Agriculture Loans and Water Stress
Critical Water Risk Factors for Ag Lenders
From reduced snowpack in California to wet droughts in Oregon and Washington, few regions will be untouched by changing climate patterns, increasing demand and subsequent increased water stress. These problems are happening now, and many stakeholders throughout the agricultural sector have been recognizing the risk that water issues pose to the entire industry.
But, according to a recent report by Ceres, few financial institutions are factoring these systemic risks into their current lending practices and financial disclosures. Ceres has put together a list of over 50 recommendations that regulatory agencies like the FDIC and the SEC could put into place to mitigate these risk factors.
In the meantime, lenders can be proactive by learning more about water risk and how they can help farmers achieve a more water resilient-future. As the Environmental Defense Fund explains,
“Lenders can help facilitate farmers’ transitions to conservation practices by familiarizing themselves with the financial impacts of practice adoption and learning about strategies to minimize costs and maximize benefits. Ultimately, supporting this transition will make farmers and their financial partners more resilient to climate change.”
This guide takes a close look at what lenders (agricultural lenders and/or any lending process that includes the water’s value in the appraisal) need to understand about water risk, as well as how agriculture loans can play a key role in food supply’s resilience in the face of water stress.
It will be continuously updated with the latest information, so check back often or sign up for our newsletter to stay in the loop.
The Importance of Water in Agriculture Finance
According to the EDF, climate risks – and associated water risks – are a “blind spot for lenders.” As many as 70% of borrowers were impacted by extreme weather events in the Midwest in early 2019. Although crop insurance can play a role in reducing these impacts, it isn’t enough to cover all losses or all types of crops.
One of the larger risks for lending beyond just the direct impact of the climate shift itself, is the changing of policy to mitigate the climate shift, recharge aquifers, and/or (think SGMA in California). The policy changes can lead to permanently fallowed land or dramatic decreases in the productive capacity of the land due to water limitations.
Additionally, lenders whose borrowers are concentrated in a particular region may be at heightened risk. Water scarcity can drive up prices in groundwater markets, causing an entire region to shift to less water-intensive – and possibly less valuable – crops.
Finally, the EDF argues that existing financial offerings don’t leave room for growers to adapt to changing climate conditions and transition to more resilient practices:
“Short-term financial products such as annual operating loans don’t integrate the value of farmer investments in practices like no-till, cover crops, and extended crop rotations that have measurable financial benefits… This disconnect undermines long-term profitability and resilience – for both farmers and their lenders.”
Without the agriculture loans they need to adapt to water stress and implement better water management practices, growers will be limited in what they can do to deal with these risks. Lenders have a key role to play in ensuring that farmers have the capital they need to invest in better water conservation technologies and practices.
The Role Agricultural Lenders Can Play
Agricultural lending is competitive, and the risks are increasing. In order to protect their investments and make smarter decisions on agriculture loans, lenders need to have an accurate understanding of their borrowers’ water risk. This detailed understanding requires an assessment of several key areas.
First, lenders must have access to up-to-date information on water resources, such as historical water data and the latest water trends. They’ll also need to be aware of their borrowers’ water rights situation, which can vary widely from state to state.
Other things to focus on include knowing how to perform a water risk assessment and learning how water impacts the value and profitability of an investment. Lenders should look at water from both a production risk perspective – to determine if a farmer will have access to sufficient water resources to operate and pay back their loans – and from a land/collateral perspective. After all, land needs water in order to retain its value.
Ultimately, though, agricultural lending is about more than just short-term stability. Lenders are responsible for providing farmers with the money they need to run their operations and feed their communities – and, by extension, the world. The stakes couldn’t be higher.
Read more about the importance of water in agriculture finance.
Water Risk Assessment Is A New Imperative in Agriculture Loans
While many of the country’s most important growing regions will experience some form of water stress & risk in the years ahead, the exact form of that risk will vary widely. Some states may implement drought mitigation plans and other policies to address those risks, but these new regulations will introduce uncertainties of their own.
For example, in California, changes in rainfall and snowpack are only part of the picture: growers will also have to adapt to new SGMA regulations that vary from basin to basin and determine how much groundwater they’ll have access to each year.
A thorough water risk assessment can give lenders the information they need to make better agriculture loan decisions that account for all of these complexities.
