Pub. 9 2014-2015 Issue 3

www.nebankers.org 12 Extraordinary Service for Extraordinary Members. Economic Cycles & Credit Risk Management At a time of relative prosperity in the ag sector, this July, the FDIC issued a warning on the need for monitoring ag credits. 1 The Financial Institution Letter (FIL) advises that banks of all sizes should carefully consider a recent, negative report by the U.S. Department of Agriculture. 2 While current market conditions are good, the FIL projects a slowdown in growth of the farming and livestock sectors and reminds bankers that ag remains susceptible to weather- related events, market volatility, and declining land values. The FIL reminds banks to maintain sound underwriting standards, strong credit administration practices, and effective risk management strategies in connection with ag credit. Cash flow analysis, secondary repayment sources, and collateral support levels must be considered to appropriately analyze the credit, according to the FIL. Risk analysis should center on a borrower’s cash flow and repayment capacity and not rely unduly on collateral values. Sound practices include evaluating baseline cash flows under significantly modified projections for key variables, such as input costs, interest rates, and sale prices (stress tests). 3 If an ag borrower hits financial diffi- culties, the FDIC encourages the bank to work constructivelywith the borrower to strengthen the credit and mitigate loss. Workout strategies must be specifically tailored for ag credits in light of the ex- perience in the 1980s with depreciating COUNSELOR’S CORNER Reaping What You Sow: Ag Lending Risk Management Jeff Makovicka, Kutak Rock LLP Agricultural loans are an important component of many bank loan portfolios, as discussed recently by panelists at Kutak Rock’s annual agribusiness seminar in Omaha. While a bank cannot control commodity prices or production levels, many banks have demonstrated that diligent adherence to prudent lending practices and regulatory guidance helps manage losses, even when a borrower’s farm operation experiences significant stress. This article discusses certain recent ag-related regulatory developments and considerations. farmland values, high interest rates, and volatile commodity prices. The FIL sug- gests that properly restructured loans to farming operations with a documented ability to repay under reasonably modi- fied terms will not be subject to adverse classification solely because the value of the underlying collateral has declined. 4 In the FIL, the FDIC encourages fi- nancial institutions to continue making prudent loans to creditworthy farmers and ranchers. And, “given the potential volatility in the agricultural sector, prudent risk management practices are necessary to ensure that agricultural credits are originated and administered consistent with sound lending stan- dards.” To that end, banks should review their ag credit files now to identify risk management weaknesses and each file should provide the bank with sufficient information to address concerns as they emerge. Ag Regulation Increasing regulation over ag impacts the bank’s borrowers. Environmental regulation is the current focus of most commentators’ assertions of ag over- regulation. As other industry segments have already faced regulation, “many in the environmental community have come to view agriculture as ‘unfinished business.” 5 For example, following a series of Supreme Court cases dealing with the extent of jurisdiction under the Clean Water Act (CWA) 6 , the Environmental Protection Agency (EPA) and Army Corps of Engineers (Corps) jointly released a proposed rule amending the definition of “waters of the United States.” 7 Touted by EPA and the Corps as an effort “to clarify” the CWA, the proposed definition would apply to all CWA programs. After numerous public requests and commentary regarding the Proposed Rule, on June 10, 2014, the EPA and Corps announced an extension of the comment period to Oct. 20, 2014. Because the term “waters of the United States” helps to define the extent