FCA Info Memo - Review of FCS Loan Underwriting Standards

Informational Memorandum
Subject:	Review of FCS Loan Underwriting Standards
Date of Memorandum:	08/21/2003
Expiration Date:
Office:	OE
Signed By:	Smith, Roland
FCA Contact Person:	Smith, Roland
Contact Phone:	703-883-4121
List of Attachments:

INFORMATIONAL MEMORANDUM

August 21, 2003

To: Chairman, Board of Directors
Chief Executive Officer
All Farm Credit System Institutions

From: Roland E. Smith, Director
Office of Examination

Subject: Review of Farm Credit System Loan Underwriting Standards

Overall Observations
Farm Credit institutions generally improved their loan underwriting standards (LUS) in 2002. Many institutions adopted new LUS for specific portfolio segments reflective of the types of specialized lending into which they were expanding. In addition, institutions were fine-tuning existing standards, with some emphasis on tightening versus relaxing standards.

More institutions changed their LUS in 2002 than in the previous year. Two districts had a significant percentage of institutions modifying their LUS, while the one district again had no modifications. In addition to updating LUS for existing institutions, 10 institutions with new charters and/or mergers effective in 2002 were added to our LUS database.

Institutions Amending LUS
The number of institutions amending their LUS increased from the prior year. Of the 106 active institutions in the LUS database as of April 2, 2003, 32 institutions (30 percent) amended their LUS in 2002. This is higher than the prior report as of March 25, 2002, when 20 (16 percent) of the 123 active institutions in the LUS database made amendments. Amendments included adopting new standards, revising existing standards, and eliminating existing standards. All institutions with amendments in 2002 and 2001 adopted one or more new underwriting standards.

Likewise, activity pertaining to revising existing loan underwriting standards was higher than the prior report. As of April 2003, 13 institutions (12 percent) revised loan underwriting standards compared to 8 institutions (6 percent) noted in the prior report. The activity was spread evenly across five districts. The institution with the most changes generally tightened standards by a slight amount in all categories of lending.

The number of institutions that eliminated underwriting standards remained stable. As of this report, 10 institutions (9 percent) eliminated some standards compared to 14 (11 percent) for the prior report. However, institutions implemented new or similar categories with generally the same criteria.

Nature of LUS Amendments
The LUS database changes were reflective of:

Adopting new underwriting standards for new types of lending (e.g., rural residence, energy, credit scoring, agribusiness);

Adopting standards for specific portfolio segments (e.g., nursery, greenhouses); and

Fine tuning existing standards (e.g., various commodities, facilities, part-time farmers, and Young, Beginning, and Small Farmers and Ranchers (YBS)).

Categories with the greatest number of loan underwriting standard additions included rural residence (9), credit scoring (7), general (6), dairy (5), nursery and greenhouses (5), agribusiness (5), YBS (4), crop operations/production (4), and beef cattle including cow/calf (4).

There was some tightening as well as relaxing of standards in different portfolio categories. Generally, the various standards like Owner’s Equity and Capital Debt Repayment Capacity were tightened while loan terms and Loan to Appraised Value standards were relaxed.

For institutions that revised loan underwriting standards, the categories most affected included nursery, dairy, general, credit scoring, and rural residence. In four cases, solvency was strengthened while in three cases it was relaxed. A similar pattern was noted concerning the debt coverage ratio and the current ratio. The repayment capacity standard was strengthened in one case while the standards for collateral requirements and loan terms were relaxed.

District Summary
The district with the most activity had 52 percent of its affiliated institutions with LUS modifications; the second highest had 47 percent. Changes in the district with the most activity related to expanding the number of specialized lending standards and the credit scoring process. Changes in the second highest district were mostly related to new standards for capital markets or specialized lending in categories including energy (power generation, ethanol) and agribusiness. The areas receiving the most attention in the remaining districts included the following:

· Expansion of the credit scoring process for diversified farms, integrators, capital markets, and specialized lending categories.
· New LUS were reflective of the types of lending the institutions are moving into including diversified farms and capital markets.
· Institutions added new LUS for specialized lending like saw mills and paper mills.

Summary

Our review of data collected by examiners on Farm Credit institutions’ LUS disclosed that the use of LUS by institutions has become more widespread, dynamic, and tailored by industry. As such, managing risk in agricultural lending is a complex issue and there are many other tools to manage risk that your institution may employ which the examiners will consider when evaluating loan portfolio management. Obviously, changes in the lending environment will require you to constantly review lending and loan servicing practices to ensure safe and sound operations. Please feel free to discuss this memorandum with the examiners assigned to your institution or contact me at (703) 883-4160. You may also contact me on the Internet at my e-mail address Smithr@fca.gov.