The Rancher’s Guide to Loan Covenants and What to Watch For
Covenants are the rules inside a loan agreement. Most ranchers read the rate and the payment, then sign. The covenants decide what happens when a drought or a bad market makes the year harder than planned.
What is a loan covenant?
A covenant is a promise you make in the loan agreement. Some require you to do things, such as provide financial statements or carry insurance. Others limit what you can do, such as selling collateral, taking on more debt or paying yourself above a set amount. Some are financial tests you must meet each year.
Breaking a covenant can put the loan in default, even when payments are current. That is why they matter, and why reading them before signing is worth the time.
Do not sign a loan agreement the day it arrives. Ask for the draft early, read it at home and mark every sentence you do not understand. A lender who respects your questions is a lender you want.
Which covenants are common?
Examples include maintaining insurance, keeping property taxes current, delivering annual financial statements, limits on additional borrowing, restrictions on selling or moving livestock and equipment, and minimum ratios such as working capital or debt service coverage. The specifics depend on the lender.
Ask your lender to explain each one in plain terms and give an example. If they use a financial ratio, ask exactly how it is calculated and when it is tested.
- Reporting and insurance requirements
- Limits on selling collateral or new debt
- Financial ratio tests
- Restrictions on withdrawals or family living draws
Why do drought years make covenants matter?
In a drought, income drops and costs rise, and a financial covenant can be tripped even when you are managing carefully. A ratio that looks easy in a normal year may fail after a forced sell-down. Think about how the covenant behaves in your low case, using the U.S. Drought Monitor to remember how often dry years come.
If you see a covenant problem coming, talk to your lender early. Many will agree to a waiver or amendment when they understand the situation, and the Farm Service Agency may have options as well.
A related issue is cross-default, where a problem with one loan triggers a default on another. If you borrow from more than one lender, ask whether your agreements contain that kind of clause and how it would work in practice.
What can you negotiate?
Many covenants can be adjusted before you sign. You might ask for a longer reporting deadline, a lower ratio target, a cure period to fix a breach, or exceptions for selling cattle in the normal course of business. Lenders vary in flexibility.
Compare loan terms across lenders, including Farm Credit associations, community banks and FSA programs. Remember that the cheapest rate may carry tougher covenants. A licensed attorney can review the document with you.
How do you stay in compliance?
Make a calendar of every reporting date, insurance renewal and test. Keep records organized, and run your own ratios quarterly. If numbers slip, call the lender before the due date. Silence tends to make lenders less flexible.
This farm money guide covers budgets and ratios, and small farm information offers record-keeping help. CSU Extension may have workshops on financial statements.
Set a quarterly reminder to compare your actual numbers against any financial tests. It takes an hour and gives you months of warning if a ratio starts to slide, which is when most lenders are most willing to adjust.
What should you ask before you sign?
Ask: Which covenants are tested and how often? Who calculates the ratio and with what inputs? What is the cure period if I fail? What happens if I need to sell collateral during a normal year? Can the lender change terms later, and under what conditions?
Write the answers down, or ask for them to be put in the agreement. Oral assurances have a way of disappearing when a loan officer changes jobs. A few minutes of questions up front can save a lot of stress if conditions turn tough.
Where can you get help reading the fine print?
An attorney who knows agricultural lending is the best source, and the Colorado Department of Agriculture can point you to local resources. The CFPB and Farm Credit Administration provide general information on lender practices.
For lighter reading, farm.FM has a farm.FM story on loan fine print, along with ranching and agribusiness sections. This is general education and not legal advice; confirm your own loan terms with your lender and attorney.
Sources and further reading
- USDA Farm Service Agency: FSA farm programs and loans
- FSA Farm Loans: FSA direct, guaranteed, microloan and emergency loan information
- Farm Credit: cooperative agricultural lending network
- U.S. Drought Monitor: weekly drought maps
- CFPB: consumer finance protection
- Farm Credit Administration: regulator of the Farm Credit System
Ask locally: Ask an attorney who handles agricultural lending, your lender and a CSU Extension ag business agent.
General education only, not financial, legal or tax advice, and Colorado Rancher Loan Guide is not a lender. Rates, terms and deadlines change, so confirm current details with the lender or agency.