loans, look to Alan Greenspan and the Fed policy,” advises Rodda. “This affects the Prime, or Reference rate, which most short-term loans will start at, depending on risk (Prime plus 1/2, Prime plus 1, etc.).”

“Long-term loans won’t behave the same,” explains Wurlitzer. “Those interest rates will be tied to the treasury, to bonds, and long-term economic forecasts. American Ag issues its own bonds through its funding corporation in New York. Our bond yields can be tracked in the Wall Street Journal. The rates track fairly closely to U.S. Treasury bonds.”

New vineyard loans still possible?
While lenders are certainly conservative these days about loaning money for new vineyards, they are still willing to fund new planting.

“It’s a capitalist economy — banks are out to loan money to make money, and provided the risk assessment is good, they’ll continue to do it,” asserts Rodda. “Cycles such as low prices can come around again to top dollar. The business cycle for vineyards is roughly seven to eight years, and experienced vineyard lenders understand that cycle. Look at Turrentine Wine Brokerage’s ‘Wheel of Fortune’ for a good overview of the cycle.”

“Some borrowers have the ability to survive this kind of cyclical overproduction and others do not,” agrees Tucker. “We support those borrowers with the financial capacity to be viable in the long run despite temporary over-supply and pricing pressures, particularly in appellations like Walla Walla that are not suffering to the extent of other regions. The current market glut is a classic agricultural phenomenon.”

In such a conservative environment, lenders look for borrowers with secondary sources of loan repayment. These borrowers have investors or other property outside of the vineyard project that is the subject of the loan. Thus they can repay the loan even if the vineyard does not support the payments in an economic downtown.

Even vineyards without existing contracts are considered for loans. Only about half of the lenders interviewed by PWV responded negatively to the idea.

“If a vineyard is in a special American Viticultural Area and/or if the grower is substantial enough to fund a vineyard from outside funds should the market slump be extended,” affirms McMillan, “we will make a loan without a grape contract.”

All of the banking officials who would consider loans without grape contracts mentioned the need for other indications of firm business footing, such as other properties or investors to fall back on.

Leasing or lending?
Some growers, knowing their risk will be assessed as high and, not wanting to pay resultant higher interest rates or risk not qualifying for a loan, choose a lease against the appreciation of the vineyard property and its yields over the long-term. Leasing offers potentially lower interest rates and no down payment, along with some tax benefits, but lenders recommend avoiding it for the sake of long-term financial stability.

“For all practical purposes, leasing is really just a form of debt, but is not the same as holding 100% equity in your property,” says Tucker. “Having high levels of equity is absolutely essential these days in the industry. If you don’t have high levels of equity, you won’t control your own destiny. Those companies that need the zero-down benefit of a lease often won’t qualify for a lease.”

“In a lease,” explains McMillan, “you effectively have the sum of the cash flow from the vineyard over the term of the lease as collateral. That is a depreciating asset. When the lease ends, there is no value to the lease.”

McMillan outlines a strong leasing arrangement as one with several parties involved. A grower would bring in an investor as the landowner/partner, and a winery to guarantee the contracted sale of the grapes over the long term of the lease. The grower uses lease funds to develop the land and produce the grapes, which the winery then bottles.

In the end, the landowner is able to keep the land and get an income stream without investing any development dollars. Plus he or she owns a producing vineyard at the expiration of the lease period. The winery gets the grapes without having to come up with the cost of land or land development. The bank is in a less desirable position (risk-wise compared to a loan) but as a result can charge higher interest rates and thus make more money from the lease if the grower is successful.

But the downside for the grower is that his business is centered on the grapes from a leased vineyard. With no ownership, the grower’s position is at risk when the lease runs out. Thus lenders advise that this is the least desirable business plan for a grower.

Industry experience critical
Growers are best served by bankers with strong knowledge of the vineyard and wine industries, lenders say. Lenders with such experience understand the grower’s risk and challenges and serve the grower’s needs better than bankers outside the industry. Such lenders are also more likely to write loans than those with no industry knowledge.

