Mitigating Agricultural Lending Risk: Best Practices

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In recent years, the U.S. agricultural industry has experienced high levels of profitability that stand in stark contrast to the crises that racked the country throughout the 1980s. According to agricultural lenders, borrowers in this industry reflect few loan delinquencies and the number of charge offs is at a forty-year low. Despite this – and despite the fact that the industry’s overall debt to income ratio is at 11 percent – the USDA is predicting 2014 will reveal significant downturns that could put lending institutions at risk.
According to the USDA, a 27 percent decline in net farm income combined with a slowdown in farmland values and increased borrowing costs should be expected. Because of this forecast, and because the agricultural industry’s profitability can be greatly impacted by a number of factors (not the least of which include market volatility and unpredictable weather patterns), the Fed has made changes to rules impacting FDIC-supervised lenders.
Although the new requirements apply only to financial institutions with $1 billion or more in total assets, the methodologies at play act as prudent guidelines that all bank directors should embrace as part and parcel of their duty to ensure the financial solvency of their institutions with respect to agricultural loans.
The following offers an overview summary of the key inclusions of FIL-85-2010, published officially on July 16, 2014.
• Remember to keep in place judicious practices that take into consideration a borrower’s cash flow and their ability to repay a loan. Collateral values should be given less weight, and projected cash flows should be sufficient to cover fluctuations in sales prices and interest rates.
• Take into consideration secondary repayment sources, such as supplemental income earned by the borrower through non-farm activities. A large part of this includes assessing the borrower’s other credit history and activity to determine their ability and willingness to repay their debt.
• Prior to making any lending decisions, it’s important to ensure thorough research of cyclical factors has been performed, including but not limited to rising and falling land values and the market performance of commodities.
• Ensure your bank managers identify and focus heavily on concentrations of credit, to both individual borrowers and among certain industry segments. This does not indicate banks should deny borrowers simply on the basis of their location or their particular industry segment. Rather, individual creditworthiness should be examined.
• Be willing to work diligently with borrowers who are experiencing downturns in business or who are going through difficult financial stretches. The FDIC is quick to point out that working with agricultural lenders – through the restructuring or re-modification of loan terms – is one of the keys to safeguarding the long term health of the U.S. agricultural industry.
As always, close and frequent examination of your bank’s internal guidelines is crucial to shoring up exposure to risk. To contact a third party that can perform an extensive review of your commercial loan review procedures, visit CEIS Review. To review the FDIC’s full recommendations, refer to their publication Prudent Management of Agricultural Credits Through Economic Cycles.
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The FDIC has issued new rules regarding the mitigation of credit risk among agricultural industry borrowers. Find out how these guidelines could impact your bank’s ability to remain financially viable during expected downturns in that industry.