Presentation on theme: "Agricultural Loan Underwriting"— Presentation transcript:
1 Agricultural Loan Underwriting Comptroller of the CurrencyAgricultural Lending HandbookDecember 1998andMay 2014
2 Agricultural lending involves some unique requirements, however, the same fundamental underwriting practices as other forms of commercial lending apply.The underwriting process, and subsequent loan administration should be governed by an effective set of lending guidelines.
3 What do we mean by “underwriting standards?” The term “underwriting standards,” refers to requirements, such as ones related to collateral, loan maturities, pricing, and covenants, that banks establish when originating and structuring loans.
4 The Comptroller’s Handbook lists the following minimum underwriting guidelines for agricultural lending.In-depth financial analysisEvaluation of budgets and projectionsSensitivity analysis as part of cash flow analysisStructuring loans in accordance with the type of borrowing and the expected income streamReliable collateral evaluations and margins, and/or other steps to minimize credit risk
5 Effective ongoing monitoring practices, including segregation of any prior period crop carryover debtThorough evaluation of the borrower’s character and history of managing debt repayment
6 Financial AnalysisQuality of financial information for agricultural operations varies significantlyIn general, many small farm operations use cash-basis tax returns and market-value financial statements that are self prepared and unaudited
7 Key Elements of Reviewing Financial Information Review the reasonableness of budget assumptions and projectionsCompare projections with actual resultsAssess working capital adequacyAnalyze net worth changesAssess the impact of capital expensesEvaluate any supplementary sources of income
8 Loan StructureIt is important to structure loans based on the purpose for which the loan is madeShort-term loansLong-term loansCarry-over debt
9 Short-Term LoansMost often short-term loans are made for production inputsShort-term loans are self-liquidating at the end of the production cycle from the proceeds from product sales
10 Long-Term Loans Commonly referred to as “term” loans Primarily associated with the purchase of capital assets, such as machinery and equipment, real estate, breeding herds and orchardsThe primary source of repayment is from cash flows from operationsCollateral is viewed only as a contingent secondary repayment source
11 Carry-Over DebtRefers to restructured short-term debt, such as the unpaid portion of an annual operating line of credit, resulting from the borrower’s inability to liquidate the debt as originally planned
12 Collateral Valuation and Documentation Collateral may be defined as property pledged as security for a loan or other obligationThe pledge of collateral adds safety to the loan, since the lender may sell the pledged property to obtain payment if the debtor fails to pay.
13 For collateral to be acceptable to a lender the following requirements should be met: IdentifiableRelatively nonperishableBe able to establish a reasonable estimate of valueBe in a saleable conditionMust have an established market
14 Collateral Evaluation Current values of all collateral should be established when the loan is madePeriodic re-evaluation of value should be practiced, with the frequency of re-evaluation depending on the price volatility of the assets
15 The documentation of collateral values should include: The location and identifying details about the collateralFair market value, as of a specific dateThe source of, or basis for calculation the value estimate
16 Lien PerfectionA lien is a charge upon property for the purpose of securing the payment or discharge of a debt or obligationThe method of obtaining and perfecting a security interest depends on the type of collateralChattelReal Property (Real Estate)
17 Chattel – An item or article of personal property, such as livestock, crops and equipment Real Property (Real Estate) – immovable property such as land, buildings, improvements, and appurtenances
18 Chattel LienA chattel lien is established under the Uniform Commercial Code (UCC)The UCC is a set of guidelines adopted by 49 of the 50 statesIn Texas, UCC filings are made with the Secretary of State’s office and are generally referred to as UCC-1 filings.The description of property secured under a UCC-1 must be reasonably specific, and current (meaning that they periodically expire and must be refiled)
19 Real PropertyIn Texas, the security interest in real property (real estate) is established through a Deed of TrustA Deed of Trust is a three party document - the lender, borrower and trusteeThe Deed of Trust is filed with the County Clerk in the county in which the real property is located, and is in effect until a release is executed by the lender and filed.
20 Credit Risk Management Many lenders require protective covenants and other affirmative undertakings by the borrower as part of the loan underwriting processA loan covenant is a condition that the borrower must comply with in order to adhere to the terms in the loan agreementIf the borrower does not act in accordance with the covenants, the loan can be considered in default and the lender has the right to demand payment (usually in full)
21 Why do banks add covenants to the loan agreements? Banks usually add covenants in order to accomplish the following objectives:Maintain loan qualityKeep adequate cash flowPreserve equityIn a borrower with a known weakness in its capital structure as a measure to improve this weaknessKeep an updated picture of the borrower’s financial performance and condition
22 Covenants may related to: A requirement to purchase insurance – hazarded or crop insuranceContractingHedgingCompensating checking account balancesRequirement to provide financial information
23 Loan MonitoringOngoing monitoring is a critically important component of the lending processCollateral inspections and re-appraisals/ valuations should be performed on a regular basis by qualified personnelA periodic review of loan documentation is important to ensure that up-to-date financial information, security agreements and UCC filings, and credit reports are maintained in the borrowers file