Family Farm Reaped Gains From Economic Crunch : Agriculture: The Schmidts got another chance at their land after downturn stung lenders who foreclosed.

The turnaround for Bob Schmidt and his family came with stunning dispatch. In mid-October of 1984 they were talking about expanding their 1,570-acre farm here in southern Minnesota by two-thirds. By March of 1985, they were handing over the farm to their lenders.

The farm economy had gone bust. It didn’t matter that the Schmidts were still making their payments. On paper, their loans were now worth less than the collateral. The Schmidts’ lenders wanted out.

Their first evening off the farm, freshly installed in a St. Paul, Minn., suburb, Bob Schmidt sat in his back yard, studying the fence that marked the boundary of his new home. At 40, he no longer was a farmer. That part of his life was over.

Or so he thought.

Public chronicles about agriculture in the mid-1980s usually ended with farmers mired in bitterness and displacement, but often the seeming victims eventually emerged as victors, while the lenders who had pulled the plugs on them ended up in far sorrier positions. The financial institutions simply did not know what to do with the farms they owned, and they couldn’t get rid of them, so not infrequently they let the foreclosed farmers stay on their land.

Largely for this reason, the Schmidt family never did lose physical possession of their farm.

After taking almost all of 1985 to decide to foreclose against the Schmidts, Travelers Insurance Co.--the holder of their $1.4-million mortgage--was required by Minnesota law to wait another year before seizing the land. So the official foreclosure sale notice didn’t arrive in the mail until November, 1986, and the land wasn’t put up for sale until February, 1987. Then it just sat for two more years without a buyer. Meanwhile, it had to be maintained, so Schmidt’s brother, Bill, and his wife, Wendy, were allowed to remain on the farm, working the hog and cattle operation in a rent-free, interest-free and tax-free partnership with Schmidt’s father, Robert D. Schmidt, who had left Control Data Corp. to start his own energy business. They called their new operation Fox Den Farm, and with such low overhead, it made money.

During this time, the Schmidts also managed to dissolve their huge short-term debt with First Bank Minneapolis. Forced liquidations had reduced the $1.2-million balance to $985,000, and Bob’s father had paid down that amount to $400,000 by signing over bonuses and stock shares from Control Data. In early 1987, sensing the bank would be inclined to write down the remaining balance, the senior Schmidt offered $40,000 to settle the account--10 cents on the dollar.

Bob Schmidt couldn’t see how his father even had the nerve to make such a puny offer, but the senior Schmidt, who had opened up the Soviet Union for Control Data, well merited his reputation as a crack negotiator. The bank jumped at his offer. What to the Schmidts was 10 cents on the dollar, after all, could be regarded by the loan officers as 50 cents on the dollar if they added the $40,000 to what had been paid off previously. Not such a bad return, considering this was by now essentially an unsecured loan.

“Their performance would look OK on paper,” the senior Schmidt observed recently. “That was important to them. The lenders aren’t looking at the situation as you are.”

If this outcome was strange, it was not at all uncommon. Lenders getting squeezed from all directions had to deal where they could.

“There was a period there when you couldn’t give a farm away,” recalled Ross House, once a Travelers Insurance farm manager who dealt with the Schmidts and who now is self-employed in a farm-management business.

“In Minnesota alone, Travelers owned 200 of them, about 80,000 to 90,000 acres. In 1985 and 1986, we were getting five or six new farms a week. There was literally no market,” he said

“No one knew what to do with these farms,” said Dave Guimond, then a First Bank vice president and the Schmidts’ loan officer and now a vice president at the regional stock brokerage of Piper, Jaffray & Hopwood Inc. “The dispossessed farmers are saying: ‘Stick it in your ear.’ It’s not like taking over an office building and shutting off the lights. You have a living, breathing organism. It needs caring for. Typically what we did is turn around and rent back to the farmer we took it from.”

