Agricultural Lending Standards Remain Prudent
Bankers and examiners need to ensure that loans made during booms are not underwritten based on assumptions that historically exceptional asset prices become even more exceptional. Agriculture is in a boom given high crop and land prices. Annually, Reserve Bank staff conducts a survey of Ninth District state member banks (SMBs) with loan portfolios concentrated in agricultural lending, in part to monitor the underwriting practices of SMBs. In the 2013 survey, bankers report that they do not rely on current asset prices or the growth of such prices when considering a borrower’s repayment ability. This article summarizes some of the techniques Ninth District SMBs are using to manage credit risk, briefly compares the financial condition of Ninth District agricultural banks to their nonagricultural counterparts, and concludes with a summary of survey respondents’ outlook.
Underwriting Practices
Despite citing a continued lack of loan demand, bankers report that underwriting practices had not loosened in an effort to attract loans. Some of the main features of reported underwriting include the following.
- When evaluating borrower cash flow and budgets, bankers noted that they
- Rely on Farm Service Agency estimates for crop prices, which tend to be below market expectations.
- Rely on historical yields, using a 3- to 10-year look-back period.
- Base input costs on contracted costs, if available, or a hybrid of historical costs and estimates provided by local suppliers.
- 68 percent of bankers noted that when underwriting loans, they use a commercially available product with the ability to run various scenarios for yield and prices. Remaining bankers use internally developed tools to evaluate projected budgets.
- Bankers noted that they require crop insurance when applicable to further strengthen collateral protection.
- Some bankers reported making greater use of government guarantee programs as a means of retaining relationships.
Virtually all bankers noted that farmland values and cash rents continue to rise. Still, bankers report that they are continuing the sound practice of using historic, rather than current, market valuations when using farmland as collateral. Most noted that they set a maximum loanable value per acre that is well below current reported values and/or take additional collateral beyond the land being purchased when funding real estate transactions.
Agricultural Bank Financial Condition
Overall, Ninth District agricultural banks remain in better condition than their nonagricultural counterparts based on supervisory assessments and standard financial metrics. The percentage of banks that are “problem banks” remains substantially lower for agricultural banks than for nonagricultural banks. Agricultural banks have lower loan delinquency levels, higher returns on average assets and more short-term liquid assets relative to nonagricultural banks. One area of potential concern is capital; agricultural banks report lower capital levels, both risk-based and leverage, than nonagricultural banks. This result is especially pronounced at banks with high concentrations of agricultural loans (greater than 300 percent of tier one capital and the allowance).
Outlook
Nearly all of the bankers surveyed have a positive to stable outlook for agriculture over the next one to two years. This positive outlook is tempered by several uncertainties that could change the picture, including concerns about moisture and high land prices—many noted concern over the impact high land prices and rents are having on young farmers. The damp spring appears to have alleviated drought conditions in the eastern half of the country; however, the May 7 drought monitor still shows pockets of severe to extreme drought in parts of the Ninth District. Continued sound underwriting practices combined with improved moisture going into the 2013 season suggest potentially strong performance for next year.
