Things are looking pretty good out there in the community financial industry these days. Many of you are likely experiencing strong to record earnings due to low funding costs and improving asset quality. Loan demand has returned and local economic conditions for business and agribusiness is steadily improving year over year. If anything is weighing you down, it’s likely some leftover OREO still on the books from the last economic recession. It may be just my nature to never be happy, but times like these make me very nervous. When times are great, it’s human nature to get complacent. In some cases, we get to feeling so good about things, we feel like taking on more credit risk in order to grow or we simply begin to cast aside prudent credit risk management practices. I am reminded of the December 2006 guidance issued by the OCC, Fed and FDIC regarding concerns over concentrations in commercial real estate (CRE) lending. At the time, economic conditions were relatively strong. Community financial institutions were taking on a much higher degree of risk and concentration in all forms of CRE lending. We all know what the impact on earnings resulting from the great recession of 2008-2009 and the devaluation of CRE during that time.
On July 16, 2014, the FDIC issued FIL-39-2014 regarding ‘Prudent Management of Agricultural Credits Through Economic Cycles”. I would encourage any institution that is involved in agricultural lending, regardless of concentration levels to review this FIL. If your institution is not involved in agricultural lending but has a local economy dependent on agriculture to some degree, it merits your attention. The FIL notes that the US ag industry has benefitted from a decade of overall strong profitability with several years of high commodity prices and livestock margins. Credit quality is strong and loan delinquencies and charge offs are near lowest levels since the early 1970’s. Despite the current strength, the USDA forecasts higher borrowing costs, moderation in farm land values and approximately a 27% decline in net farm income in 2014. Then there are the ever present risks that could shock the industry regarding weather, market volatility, declining commodity prices and geopolitical risk.
In the FIL, ag lenders are reminded of the following:
- Prudent risk management that focuses on a borrower’s cash flow and repayment sources across a range of conditions.
- Consider, but not rely unduly on, secondary repayment sources and collateral.
- Closely monitor cyclical factors, such as land values, before and after making credit decisions.
- Be cognizant of speculation in agricultural land or commodities
- Identify and manage credit concentrations
While I am not sure the FDIC is firing off a warning shot on par with the 2006 joint agency guidance on CRE Concentrations, I do believe the timing of this issuance is prudent. Times have been good in farm country and farm real estate prices sound pretty high to me. I was an ag lender in the early 80’s and understand the downside of the cycle and its impact on a financial institution. I think it’s time to be a little nervous, and not complacent. A review of your ag concentrations and risk management practices may be in order before the next downturn.
Thank you for your business and continued support.