How Much Is FCS Underestimating Its Future Loan Losses?

By Bert Ely

As bankers and other FCW readers know all too well, American agriculture has experienced severe stress in recent years due to weak commodity prices, an agricultural trade war, and especially broad and severe adverse weather events. While net cash farm income in 2020 is projected to rise above the average net cash farm income for the 2013–2019 period, increased government payments to farmers and ranchers accounted for a substantial portion of that rise. While government payments accounted for 8.4 percent of net cash farm income for the 2013–2015 period, that percentage will have risen to approximately 28 percent for the 2019–20 period.

Given the election outcome, the severity of the economic downturn and political uncertainty about the sustainability of government payments at their present level, ag lenders, including the FCS, need to be especially cautious at this time in assessing the creditworthiness of their borrowers. Accordingly, ag lenders must be conservative when identifying actual and potentially troubled loans, and reserving for future loan charge-offs. Even though FCS lenders are not yet subject to the Current Expected Credit Loss accounting requirement for estimating future loan losses, it would be prudent for FCS institutions to anticipate the eventual adoption of CECL by the Farm Credit Administration by adequately reserving, as of the end of 2020, for reasonably expected loan losses.

A review of data published in the FCS’s Sept. 30, 2020, quarterly financial report issued by the Federal Farm Credit Banks Funding Corporation should elevate concerns as to whether at least a few FCS associations are adequately identifying troubled loans and reserving for likely losses on those loans. This concern is based on an analysis of summary data on the 29 largest of the 68 FCS associations, as published in a table on page F-58 of the September quarterly report―each of these associations had more than $1.5 billion of assets as of Sept 30. Collectively, the largest associations accounted for 86.7 percent of all association loans on that date.

This table presents data for each of the 29 associations as of Sept. 30, 2020, (columns 1 to 5) and compares this data with comparable numbers for the 26 associations at Sept. 30, 2019, that had more than $1.5 billion of assets on that date (columns 6 to 10). These columns present three key measures of each association’s loan quality―non-performing-assets as a percentage of gross loans outstanding (columns 3 and 8), the association’s allowance for loan losses as a percent of gross loans (columns 4 and 9), and the association’s ALL percentage as a percentage of its NPA percentage (columns 5 and 10). This ratio provides some sense of how adequately an association has reserved for prospective loan charge-offs as a relatively high ratio indicates a more prudent estimate of future loan losses.

What is especially troubling about the numbers in column 3 is the tremendous variance in the NPA percentage, from .09 percent to 3.16 percent (35 times as high). Does loan quality really vary that greatly across the FCS’s larger associations or are some, or perhaps most associations, rather slack in assessing the quality of their loans? Not surprisingly, there were enormous differences in the ALL%/NPA% ratio at Sept. 30, ranging from 18.7 percent for FCS of Western Arkansas to 225 percent at the nearby First South Farm Credit (column 5). The unweighted average for this ratio across all 29 associations was 57.3 percent while the median was 55.9 percent. Low ALL%/NPA% ratios, especially at the second-largest association, Farm Credit Mid-America (23.4 percent), should be ringing alarm bells at the FCA.

Comparing these ratios for the two Sept. 30 dates, which eliminates seasonal differences, raises additional questions as to how well the larger FCS associations are flagging troubled loans and how adequately they are reserving for future loan charge-offs. Only eight of the 26 associations for which a comparison can be made (column 11) reported an increase in their NPA percentage over the last year.

The other 18 associations, including the seven largest, each with more than $10 billion of loans, effectively asserted, by lowering their NPA percentage―the negative numbers in red in column 11―that their loan quality had improved. Some of these improvements are quite dramatic. For example, Carolina Farm Credit lowered its NPA percentage by more than a third, from 1.61 percent to 1.02 percent while the smaller Yosemite Farm Credit by half, from 1.35 percent to .67 percent. Each of the seven associations with more than $10 billion in loans lowered their NPA percentages, but by lesser amounts.

ALL percentages decreased at half of the associations (column 13), which is a questionable proposition given a likely decline in the creditworthiness of many FCS loans. Has FCS loan quality really improved that much? The ALL percentage increases at the rest of the associations were relatively modest. The net effect of these changes is shown in column 14―the change in the ratio of the ALL% to the NPA%. This ratio increased in 20 of the 26 associations for which there is comparable data.

On the surface, this appears to be good news, but it must be qualified by the fact that one of the least well-reserved of the largest associations―second-ranked Farm Credit Mid-America―had the third-lowest ALL%/NPA% ratio of all 29 associations as of Sept. 30, 2020, at 23.4 percent, less than half the ratio of the largest association, FCS of America, which was at 54.9 percent. None of the larger associations had a ratio that was anywhere near as low as it was at Farm Credit Mid-America.

Columns 15 to 20 impute dollar values for the percentages presented in the tables in the two quarterly financial reports cited above, with the changes in dollars from one quarter-end to the other shown in columns 19 and 20. The net decrease in the amount of NPAs is suspicious, especially since it is concentrated in just six associations. Eighteen of the associations boosted the amount of their ALLs, but in only two cases was that increase more than $10 million, with Compeer Financial accounting for over half of the net change.

As the FCS approaches the end of this year, FCA examiners, the four FCS banks, and the FCS’s outside auditor, which has been PWC, need to aggressively assess how consistent a job FCS associations have been doing in identifying and quantifying non-performing loans, the quality of each association’s restructured loans, and the adequacy of their allowances for loan losses given the continuing stresses farmers, ranchers and rural America are experiencing amidst the pandemic and the resulting recession.

A recent American Banker article (subscription required), “Banks intensifying loan review schedule finds it pays off,” reported that “more frequent loan reviews can uncover blind spots created by loan deferrals and government stimulus programs . . . [they]also help lenders to more quickly address potential issues.” That sounds like great advice, especially for those FCS associations that appear to be under reserving for future loan losses.

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About Author

Bert Ely

Bert Ely is a consultant specializing in banking issues. He writes ABA's Farm Credit Watch.