Then in 1986, the Minnesota Legislature passed a “right of first refusal” law that gave the original owner of dispossessed property the right to match any potential buyer’s bid. As a result, a farmer who had borrowed heavily to buy land at $2,000 an acre could default on his debts, accumulate cash by working his land rent- and tax-free, then buy it back at a deflated price, perhaps $550 an acre.

Don’t fight and don’t quit, the shrewder farmers came to realize.

When Norwest Bank pulled the plug on the Schmidts’ neighbor, John Derham, he just handed over the keys to the farm. Then he asked his loan officer a question: “Who’s gonna feed your 700 head of cattle?” The banker had no answer. Four days later, Derham called him. “Well, nine of your cattle are dead, and a couple others don’t look so good,” he reported. After a few weeks of such exchanges, the bank agreed to pay Derham $1,000 a month to care for the livestock. He accepted only after the bank tossed in extra cash for feed, feeders and two full-time farm workers.

“You don’t tap dance with a gorilla,” Derham advised recently, standing on the land he has now bought back from the bank. “Better to get away, kick at his shins from a distance.”

In time, lenders were more than happy to take whatever they could get for the farms, livestock and machinery they owned. Rushing in concert to dump property on an already depressed market, they managed only to drive down prices further.

“We didn’t know where farm prices were going to bottom out,” Guimond recalled. “It turned out $435 an acre was the bottom. But we didn’t know. Some guys were saying $200. So suddenly you’re happy for 40 cents on the dollar.”

“The idea at Travelers first was to hold the land, rent it to farmers, watch it bottom out, then sell it when the market went up,” House said. “But then they panicked. Travelers had cash flow problems and needed money. Let’s try to sell the dogs, they said at first. Within six months, they were trying to sell everything. In 1988, they were selling land for 30 to 50 cents on the dollar. And 80% of the sales went to local farmers, even to the former owners.”

In that year, 1988, however, the Schmidts were not among those who bought back their farms. Travelers’ price was still too high for them. The family occupied the land, but lacked the means to make an offer. Potential buyers, meanwhile, had started approaching and hovering.

It was then that Bob Schmidt decided to make his move.

The job Schmidt had taken as director of marketing at Ballistivet--a fledgling firm marketing a biodegradable medical pellet that could be shot painlessly into animals from 50 feet-- had soured for him, what with operational problems in the home office and long weeks on the road in motel rooms.

One evening in the early spring of 1988, just when it seemed to him that farmland was close to the bottom of the market, his wife, Sheri, returned from her job at an industrial graphics manufacturer with good news. “Guess what,” she said. “I was promoted to director of operations today. I’m getting a $12,000 a year raise.”

“That’s bitchin,” Schmidt responded. “I’m going farming.”

Within days, he began commuting in reverse, from his suburban White Bear Lake, Minn., home to the farm. Usually he came home only on weekends. After discussion, he and Sheri bought into the partnership that had been formed by Bob’s father and brother. Together they signed a 10-month lease with Travelers to work the farm into mid-January of 1989.

That’s all they could do, though. Travelers’ asking price, $525,000 for 685 acres of the original farm, was still too high for them.

While they waited that summer and fall, real estate agents began bringing around potential buyers. Watching with increasing agitation, Schmidt began blocking out operating plans, cash flows, projections. The family had the right of first refusal, but that wouldn’t matter if the price offered was too high.

“We had to know what we could operate with,” Schmidt said. “We weren’t going to commit suicide again. We’d only match the price if it made sense.”

One potential buyer kept returning. The people from Benson-Quinn Hogs over in Owatanna, Minn., looked serious and asked lots of questions.

Looking back later, it is hard to say precisely when the question of personal and real property on the farm first arose. Most likely, it was in October, 1988, just as Benson-Quinn’s interest was peaking.

One day, House, Travelers’ farm manager, mentioned to Schmidt that they should sit down and agree on what was real estate and what was personal property, particularly in the hog barn. Travelers, after all, owned only the real estate.

