FCA Info Memo - Office of Examination Focus Areas for Fiscal Years 1999/2000

Informational Memorandum
Subject:	Office of Examination Focus Areas for Fiscal Years 1999/2000
Date of Memorandum:	11/25/1998
Expiration Date:
Office:	OE
Signed By:	Smith, Roland
FCA Contact Person:	Smith, Roland
Contact Phone:	703-883-4160
List of Attachments:	OE Focus Areas

INFORMATIONAL MEMORANDUM

November 24, 1998

To: Chairman, Board of Directors
Chief Executive Officer
Each Farm Credit System Institution

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

Subject: Office of Examination Focus Areas for Fiscal Years 1999/2000

As a part of the Farm Credit Administration (FCA or Agency) Strategic Plan, select examination focus areas are developed each fiscal year (FY) to assist examiners in determining the scope of examinations of Farm Credit System (System) institutions. Just as last year, I want to share with you the OE Focus Areas in order to help you better understand FCA’s examination of your institution. Hopefully, this will give you an opportunity to review each of those aspects of your operations so you can ensure your institutions have appropriately considered and addressed the issues covered by the OE Focus Areas. I am certain that many of you have already included one or more of these OE Focus Areas as a part of your institution’s business planning and internal control programs. I encourage you to share and discuss your activities in these areas with the FCA Examiner-in-Charge during your next examination.

For the FY 1999/2000 period, we have identified four focus areas. The conditions unique to each of your institutions are, of course, also considered when determining the scope of examination and the resources allocated for the examination. Your discussion with the examiners relative to the actions you have taken will help ensure an examination that will be more beneficial to your organization. The OE Focus Areas for FY 1999/2000 are:

· Year 2000
· Emerging Risk
· Young, Beginning, and Small Farmers Program, and Minority Farmers
· Credit Delivery

Further explanation of these focus areas is included in the accompanying attachment. This attachment is an excerpt from the OE Operating Plan, which provides guidance to all FCA examiners. Should you have any questions regarding the OE Focus Areas, or any other aspect of the Agency’s examination program, please contact me at (703) 883-4160 or the Director of your respective FCA Field Office.

In closing, I want to thank you and your staff for the cooperation given to FCA examiners this past year. Because we are all working towards the same goal, I believe that sharing information will help all of us maintain a successful, safe, and sound Farm Credit System.

Attachment
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OFFICE OF EXAMINATION
FOCUS AREAS

The following represent primary focus areas for examination activities. These focus areas shall be considered in individual examination and oversight programs, and they will be discussed and concluded on, as appropriate, in Reports of Examination. Several of the focus area discussions include specific guidance on the treatment of deficiencies found. However, as always, judgment must be used in the application of this guidance after considering the specific circumstances of the institution.

Year 2000
One of the more significant issues confronting Farm Credit System (FCS or System) institutions is their ability to attain Year 2000 compliance. The inability of institutions to process electronic information after December 31, 1999, will have serious ramifications for loan and accounting systems and other operational areas for System institutions, their borrowers, and third-party providers. OE has processes in place to accurately assess the degree of exposure in all System institutions and data centers. OE has also identified high-risk institutions early enough to enable examiners to follow up on corrective actions implemented by those institutions. In addition, OE surveys each System institution quarterly to measure progress toward achieving Year 2000 compliance, and that information is used by examiners in their examination and oversight activities. There is an OE Year 2000 Task Force that coordinates examination activities and makes periodic reports on progress to the FCA Board and to Congress.

Year 2000 examination activities are scheduled for each institution and data center. Under the direction of the Examiner-in-Charge, examiners will utilize the same Year 2000 examination procedures as the other Federal regulatory agencies to assess the institution’s computer software and hardware, as well as other related systems. These procedures were provided to each FCS institution via an Informational Memorandum dated August 18, 1998. All institutions were encouraged to utilize these procedures as a self-assessment tool.

Emerging Risk
Greater price and income volatility and changes in the comparative advantages for some commodities will likely characterize the new market environment for U.S. farmers. These developments suggest greater risk for the System. System institutions should appropriately consider any impact that disruptions in the agricultural economy may have on their financial stability. Emerging risks include changes in U.S. Government support programs, domestic and international market fluctuations, environmental risks associated with larger commercialized farming operations, heightened competitive pressures within the lending industry, fluctuations in market prices for farm commodities, and interest rates. Examination programs should be tailored to identify potential market-related risks that could potentially impact the stability of an institution’s financial condition and performance. Examiners should determine whether institutions have appropriately implemented risk management practices that address potential exposures to the financial stability of the institution. Examiners should also review strategic business plans, contingency plans, portfolio management practices, and sensitivity testing of the loan portfolio.