AQUAOSO developed a strategy that involves four key steps (and was featured in ASFMRA’s Water Trends Report):
First, identify the water risks that are most relevant to the agricultural region. These may include predictable risks like seasonal weather variations and less predictable risks like floods and droughts. Other factors include regulatory changes, such as annual pumping restrictions or a moratorium on new water rights.
It’s important to look at actual data so as to not make uneducated decisions, since water risks can be counterintuitive and impact regions in ways that may not be expected. Resources such as AQUAOSO’s Water Security Platform and the NDIS Drought Monitor can provide real-time information on water security issues.
Next, understand how all of these issues fit together. While macro trends are useful, it’s also important to assess water risk on a parcel-by-parcel basis. Some growers may be able to mitigate their risk by banking or trading water in a smart water market. Others may be at heightened risk of infrastructure decay if they rely on irrigation networks.
Knowing what options a farmer has to respond to drought and what those options will cost can provide critical context to a water risk assessment.
Once a borrower’s overall water risk is determined, that picture can be refined continuously by monitoring water data in real-time. This can take the form of smart water meters and IoT devices that farmers can install themselves, or publicly-available data from the USGS and other regional sources.
Data like this can be tedious and time-consuming to assemble, but with tools like AQUAOSO’s Water Security Platform, this process and its advantages are more accessible. The platform’s dashboard and geospatial mapping tools make it easy to access the necessary data.
Finally, a water risk assessment is only effective if put into practice and used to inform loan decisions. While lenders could take the easy way out and avoid risky agriculture loans altogether, the magnitude of the issue means that that’s not always practical.
Rather, lenders can mitigate their risk by maintaining a diverse agriculture loan portfolio that includes multiple regions and crops. They can also work directly with borrowers to reduce their water risk by developing new funding models, encouraging a transition to more sustainable agriculture, and investing in better water infrastructure.
Learn more about water risk assessment in agricultural lending.
How Sustainable Water Practices Can Come from Agriculture Relationships
As lenders use more thorough water risk assessments to inform their loan decisions, there is a possible scenario that not all farming operations will qualify for an agriculture loan. Some growers may be left behind, unable to transition to meet water resilience requirements. They may not be financially equipped to invest in the water-efficient infrastructure that they would have needed in order to improve their operation and be granted the loan.
As the World Bank explains:
“Farmers worldwide have been testing solutions to water scarcity, but they need to be supported with appropriate policies, the right mix of public and private investments, and access to knowledge and resources for producing more and better with less water.”
Lenders have a unique opportunity to support farmers through this transition, especially as more banks are rolling out ESG initiatives and embracing sustainable agricultural investments.
Examples could include:
- Incorporating water management discussions into their CRM routine, ensuring that their customers have access to the latest information and a shared understanding of water risk.
- Providing water management tips and practices, connect borrowers with workshops and training programs, strengthening their relationships with other stakeholders in the agricultural sector.
Other options include developing pathways to better water management – such as a long-term plan to improve a grower’s water resiliency – and supporting regenerative farming practices, which take time to establish but can result in healthier soils, less pollution, and more efficient water use.
One report suggests that, “as a business developer works to improve an organization’s market position, funders and other partners might consider a similar approach with farmers and ranchers, taking a longer-term perspective.”
Learn more about how building agriculture lending relationships that steward water sustainability can create mutually beneficial situations between lenders and their borrowers.
The Bottom Line of Agriculture Loans and Water Stress
We would argue that understanding water risk is a core driver in maintaining a healthy agricultural loan portfolio in both the short-term and long-term, and contributing to a more sustainable agricultural sector. Lenders and farmers can drive the shift to more resilient water management, creating more potential for sustainable wealth in the agriculture sector, but they need a combination of funding and information to do it.
Ag lenders can help farmers feed the world by factoring water risk assessments into their loan decisions, and by working with borrowers to mitigate those risks.
AQUAOSO’s Water Security Platform can aid in this process. The geospatial mapping tool aggregates up-to-date water information on a parcel-by-parcel basis from multiple sources. The Portfolio Connect tool can be used to analyze loan assets in the context of water risk, helping them to better understand and finance water risk mitigation strategies. All of these tools are designed to help foster community and collaboration between lenders and their borrowers.
Reach out to us today for a chat or a product demo, and or download one of our free e-books on water security issues from our resources page.