Then the Benson-Quinn people started making similar suggestions. To Schmidt the matter was obvious: The totally separate, movable things (office equipment, scales, washers) were personal. The fixed stuff (the furnace, the farrowing crates, the feeders) was real property. So Schmidt gave the Benson-Quinn people a list.

“That’s how naive we were,” he said. “I didn’t grasp what this was about.”

Two days later, a Benson-Quinn representative called Schmidt, asking if they could get Schmidt’s signature on that list. They needed Schmidt to guarantee exactly what was real and personal property, he explained, because Travelers wouldn’t guarantee anything.

That, Schmidt would say later, was when he finally wised up. “I didn’t entirely understand what was going on, but I figured we must have some cards in our hand that we didn’t know about.”

They did. Schmidt, in fact, had Travelers over a barrel.

“Benson-Quinn wanted a bill of sale on all the stuff inside the hog barn,” House explained recently. “So we go back, check the records, and lo and behold, there’s no fixture filing. Oooh, I think. We have a little problem. You don’t have to be a rocket scientist to see nobody’s going to buy this farm without a warranty. The Travelers’ lawyers decide the risk of an unwarranted sale is not worth it. We should bite the bullet, they say. Cut whatever deal you can with the Schmidts.”

For a while, House vacillated.

“I know Bob doesn’t know what’s going on. But I represent Travelers. I can’t tell Bob to wake up, smell the roses, you have them by the short hairs. But Bob didn’t come down with yesterday’s rain. He finally figures it out.”

This time when the Schmidts went shopping for financing, they found an interested lender.

The tiny State Bank of Faribault, with just $90 million in resources, had always played its hand fairly conservatively, avoiding loans to the more leveraged farmers. As a consequence, the bank had ridden out the farm depression fairly well. It never had pulled out of farm loans. Where necessary, it had restructured and extended the terms of loans until conditions improved.

The bank’s senior vice president, Tom Laughlin, with whom the Schmidts now do business, recently explained his thinking:

“Many farmers could have survived if the lenders had reduced interest rates to their borrowers and restructured, but most lenders instead pulled out or raised rates. Theoretically that’s what you do, but such an approach guaranteed that everyone would lose. Yes, land values were going down, and farmers just had too much debt. But the loans were already out there. For those who were still making their payments, why pull out? In that situation, we rode it out. Just the other day, I reset the loan on one farmer where we’d reduced the rate for four years. At one point during those years the value of the farm was less than the loan. Now the value exceeds the loan.”

Making a commitment to the Schmidts, he said, “was not a real difficult decision. The Schmidts had done their homework. They had the papers to show cash flow. They would have a much smaller debt. And we felt comfortable with these people. Even though they had gone through bad times, the record showed they were good people.”

On Monday, Jan. 1, 1989, Schmidt called House and made his offer: They would pay $350,000 cash for the 685 acres, including the hog barn, that Travelers had on the market for $525,000. And they would pay $90,000, secured by a two-year note, for the 200-acre south farm that Travelers then was renting out separately. That was a total of $440,000 for 885 acres.

“I don’t think they’ll do it,” House responded. “The price is low, and I don’t think they’ll finance that $90,000.”

“Well . . .” Schmidt said. “See what they’ll do.”

A day later, the phone rang in the Schmidt farmhouse.

“Bob, are you sitting down?” House began.

“Yeah, I guess.”

“First of all,” House said, “they wouldn’t accept your offer. I was right. They don’t want to finance a note. But they have made a counteroffer. They’ll sell everything for $395,000 cash. The whole 885 acres. You take it all.”

Schmidt was nonplussed. Travelers’ price was $45,000 less than what his family had offered. It came to a rock bottom $446 an acre. He could barely choke out his assent.

“The Schmidts bought back their farm at what now appears to be a ridiculously low price,” Laughlin, their banker, said recently. “But it was the bottom of the market. The insurance company got a little excited. They really took some baths they didn’t have to take.”

The deal closed in March, 1989. Bob and Sheri Schmidt put their White Bear Lake home up for sale and moved back to the farm that June. In November, after a series of family conferences, they bought out Bill and Wendy’s share of the farm and formed a new partnership with Schmidt’s father.

