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Informational Memorandum
Subject:Year 2000 Impact on Customers of Farm Credit System Institutions
Date of Memorandum:04/27/1998
Expiration Date:
Office:OE
Signed By:Smith, Roland
FCA Contact Person:Glenn, Thomas
Contact Phone:703-883-4412
List of Attachments:None



INFORMATIONAL MEMORANDUM

April 23, 1998



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

From: Roland E. Smith, Chief Examiner Roland E. Smith
Office of Examination

Subject: Year 2000 Impact on Customers of Farm Credit System Institutions


The Year 2000 issue presents many challenges for financial institutions, including Farm Credit System (FCS) institutions. This Informational Memorandum is directed to one specific, and sometimes overlooked, challenge; that is, the risk arising from the failure or inability of an institution’s customer to address their Year 2000 vulnerabilities. The Farm Credit Administration (FCA) recognizes that the extent of work necessary to assess customer Year 2000 risk will vary among FCS institutions, depending on the borrower characteristics typical for the institution and the complexity of customer information and operating systems.

FCS institutions should establish a process to manage the Year 2000 risk posed by its customers. The assessment of individual customer’s Year 2000 risk and the impact on an institution should be addressed as a part of an institution’s internal Year 2000 project management program. The process should include the following elements:

Identify Material Customers

Management should identify customers that represent material Year 2000 risk exposure to the institution, including international customers. Material risk exposure may depend on:

Size of the overall relationship.
Risk rating of the borrower.
Complexity of the borrower's operating and information technology systems.
Customer's reliance on technology for successful business operations.
Customer's dependence on third-party providers of data-processing services or products (previously covered in FCA's Informational Memorandum dated March 17, 1998).

Assess Preparedness of Material Customers

The impact of Year 2000 issues on customers will differ widely. Smaller financial institutions may find that most of their material borrowers use either manual systems or depend on commercial software products and services. The evaluation of Year 2000 preparedness for these customers will be less involved and may not require additional risk management oversight. To ensure consistent information and a basis for comparisons among customers, management should determine the following:

Account officers are able to perform a basic assessment of Year 2000 risk of customers.
A standard set of questions is employed to assess the extent of a customer's Year 2000 efforts. Institutions should make certain they know whether a customer's suppliers or its clients have material Year 2000 problems.
The status of a customer's Year 2000 efforts are periodically updated. For customers that represent significant Year 2000 exposure to the institution, quarterly updates may be necessary.
Year 2000 assessment conclusions, subsequent discussions, and status updates are documented in the institution's customer files.

Evaluate Year 2000 Risk to the Institution

After identifying all customers representing material Year 2000 risk and evaluating the adequacy of their Year 2000 programs, management should assess the Year 2000 risk posed to the institution by these customers, individually and collectively. Management should provide updates to the board of directors on customers that are not addressing Year 2000 problems effectively and discuss the actions taken by the institution to control the risk.

Risk Control Guidelines

Once the institution has evaluated the magnitude of Year 2000 risk from its customers, management should develop and implement appropriate controls to manage and mitigate the risk. This activity should include developing risk-mitigating strategies and ensuring that effective procedures are implemented on a timely basis. Again, the degree of work necessary in this activity will depend on the institution's circumstances.

Underwriting

During any underwriting process, management should evaluate the extent of the borrower's Year 2000 risk. Specifically, management should:

- Ensure that loan officers have sufficient knowledge to perform a basic assessment of Year 2000 customer risk. There are a number of resource materials available that will assist in informing lenders of Year 2000 issues. - Require loan officers to determine whether Year 2000 issues will affect the customer's cashflows and balance sheet. As a part of the assessment, loan officers should consider the complexity of the customer's operations; their dependence on service providers or software vendors; the extent of management oversight of the Year 2000 project; the resources the customer has committed to the project; and the date the customer expects to complete the Year 2000 effort. - Control credit maturities or obtain additional collateral, as appropriate, if credit funding is to be continued for high-risk customers.

Documentation

Proper loan documentation provides an effective means to monitor and manage the Year 2000 risk posed by borrowers. Loan documents should reflect the degree of risk posed by customers. Institutions should consider incorporating some or all of the following into loan agreements:

- Representations by borrowers that Year 2000 programs are in place.
- Representations that borrowers will disclose Year 2000 plans to the lender, provide periodic updates on the borrower's progress of the Year 2000 program, and provide any assessment of the borrower's Year 2000 efforts conducted by a third party.
- Disclose any annual audits addressing Year 2000 issues.
- Warranties that the borrower will complete the plan.
- Convenants ensuring that adequate resources are deployed to complete the Year 2000 plan.
- Default provisions allowing the lender to accelerate the maturity of the debt for non-compliance with Year 2000 covenants.

Credit Administration

After the initial assessment, ongoing credit administration provides the best opportunity for an FCS institution to manage Year 2000-related customer risk. Periodic credit analyses, which should include an update of the customer's Year 2000 efforts, can help to monitor a borrower's Year 2000 efforts. When performing credit analyses, loan officers should determine whether a customer's Year 2000-related risk merits an adjustment to its internal risk rating.

Analysis of the Allowance Account

Management's review of the adequacy of loan and lease loss allowances should include Year 2000 customer risk. When Year 2000 issues adversely impact a customer's creditworthiness, the allowance for loan and lease losses should be adjusted to reflect adequately the increased credit risk. Additionally, management's analysis of loss inherent in the entire portfolio should reflect Year 2000 risk.


Additional Information

Year 2000-related risks posed by customers need to be addressed by FCS institutions. The guidance provided in this Informational Memorandum is designed to assist institutions in developing appropriate risk controls. Additional information regarding Year 2000 risk posed by borrowers, though not fully applicable to FCS institutions, can be found on the Federal Financial Institutions Examination Council website (http://www.ffiec.gov).

If you have any questions regarding this document, please call Thomas M. Glenn, Director of Operations, Office of Examination, at (703) 883-4412. Contact may also be made at the following e-mail address: glennt@fca.gov.