Young, Beginning, and Small Farmer Program, and Minority Farmers
Examination programs shall assess each institution’s program for furnishing sound and constructive credit and related services to young, beginning, small, and minority farmers and ranchers. These types of lending programs help the System finance the next generation of farmers and help foster a viable agricultural economy. Section 4.19(b) of the Farm Credit Act of 1971, as amended, requires each association to have a program for furnishing sound and constructive credit and related services to young, beginning, and small farmers and ranchers. These programs must provide assurances that credit and services are available in coordination with other units of the System serving the territory and with other U.S. Governmental and private sources of credit. Key aspects of the examination program include:

1. Examine the institution’s analysis of the demographics of the young, beginning, small, and minority (YBSM) farming and ranching activities in the territory serviced by the institution.

2. Examine the institution’s analysis of the demographics of the YBSM loans in the institution’s portfolio.

3. Determine the extent of the institution’s market penetration and any disparities that may reflect areas, which are being under-served by the institution.

4. If disparities exist, identify the underlying cause and evaluate the institution’s actions to address and resolve any under-representation, including quantifiable goals and ongoing monitoring and reporting requirements.

Annually, each Farm Credit Bank is required to obtain from associations reports of activities under programs developed for young, beginning, and small farmers and ranchers, including progress toward achieving program objectives. The examination program shall include an assessment of the adequacy and accuracy of the bank’s annual reporting in compliance with instructions issued by the Agency.

For Minority farmers and ranchers, examinations should include an evaluation of how well the institution has marketed its products to minority farmers and ranchers and other categories as addressed in Regulation B. This regulation prohibits creditors from discriminating against credit applicants on the basis of age, race, color, religion, national origin, sex, marital status, or receipt of income from public assistance programs. A review of rejected loan applications should be included in the scope of examination to evaluate fair and equitable treatment of applicants. An evaluation of underwriting standards should also be made to ensure they are equitable and do not exclude minority applicants.

Credit Delivery
Lending practices continue to be an area of examination emphasis. In particular, scorecard lending and limited documentation programs are new endeavors to expand market share that could result in excessive risk, if not carefully implemented. An institution’s underwriting standards may become outdated given the dynamics and demographics of the current agricultural lending environment. Furthermore, competitive pressures may persuade institutions to relax underwriting standards or permit more exceptions. Examiners should review all aspects of an institution’s loan portfolio, particularly new loans, to assess the adequacy of loan underwriting standards and related business and capital adequacy plans. In those instances where risk is emerging in a particular segment(s) of the portfolio, a careful evaluation should be made to determine if management and the board have updated underwriting standards to ensure they appropriately manage risk exposures relative to the institution’s risk-bearing capacity. The Examination Manual, the "Director's Role" handbook, and the Agency’s Bookletter on loan underwriting standards contain guidance on lending practices and underwriting standards.

Scorecard lending and limited documentation programs provide institutions with highly efficient means for processing and approving loans. However, these programs present unique risks because they are not fully matured and some are still in the process of implementation. A specific focus for examinations of these programs is whether institution boards have established controls that effectively manage risk exposures inherent in such lending activities. In particular, the examiner should determine if the board has established program limits commensurate to the institution's risk-bearing capacity. An evaluation should also be made to determine if those limits would result in a financially sound institution, or whether the limits would result in excessive risk and, therefore, constitute unsafe or unsound practices. The percentage of program activity in relation to risk funds will be a critical measure of the safety and soundness of these programs. Operating parameters that are based on a percentage of total loans can inappropriately result in excessive risk. The examination and supervision of the institution must make certain that boards and management appropriately relate program activity to the institution’s risk-bearing capacity (i.e., authorized program activity as a percentage of risk funds). Additionally, the examination should include an evaluation of adherence with the FCA Bookletter dated October 28, 1997, entitled "Lending Policies and Loan Underwriting Standards Regulations."

The scope and approach of such examination programs will obviously vary considerably among institutions, depending on risk evident in the institution and the exposures permitted by board policy. Accordingly, examiners should consider the appropriateness of policies, procedures, and controls, and the adequacy of capital and the allowance for losses. Examiners should also assess the adequacy of: (1) loan underwriting standards, (2) adjustments to underwriting standards when changes in the lending environment occur, and (3) control and reporting systems that monitor compliance and identify exceptions.