Combined with 120 privately financed acres they had managed to keep through the years, the Fox Den Farm holdings totaled 1,005 acres, the shank of the original farm. Where there once had been a $1.4-million mortgage, though, there now was a $395,000 obligation. And where there was once a $1.2-million short-term debt, there now was a $150,000 line of credit, only $30,000 of it being used.

Fox Den Farm sent 6,000 hogs to market in 1990, 250 every two weeks, and produced 30,000 bushels of corn. The cow herd climbed back up to 114 head. Total revenue, $850,000, was not much different from what it was in 1984, but the cost of operations dropped from $793,000 to $654,850, and interest payments dropped even more, from $345,000 to $59,210. The farm, consequently, yielded an operating profit of more than $100,000. Independent appraisers now value Fox Den Farm at $1,000 an acre, more than twice what the Schmidts paid Travelers in early 1989.

Meanwhile, the Schmidts’ past lenders, First Bank and Travelers, have not fared nearly as well as their former borrower.

In the mid-1980s, the decision by First Bank System, the parent company of First Bank Minneapolis, to bet on interest rates in the bond market proved highly profitable for awhile but then turned disastrous when interest rates unexpectedly headed higher in April, 1987. After holding on to its $8-billion portfolio for months, vainly hoping for rates to fall, the bank finally bailed out and took a $506-million loss in the fourth quarter of 1988, which resulted in a $310-million net loss for the year and one of the worst interest rate fiascoes in modern banking history.

Travelers’ mid-1980s foray into commercial real estate proved an even worse investment. With $17.3 billion--a third of its assets--tied up in hotels, office buildings and shopping centers, the company set aside $415 million for real estate losses in the second quarter of 1988, then added $650 million in October, 1990. It reported a record $499-million loss in the third quarter and a net loss for 1990 of $178 million.

Heads have rolled at both institutions--Travelers’ entire real estate operation has been restaffed in the past two years, and First Bank System’s president and chairman have departed. The new First Bank chairman, John F. Grundhofer, recently expressed regret that his predecessors had sold off the company’s smaller rural branches to rid itself of exposure to the farm economy. Agriculture is once again profitable, after all--institutional investors such as pension and mutual funds are rediscovering the heartland, and even supply and seed companies are now competing with banks for the right to lend money to farmers. No wonder--overall, at 10.7% a year, farmers in southern Minnesota have matched Wall Street and mutual funds on annual rate of return from 1960 to 1988.

“In hindsight,” Grundhofer told a reporter last spring, “First Bank would be even more valuable if we still had those rural branches.”

Bob Schmidt cannot avoid feeling bemused when reflecting on such a turn of events, but in the end, his thoughts about what has happened are more conflicted and shaded than triumphant, and they are weighted by a sense of his own responsibility. He still believes there were good reasons for their rapid expansion and heavy debt burden, not the least being tax laws that allowed large writeoffs and government policies that encouraged growth. But the laws and policies have changed and so has his outlook.

He operates more carefully now. He sends some hogs to feed at a neighboring farmer’s facilities rather than pay to expand his physical plant. He spends much of his time in the upstairs office adjacent to his bedroom, studying cash flow sheets, reading consultants’ reports and hedging both corn and hog prices by playing the commodities market. He still hankers to expand, but he’s going to move slowly, in stages, paying his way through cash flow and some short-term debt.

“I look back at stupid things we did,” he said one recent evening, sitting on his porch and gazing at all the land he has regained. “Yeah, we did stupid things. So did the lenders and the government. I think the basic idea behind what we did was reasonable, though. Maybe we would have needed some restructuring, but there was money there. Consider this--12 months after the forced selling of our calves for 50 cents a pound, the going market price was 80 cents. I can’t help wondering--what would have happened if First Bank and Travelers just hadn’t changed their investment direction? What would have happened if they just hadn’t pulled out of agriculture?”

Times researcher Nina Green contributed to this story.