Agricultural Bank Survey (2014)
Safety and Soundness Update - March 2015
Published March 6, 2015 | March 2015 issue
The supervision department of the Federal Reserve Bank of Minneapolis conducts an annual survey of state member banks (SMBs) with agricultural loan concentrations. We ask presidents or senior agricultural loan officers at agriculturally focused SMBs about borrower financial conditions, bank underwriting practices, farmland values and other factors affecting the agricultural economy. This article summarizes the major survey results, identifies challenges facing agricultural bankers revealed by the survey and outlines steps bankers should take to address these challenges. We found that agricultural conditions remained generally sound in 2014, but are entering a period of change for which bankers must be prepared as prices for crops fall and borrowers have begun to reduce working capital.
Bankers with customers primarily engaged in crop production generally noted increasing stress on borrower cash flow. These bankers indicated that most borrowers met loan repayment terms due to effective marketing or existing working capital in 2014. A significant percentage of these agricultural bankers, however, expect that borrowers will struggle to break even in 2015. Bankers with livestock producing customers (whether cattle, dairy or swine) were more optimistic, noting that conditions were “awesome” or “unbelievable.”
Most bankers indicated that farmland values have stabilized over the past year, while about a fifth noted some degree of decline. Bankers uniformly noted limited farmland sales activity. The limited land sale activity involves local purchasers funding the acquisition with debt, in contrast to reports in prior years, which pointed to cash purchases.
About two-thirds of bankers noted an increase in loan growth in 2014, concentrated in crop production. Several bankers found that with this increase in 2014, agricultural lending had returned to more normal levels, with dormant operating lines seeing more use. Over 80 percent of the bankers planned to keep loan underwriting the same despite the changing conditions.
The survey results reveal a number of challenges facing agricultural banks in the coming year, including tightening borrower cash flow, increasing loan demand and worsening loan performance. Proactive actions from bankers could help mitigate potential adverse results from these challenges. We discuss these steps below, some of which bankers self-identified in the survey.
Responses to challenges
Several bankers reportedly have responded to changing conditions by monitoring problem borrowers more closely and reviewing significant borrowing relationships more regularly. Bankers reported linking frequency and intensity of monitoring to the level of risk posed by individual borrowers. Banks should closely monitor problem credits and make sure to risk focus ongoing credit reviews in response to emerging concerns in the agricultural sector. We next discuss additional steps banks should take as they review 2015 operating lines in an effort to prevent future problems from emerging.
First, agricultural banks should ensure that they have strong formal agricultural loan policies. Banks should incorporate internal agricultural lending practices and procedures into a formalized agricultural loan policy. An overall agricultural lending policy is critical during a review of operating lines, as it articulates clear underwriting expectations that management can enforce uniformly. Agricultural loan policies should contain loan-to-value guidelines as well as minimum debt service coverage, permissible loan structures and borrowers’ financial reporting expectations. Policies should also outline considerations for lenders when responding to a borrower experiencing short-term cash flow shortfalls. Policies should establish parameters for when the bank will roll unpaid operating debt into term debt versus when lenders should pursue other options, such as guarantees or curtailing further advances. The Federal Reserve’s guidance on expectations for risk management of agricultural credit risk provides guidance on desired features of bank policies.1
Second, bankers should reemphasize the importance of cash flow analysis during this review. The lender should evaluate the borrower’s assumptions regarding production and pricing, both revenues and expenses, when analyzing a borrower’s financial condition, in order to identify those customers who might experience strained cash flow. The banker can then work with the borrower throughout the year to evaluate options for addressing any shortfall that materializes. Regulators encourage banks to work with agricultural borrowers to develop responsible and effective means of addressing financial weaknesses. Banks should consider not only the availability of other collateral to support debt when rolling operating loans into term debt, but also the bank’s and borrower’s willingness to liquidate the collateral to pay debt should it become necessary.
Finally, banks should review their capital position and ensure its adequacy against their loan portfolio risk.
Agriculture, particularly crop production, could face a challenging near-term future. The use of prudent risk management techniques will enable agricultural bankers to meet the upcoming challenges and have a firm base to support future growth opportunities.