Agricultural lenders are facing yet another challenge.

A report released last week by the Small Business Administration’s independent Office of the Inspector General questions the independent status of chicken farmers.

The report, in a nutshell, determined that most chicken growers are tied so closely to larger poultry companies — the result of vertical integration efforts — that they operate more like subsidiaries than independent businesses. That could create a problem with lending under the SBA's 7(a) program, which is intended to assist small businesses and startups.

As a result, the SBA may consider barring future loan guarantees to growers who sell their production to a single company. Such a move would harm scores of community banks that count poultry lending as a lucrative line of business.

Poultry makes up the bulk of agricultural loans backed by the agency. The SBA guaranteed more than 1,500 poultry loans totaling about $1.8 billion between fiscal years 2012 and 2016.

The threat has gotten the attention of bankers' groups.

The watchdog's report could be “extremely damaging to small banks and their communities," said Bill Holmes, president of the Arkansas Bankers Association. "We’re certainly going to respond."

The findings create "some issues that need to be addressed ... and we’ll be happy to do that,” said Tony Wilkinson, CEO of the National Association of Government Guaranteed Lenders. “I doubt many lenders will be using their delegated authority [to make poultry loans] until this is cleared up.”

The matter has also drawn the ire of the National Chicken Council, which represents entities that raise broiler chickens and make and market chicken products.

The relationship between chicken growers and larger food companies “is no different than any other small business that enters into a contractual relationship to provide services to a larger company,” said Tom Super, the trade group's senior vice president for communications.

“These loans … go directly to small, independent family farms in rural America,” Super added. “If anything, the government should be doing more, not less, to drive growth and opportunity in the rural economies.”

The report comes at a time when lawmakers are looking closely at the SBA’s enforcement of the “credit elsewhere” test, which is supposed to ensure that government guarantees go only to small businesses that cannot qualify for conventional bank credit. During an oversight hearing held by the House Small Business Committee in January, legislators repeatedly stressed the importance of limiting the availability of 7(a) loans to legitimate small businesses.

Nydia Velazquez, a New York lawmaker and the committee’s ranking Democrat, said in a written statement to American Banker that she was “deeply concerned SBA loans may have been made to agriculture companies that should not have been eligible.” Velazquez added that she “looks forward” to investigating the matter.

“Unfortunately, the report confirms what the committee already suspected: That there is misuse within the program regarding 7(a) loans made to poultry farmers that began in previous administrations," Steve Chabot, the Ohio Republican who chairs the committee, said in his own statement. "This report is further justification that more oversight at the SBA is needed to ensure the integrity of the 7(a) loan program."

Chabot said he planned to call SBA officials to a hearing to testify on the report's findings.

The biggest issue is the Office of the Inspector General's conclusion that larger food companies “exercised comprehensive control over the growers through a series of contractual mandates and restrictions, management agreements, operating procedures, oversight, inspection and market controls that overcame all of the growers’ ability to operate their businesses independent of integrator mandates.”

Banks are now left to assess the office's full report.

Live Oak Bancshares in Wilmington, N.C., is among the institutions trying to understand how the determination will influence its operations. The company is one of the nation's most active SBA lenders.

“We believe in the American farmer and that these loans indeed support small family businesses,” said Claire Parker, a spokeswoman for the $2.8 billion-asset Live Oak.

The issue the inspector general office raised is difficult because “it clashes with our image of the independent yeoman agriculturalist,” said John Blanchfield, the former longtime director of the American Bankers Association’s Center for Agricultural and Rural Banking.

While growers may have “taken on the position of becoming the assembler” under their contracts, they still have to invest their own money to build chicken coops, added Blanchfield, who now works as an independent consultant. Many of those facilities cost $1 million or more to construct, which makes the SBA guarantee so important to lenders, Holmes said.

A policy that treats small chicken producers as affiliates rather than independent producers could also spill over into the pork and beef industries, Blanchfield said.

“Farmers are looking for all ways to get more income because commodity prices are so depressed right now," Blanchard added. "Raising hogs or chickens under a contract is a hell of a lot more attractive than driving a school bus, it pays a lot more, and you get to stay on the farm.”

The report created so much concern and uncertainty that the SBA saw fit to issue a statement Monday pledging to honor the guarantees it has already made, since lenders and borrowers were acting “in accordance with agency policy at the time” — but it left the direction of future policy guidance unsettled.

William Manger, associated administrator of the SBA's Office of Capital Access, also vowed to review the arrangements between chicken growers and the larger companies they supply.

“If needed, we will establish and implement controls and supplemental guidance to ensure that SBA loan specialists and lenders make appropriate affiliation determinations,” Manger wrote in a letter to Mike Ware, who oversees the inspector general office.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.