Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
Classification Guidelines for Agricultural Credit
When determining the level of risk in a specific lending
relationship, the relevant factual circumstances must be
reviewed in total. This means, among other things, that
when an agricultural loan’s primary repayment source is
jeopardized or unavailable, adverse classification is not
automatic. Rather, such factors as the borrower’s historical
performance and financial strength, overall financial
condition and trends, the value of any collateral, and other
sources of repayment must be considered. In considering
whether a given agricultural loan or line of credit should be
adversely classified, collateral margin is an important,
though not necessarily the determinative, factor. If that
margin is so overwhelming as to remove all reasonable
prospect of the bank sustaining some loss, it is generally
inappropriate to adversely classify such a loan. Note,
however, that if there is reasonable uncertainty as to the
value of that security, because of an illiquid market or
other reasons, that uncertainty can, when taken in
conjunction with other weaknesses, justify an adverse
classification of the credit, or, at minimum, may mean that
the margin in the collateral needs to be greater to offset this
uncertainty. Moreover, when assessing the adequacy of the
collateral margin, it must be remembered that deteriorating
financial trends will, if not arrested, typically result in a
shrinking of that margin. Such deterioration can also
reduce the amount of cash available for debt service needs.
That portion of an agricultural loan(s) or line of credit,
which is secured by grain, feeder livestock, and/or breeder
livestock, will generally be withheld from adverse
classification. The basis for this approach is that grain and
livestock are highly marketable and provide good
protection from credit loss. However, that high
marketability also poses potential risks that must be
recognized and controlled. The following conditions must
therefore be met in order for this provision to apply:
• The bank must take reasonable steps to verify the
existence and value of the grain and livestock. This
generally means that on-site inspections must be made
and documented. Although the circumstances of each
case must be taken into account, the general policy is
that, for the classification exclusion to apply,
inspections should have been performed not more than
90 days prior to the examination start date for feeder
livestock and grain collateral, and not more than six
months prior to the examination start date for breeder
stock collateral. Copies of invoices or bills of sale are
acceptable substitutes for inspection reports prepared
by bank management, in the case of loans for the
purchase of livestock.
• Loans secured by grain warehouse receipts are
generally excluded from adverse classification, up to
the market value of the grain represented by the
receipts.
• The amount of credit to be given for the livestock or
grain collateral should be based on the daily,
published, market value as of the examination start
date, less marketing and transportation costs, feed and
veterinary expenses (to the extent determinable), and,
if material in amount, the accrued interest associated
with the loan(s). Current market values for breeder
stock may be derived from local or regional
newspapers, area auction barns, or other sources
considered reliable. If such valuations for breeding
livestock cannot be obtained, the animals’ slaughter
values may be used.
• The bank must have satisfactory practices for
controlling sales proceeds when the borrower sells
livestock and feed and grain.
• The bank must have a properly perfected and
enforceable security interest in the assets in question.
Examiners should exercise great caution in granting the
grain and livestock exclusion from adverse classification in
those instances where the borrower is highly leveraged, or
where the debtor’s basic operational viability is seriously
in question, or if the bank is in an under-secured position.
The issue of control over proceeds becomes extremely
critical in such highly distressed credit situations. If the
livestock and grain exclusion from adverse classification is
not given in a particular case, bank management should be
informed of the reasons why.
With the above principles, requirements, and standards in
mind, the general guidelines for determining adverse
classification for agricultural loans are as follows, listed by
loan type.
Feeder Livestock Loans - The self-liquidating nature of
these credits means that they are generally not subject to
adverse classification. However, declines in livestock
prices, increases in production costs, or other unanticipated
developments may result in the revenues from the sale of
the livestock not being adequate to fully repay the loans.
Adverse classification may then be appropriate, depending
upon the support of secondary repayment sources and
collateral, and the borrower’s overall financial condition
and trends.
Production Loans - These loans are generally not subject to
adverse classification if the debtor has good liquidity
and/or significant fixed asset equities, or if the cash flow
information suggests that current year’s operations should
be sufficient to repay the advances. The examiner should
DSC Risk Management Manual of Examination Policies 3.2-21 Loans (12-04)
Federal Deposit Insurance Corporation