Are You Aware of the Risk in Your Agriculture Loan Portfolio?

The 2012 summer growing season has brought with it the worst U.S. drought in more than 20 years. Lack of rain and extreme heat have affected most of the continental United States, including a majority of the states in which crops are produced. To put the issue in context, the U.S. Department of Agriculture announced these statistics in July:

• Twenty-four percent of the corn crop was considered to be in good or excellent condition as of July 29, 2012; this represents a 38 percent decline from one year prior and a 2 percent decline from the previous week.
• Twenty-nine  percent of the soybean crop was considered to be in good or excellent condition, a 31 percent decline from one year prior and a 2 percent decline from the previous week.
• For 48 states (excludes Alaska and Hawaii), the portion of pasture and range area rated as good or excellent has decreased from 41 percent in 2011 to 17 percent in 2012.

The above statistics lead to an expectation that 2012 crop supplies will be less, and lower supply leads to several issues for our nation’s farmers.

Potentially helping to mitigate some of the risk associated with the 2012 season is the fact that many crop farmers are coming off a record-high year in 2011 and could potentially be better prepared to weather the oncoming storm. In addition, many farmers have revenue crop insurance protecting approximately 65 percent to 85 percent of their anticipated revenue streams, which could allow them to experience some benefit from the increased prices. The government also has announced steps to provide aid to livestock farmers through a USDA meat purchase of up to $170 million. The USDA is approved to buy as much as $100 million of pork, $50 million of chicken and $10 million each of lamb and catfish to aid farmers.

Banks should take a proactive approach in determining their exposure through lending to agricultural and agriculture-related industries. Here are some items to consider when determining exposure:

• What types of credits to agricultural and agriculture-related borrowers are recorded on the books, and what is the dollar magnitude?
• What secures these credits?

If management determines the bank has exposure through agricultural lending, it will be important to assess the risks associated with the 2012 drought on the bank. Some key risks to consider could include:

• Does the bank require crop insurance for borrowers? Are borrowers without crop insurance financially stable enough to survive, e.g., high net worth, low debt/equity ratio, sufficient unencumbered assets to borrow against?
• Has the bank documented the amount and type of crop insurance its borrowers have in place?
• Have borrowers entered into any future production contracts?
• Is collateral coverage still sufficient considering expected price changes?
• For larger credits, what does the borrower’s current debt-service coverage look like? How leveraged is the borrower? Are there unencumbered assets they can borrow additional funds against to help cash flow?
• How much of the borrower’s land is cash rented or sharecropped? Are the borrowers paying market rent or do they have typical sharecrop agreements?
• Does the borrower have off-farm income?
• For livestock farmers, cash flow could become stressed in the short-term as input costs, i.e., feed, continue to increase. Are there other sources of income they can rely on? Are they financially stable enough to survive the down year?
• For agricultural industry-related borrowers, such as farm implement dealers or feed operations, are contingency plans in place to deal with effect of their customers spending less?

Ultimately, the bank should thoroughly document its agricultural risk position in light of the 2012 drought. The effect this has on allowance for loan losses also should be documented, including why (or why not) increased provisions to the allowance might be justified, i.e., through an environmental factor adjustment and or specific allocations for specific credits.

Nick Keener is supervisor, financial services, manufacturing & distribution, for BKD in Evansvile, Ind. Christopher Meriwether is a manager, financial services, for BKD in Louisville, Ky.

Copyright (c) November 2012 by BankNews Media