I. INTRODUCTION
The FDIC has issued a Financial Institution Letter in which financial institutions engaged in agricultural lending are encouraged to remain diligent in enforcing sound underwriting principles and establishing effective risk management procedures to help mitigate these risks. The FDIC noted that while the U.S. agricultural sector has benefited from almost a decade of solid farm production, strong demand, and favorable financing costs, despite a generally positive outlook, the agricultural sector remains susceptible to shocks from a number of sources, including volatile commodity prices.
II. PRUDENT CREDIT RISK MANAGEMENT FOR AGRICULTURAL LENDING
Financial institutions engaging in agricultural lending should implement a prudent credit risk management process that places a strong emphasis on borrower cash flow and repayment capacity, and does not place undue reliance on collateral. Many successful agricultural lenders have developed a strong knowledge of the farm sector and a deep understanding of individual borrowers and their businesses. This helps lenders establish appropriate loan structures and repayment plans based on the local agricultural base and customer credit needs.
For most agricultural loans, the primary source of repayment is often the cash flow derived from crop production or livestock operations, which are subject to the vagaries of the agricultural markets. Accordingly, farm credit analytics should be thorough and include projected cash flows over a reasonable range of future conditions that may affect commodity and farm land prices. In many cases, smaller farms rely on their principals’ personal wealth and resources to support ongoing operations; therefore, a borrower's credit history and financial strength are critically important components of assessing their willingness and ability to repay, and should be considered in conjunction with other subjective factors, such as the borrower’s management capabilities and experience. In addition, the structure and terms of agricultural loans should be appropriate for the borrower's funding needs given the timing of cash flows from farm operations.
Institutions also should analyze secondary sources of repayment and the strength of collateral support. Lenders should not rely solely on agricultural real estate collateral, but rather should focus on each borrower's cash flow position. Institutions should be sensitive to evidence of speculation in agricultural land prices or commodities that are influencing the market, and remain focused on repayment ability and borrower underwriting. In addition, the FDIC recognizes that other secondary sources of repayment and risk mitigation may be particularly useful in managing loan risks. For example, a borrower's informed use of crop insurance and true hedging activities can serve to lessen risk for the farming operation and lending institution.
Concentrations of credit to individual borrowers or segments of the agricultural industry also should be closely monitored and managed. Although the FDIC expects institutions to effectively manage credit concentrations, lenders should not automatically refuse credit to sound borrowers because of their particular business segment or geographic location. Instead, loan decisions should be based on the creditworthiness of the individual borrower, consistent with prudent management of credit concentrations.
III. DEVELOPING APPROPRIATE WORKOUT STRATEGIES FOR AGRICULTURAL CREDITS
The FDIC recognizes that some agricultural sectors, including dairy farming operations, have not experienced favorable business conditions and are constrained by diminished cash flows and reduced collateral values. During the agricultural crisis of the 1980s, agricultural borrowers experienced short-term deterioration in their financial condition because of commodity price volatility, depreciating land values, and rising input prices. Nonetheless, many of those farms continued to be profitable, creditworthy bank customers that demonstrated a willingness and capacity to repay debts over time. In cases where farming operations are struggling to make payments, financial institutions and borrowers often find it mutually beneficial to work constructively to restructure agricultural credit facilities.
The guidelines and principles presented in the October 30, 2009, Interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts (CRE Loan Workouts Guidance) can and should be readily adapted to lending relationships in the agricultural sector. The FDIC has found that prudent commercial loan workouts are often in the best interest of the financial institution and borrower, and workouts can take many forms including a renewal or extension of loan terms, the extension of additional credit, or a restructuring with or without concessions. Such a restructuring may improve a lender’s prospects for principal and interest repayment and remain consistent with sound banking, supervisory, and accounting practices. At the same time, loan restructures can help farmers negotiate adverse business conditions or volatility in commodity or land prices. Allowing additional time can help farms stabilize operations and mitigate bankers’ risk of loss.
Institutions should consider loan workouts after analyzing a farming operation and repayment capacity. Agricultural loan workouts should ensure the institution maximizes its recovery potential. From a supervisory perspective, restructured loans to farming operations with the ability to repay debts under reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount less than the loan balance. An institution that implements prudent loan workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts—even if the restructured loans have weaknesses that result in adverse classification provided management has adopted the principles of the CRE Loan Workouts Guidance.
As stated in previous supervisory guidance, including the February 2010 Interagency Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers and the November 2008 Interagency Statement on Meeting the Needs of Creditworthy Borrowers, the FDIC encourages financial institutions to prudently make loans to creditworthy farms in their local markets.