Are Your Ag Loans Ready to Withstand the Onslaught?

According to a recent market analysis completed by John Newton, Ph.D., Chief Economist with the American Farm Bureau Federation, Chapter 12 family farm bankruptcies in 2019 increased by nearly 20% from the previous year. Compared with figures from over the last decade, the 20% increase trails only 2010, the year following the Great Recession, when Chapter 12 bankruptcies rose 33%.

Chapter 12 farm bankruptcies rose in many states across the Midwest, West and Southeast.

Georgia had the largest increase — 14 more filings than the prior year. Following Georgia were Iowa and Florida with 14 additional Chapter 12 bankruptcy filings and Nebraska with 11 additional filings. As a banker in Nebraska this analysis should serve as a cautionary tale as to what may lay ahead in 2020 and beyond.  By instituting and following sound underwriting policies and procedures throughout the term of the loan, a bank’s ag loan portfolio stands a better chance to withstand this onslaught. In October of 2018 the Office of the Comptroller of the Currency released a new version of its Safety and Soundness Handbook for Agricultural Lending to include updated best practices. Below is a few highlights from that release.

Each bank should identify, measure, monitor, and control risk by implementing an effective risk management system and loan policy appropriate for the size and complexity of its Ag lending operations. 

In particular, the policy should address Ag lending objectives and risk appetite, including acceptable types of Ag loans, portfolio distribution, lending market or territory, and risk limits expressed as a percentage of the bank’s capital. The policy should establish guidelines and requirements for the structure, reporting lines, and oversight of the Ag lending department or program.

The policies should address Ag credit administration and loan documentation standards pertinent to the scope and type(s) of Ag lending, including:

• financial documentation and repayment capacity analysis, including updates on outside debt.
• budget or cash flow projection analysis.
• liquidity monitoring.
• stress testing.
• guarantor analysis, when applicable.
• crop and livestock inspection requirements, including appropriate frequency and timing of inspections and valuations.
• equipment inspections and valuation expectations.
• expectations for the content and frequency of real estate evaluations and appraisals.
• title and lien verification.
• insurance policy requirements.
• frequency of credit checks.

A bank’s Ag loan portfolio is also highly dependent upon the type of collateral. 

For example, liquid Ag commodities, such as harvested crops and livestock, may be transported and easily purchased or sold. While the liquid nature of this collateral gives banks and Ag borrowers the flexibility to quickly raise cash when needed, it can also cause rapid shifts in the bank’s collateral position and the borrower’s balance sheet structure. As a result, banks need an effective collateral valuation program to monitor and verify crop or livestock collateral coverage. An inspection and reevaluation should be performed by a qualified person other than the lending officer responsible for the credit decision. When such a separation of duties is impossible or impractical, every effort should be made to periodically reaffirm inspection results by independent means.

In assessing the value of cash crops on hand, normal practice is to include all harvested crops being held for sale and stored in the farmer’s storage facilities, in an elevator, or elsewhere.

These harvested crops should be valued using the current market price, unless there is documented evidence that the borrower has a firm, contracted price for the crops, in which case the contracted price should be used.

Breeding stock normally should be inspected at least annually.

Some livestock, such as those being fed to market weight or the offspring from reproduction, are under the borrower’s control for less than one year. In these cases, the lender should generally inspect and appraise the collateral at least once during the period of ownership, if feasible. Management should also establish procedures to monitor changes in the collateral. Livestock may be located on the farmer’s or rancher’s premises, at a third-party feedlot, or elsewhere (such as leased pastureland, public or private). As with crops, the lender should confirm the borrower’s rights of ownership and possession.

Since a farmer’s or rancher’s cash flow is often seasonal or cyclical depending on the collateral, appropriate loan structure is critical to managing credit risk within an Ag lending relationship.

Banks should thoroughly understand the Ag borrower’s cash flow cycles and structure loans accordingly, and ensure they have the appropriate documentation within the loan file.  That documentation should include:

• A fully completed loan application
• Financial statements for the both the borrower and any guarantor(s)
• Credit and trade checks on both the borrower and any guarantor(s)
• Copies of all Ag budgets or cash flow projections
• Loan agreement
• Inspection and appraisal reports
• Other supporting valuation documentation, such as an auctioneer’s value estimate
• Title searches and other lien searches
• Mortgage
• Financing statements and security agreements
• Disbursement authorizations
• Insurance policies
• Hedging contracts or commitments
• Bank and customer correspondence

Once the loan has been underwritten and approved, it is also extremely important to develop policies and procedures related to ongoing monitoring.

This involves staying abreast of the borrower’s operations and market events that may affect the borrower’s condition. Lenders should regularly monitor crop and livestock development and compare it to assumptions provided in the borrower’s budget or cash flow projection. When there is significant deviation, a new or updated analysis should be considered. Lenders should also assess current market prices and the discount rate in comparison with prior assumptions. The updated analysis should be documented and should consider whether the borrower’s ability to repay debt has deteriorated to a point below the bank’s underwriting standards. The quality of financial information and subsequent analysis is an integral part of any Ag credit. This analysis should include:

• Determining the adequacy of cash flow to service debt
• Determining compliance with any financial covenants contained in the loan agreement
• Reviewing the reasonableness of budget assumptions and projections
• Comparing projections with actual results
• Assessing and documenting crop or livestock development
• Determining the effect of crop or livestock perils from weather, disease, or pests
• Analyzing net worth and leverage changes
• Updating changes in collateral value
• Assessing the effect of capital expenses

By instituting and following sound underwriting policies and procedures throughout the term of the loan, a bank’s Ag loan portfolio stands a better chance to withstand the onslaught of farming bankruptcies. 

Ensuring you loans are up to the task can be difficult.  If you need assistance understanding whether your loans are up to the task, contact the experienced banking and business attorneys at Goosmann Law in our Sioux City, Sioux Falls, and Omaha offices.