As with vineyards, a lender’s location can be important. Banner Bank sits in Walla Walla, in Washington’s prime winegrowing country. Tucker, who handles the bank’s wine and vineyard clients, started his career with a company that developed Canoe Ridge Vineyard, later sold to Chalone Wine Group. Tucker is a stockholder there, and he still holds an interest in Forgeron Cellars and Ash Hollow Vineyards.

“My personal banking background involves a significant level of agricultural lending, so I absolutely understand that agricultural economics are cyclical,” explains Tucker. “I understand, going into a production loan, that we will see strong economic periods as well as weak periods.”

Mary Leonard-Wilson has been a wine/vineyard industry loan officer for nearly 10 years at National Bank of the Redwoods (Santa Rosa, CA). NBR works with growers, wineries, and winery suppliers as a large part of its customer base. “We prepare for the cyclical nature of the industry by measuring the impact of a downturn in grape/wine prices on the grower’s cash flow, and discussing plans with our customers. Options are numerous, including downsizing operations, decreasing expenses, recapitalizing the business, postponing growth plans, focusing on quality development, and so on.”

McMillan runs a full-service Wine Division of Silicon Valley Bank. “We specialize in banking wineries and vineyards. It’s all we do. The wine industry is a very complex market in which to develop expertise. Many banks, like the tides, are in when the market is good and out when it’s bad. There is insufficient time to develop real expertise through the lending staff and credit administration.

“We ‘roll with the tide’ by aggressively marketing for new business, assisting borrowers in removing vineyards that need replanting to prepare for the next upturn in the market, and trying to find ways to accommodate borrowers’ collateral positions,” concludes McMillan.

Travis Foxx has been president of Merchant Capital (Portland, OR), a consulting company that helps wineries obtain or restructure their financing, since its inception in 1991. “My perspective is that of an outsider, not a direct lender, so I look at more combinations and creative ways to mount a business plan in the industry,” explains Foxx. “We not only arrange financing for wineries and vineyards, but also lease equipment and barrels and offer cash flow management assistance and debt restructuring.”

Merchant Capital works with growers on many forms of financing, from traditional loans and leasing to more creative methods. “A seller could become a partner in the new vineyard venture,” Foxx offers as example. “Or a winery could participate in the funding, or joint ventures between companies could be set up. Existing vineyard operators could put in pure cash, sell assets to raise cash, or even obtain short-term financing from their own vendors in some cases. Other options exist — sometimes you just have to do a little brainstorming with all the parties involved.”

American Ag Credit has been an ag-specific lender for almost 100 years. The bank’s charter limits it to agriculture lending exclusively. Wurlitzer has been with AAC for over 26 years, and Rodda for over 20 years, mostly with grape and wine industry clients. More than 90% of the loans in the Santa Rosa office go to wine industry borrowers.

“We’ve have not changed our criteria or way of doing business, whether the industry cycles up or down,” says Wurlitzer.

“When you’re writing 20-plus-year loans as we have for nearly a century now, you’re going to write the next one the same way you handled the last one,” notes Rodda. “We’re very consistent because we see the long term.”

Resources:
Bill Rodda and Lindsay Wurlitzer, American Ag Credit, PO Box 1200, Santa Rosa, CA, 95402; tel: 707/545-7100; fax: 707/545-7200.
Matt Tucker, Banner Bank, 1 East Alder St., Walla Walla, WA, 99362; tel: 800/272-9933.
Travis Foxx, Merchant Capital, PO Box 19069, Portland, OR, 97280; tel: 800/333-5513; fax: 503/525-4365.
Mary Leonard-Wilson, National Bank of the Redwoods, 111 Santa Rosa Ave., Santa Rosa, CA, 95402; tel: 707/573-4800; fax: 707/544-3115.
Rob McMillan, Silicon Valley Bank, 899 Adams St., #G2, St. Helena, CA, 94574; tel: 707/967-1367; fax: 707/967-4827.