|Subject:||Review of Farm Credit System Loan Underwriting Standards (LUS or standards)|
|Date of Memorandum:||07/14/2004|
|Expiration Date:|| |
|Signed By:||Smith, Roland|
|FCA Contact Person:||Smith, Roland|
|List of Attachments:|
July 14, 2004
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 (LUS or standards)
Farm Credit institutions made a notable number of changes to their LUS in 2003 that should, in aggregate, strengthen controls over lending activities. The changes focused on defining new standards reflective of the types of specialized lending the institutions were expanding into while fine-tuning existing standards. Two districts had a significant percentage of institutions modifying LUS, while one district had only a few modifications. This continues a positive trend that has existed since we began tracking this information in 2001.
Institutions Amending LUS
The number of institutions amending their LUS increased from the prior year. Of the 102 active institutions in the Loan Underwriting Standards Database as of December 31, 2003, 40 institutions or 39 percent made changes to their underwriting standards. This was higher than the prior report, which noted 30 percent of the institutions amended their LUS. During 2001, 16 percent of the institutions amended their LUS.
Amendments to LUS include adopting new standards, revising existing standards, and eliminating standards. The most common amendment was adopting new standards. During 2003, 29 percent of institutions adopted new standards for a diverse set of commodities and industries or to supplement existing standards.
Revisions to existing LUS also increased. In 2003, 21 percent of the institutions revised standards, compared to 12 percent and 6 percent of institutions in 2002 and 2001, respectively. The most revisions were noted in institutions associated with two districts.
Nature of LUS Amendments
The Loan Underwriting Standards Database amendments reflected a trend in institutions developing more specific loan underwriting direction. The Loan Underwriting Standards Database changes were reflective of institutions:
· Adopting new underwriting standards for new types of lending (e.g., capital markets, energy, agribusiness).
· Adopting standards for specific portfolio segments including dairy, cattle, swine, and poultry.
· Fine tuning existing standards for various commodities, facilities, part-time farmers, and Young, Beginning, and Small Farmers (YBS) to adjust the institution’s desired risk exposure.
Most amendments were related to institutions implementing new standards. Categories with the greatest number of additional standards included dairy and dairy expansions (10), credit scoring (10), feeder, feedlot cattle, cow/calf operations (7), and hogs/swine/contract finish (5). Other categories with LUS additions included logging, horticulture, coop gins and service coops, absentee landowner, part-time farmer, rural local exchange carriers, power supply companies, and telecommunications.
Revisions to standards included both the tightening and loosening of various existing standards, although tightening was slightly more prevalent. In addition, some revisions neither tightened nor loosened standards, but reflected other changes, such as a change in credit scoring formula. The category of standards most affected included collateral ratios (loan/appraised value, debt coverage, and collateral margin) and financial ratios (owner equity and current ratio). Industries being addressed included dairy, various cattle operations (cow/calf, feedlot), and hogs. In addition, institutions were revising LUS related to credit scoring, inventories, agribusiness, part-time farmers, and YBS. While the revisions lacked much consistency from institution to institution, the data did reflect a general loosening of agribusiness standards.
All districts had LUS amendments in 2003. The district with the most activity had 58 percent of its affiliated institutions with LUS modifications, while the second highest district had 55 percent. Changes in the district with the most activity were related to the adoption of new standards for capital markets or specialized lending categories. These categories included energy (power generation, ethanol), agribusiness, horticulture, timber, absentee landowner, and marketing and processing. Changes in the second highest district were mostly related to credit scoring, rural local exchange carriers, cattle (dairy, feeder, stockers), and coop gins and service coops. Other observations in the remaining districts included the following:
· New LUS were reflective of the types of lending the institutions are moving into, including diversified farmers and capital markets.
· Expansion of the credit scoring process for diversified farms, integrators, capital markets, and specialized lending categories; which include dairy, construction, cattle, finance companies, logging, food and agribusiness, power supply companies, telecommunications, integrated contract growers, and irrigated crops.
· One district made only revisions to existing water and sewer LUS, but no associations in that district made LUS amendments to add new standards.
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. Institutions made a notable number of changes to their LUS in 2003 that should, in aggregate, strengthen controls over lending activities and improve risk management. Managing risk in agricultural lending is a complex issue and there are many other tools to manage risk that your institution may employ which 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.