Arkansas Bankers Association 2018 Agri-Conference Little Rock, AR

Transcription

1 Arkansas Bankers Association 2018 Agri-Conference Little Rock, AR SESSION II: Performance Benchmarks for Financial Triage Turn CECL compliance into competitive advantage! Presented by Dan Manternach, President Perfect Fit Presentations LLC St. Louis MO

2 Financial triage borrows from medical triage practiced in war zones or natural disasters: Casualties are prioritized into three categories for optimal use of available medical staff and best collective outcome for all: PRIORITY 1: Those who will survive and recover only if they receive top priority and immediate attention. PRIORITY 2: Those with non life-threatening injuries that can wait until Priority 1 victims are cared for. PRIORITY 3: Those unlikely to survive regardless of care and treatment will only prolong the death process.

3 Financial triage applies the same principal to pooling ag loans for varying risk of loss: POOL 1: Competitive operating costs and marketing skills but over-leveraged in fixed costs and under-utilized labor, management and assets. POOL 2: Those with shrinking margins due to falling prices, but competitive in costs of production and still positive cashflow. POOL 3: Those with shrinking equity and bleeding red ink faster than peers. Most evident reason: Uncompetitive costs of prod. and/or marketing skills.

4 So how does performance benchmarking help turn CECL compliance to a competitive advantage? REMEMBER THESE TWO CECL REQUIREMENTS FROM SESSION 1? Portfolio segmentation: Loans are expected to be pooled into groups where similar risk characteristics exist. Any loan that does not share risk characteristics with other loans must be measured on an individual basis. PERFORMANCE BENCHMARKING WILL HELP YOU MEET BOTH!!

5 Benchmarks for pooling loans by KEY FINANCIAL RATIOS developed by Dr. David Kohl (now retired), Ag Economist, Virginia Tech University Benchmarks for pooling 3 key measures of LIQUIDITY Benchmarks for pooling 3 key measures of SOLVENCY Benchmarks for pooling 3 key measures of PROFITABILITY Benchmarks for pooling 4 key measures of FINANCIAL EFFICIENCY Benchmarks for pooling 2 key measures of REPAYMENT ABILITY

6 Triage Benchmarks for 3 client LIQUIDITY pools: 3 Measures of Liquidity: Pool 1 Pool 2 Pool 3 # 1 # 2 # 3

7 Current national trends in Liquidity: Stable to weak Current ratio F2018F 180,000 Working capital ($1,000) 70% WORKING CAPITAL RULE: ** Working Capital/Total Expenses 160, , , ,000 80,000 60,000 40,000 20, F 2018F 60% 50% 40% 30% 20% 10% 0% F 2018F

8 Triage Benchmarks for Client SOLVENCY pools: 3 Measures of Solvency: Pool 1 Pool 2 Pool 3 # 1 # 2 # 3

9 National trends in solvency: Soft, but still in strong zones: Debt/asset ratio F 2018F Equity/asset ratio F 2018F Debt/equity ratio F 2018F

10 Triage Benchmarks for Client PROFITABILITY pools: 3 measures of profitability: Pool 1 Pool 2 Pool 3 # 1a # 1b # 2 # 3

11 National trends in ROA: stable at best if most land owned; weak if mostly rented or leased # 1a # 1b Total rate of return on farm assets (all farms, owned or leased) F 2018F

12 National trends in ROE & Operating Profit: decidedly weak Pool 1 Pool 2 Pool 3 Total rate of return on farm equity Operating profit margin % 20% % % % F 2018F 0% F 2018F

13 Triage Benchmarks for FINANCIAL EFFICIENCY pools: 4 measures of financial efficiency: Pool 1 Pool 2 Pool 3 # 1 # 2A # 2B # 3 # 4

14 National trends in financial efficiency: mixed # 1 # 2a # 2b 20% 19% 18% 17% 16% 15% 14% 13% 12% Asset turnover ratio F 2018F 72% 70% 68% 66% 64% 62% Operating expense ratio F 2018F

15 National trend in Interest Exp. Ratio: Rising, but still strong (financial efficiency measures continued) 6% Interest expense ratio 30% Net farm income ratio 5% 4% 25% 3% 20% 2% 1% 15% 0% F 2018F 10% F 2018F

16 TRIAGE BENCHMARKS FOR REPAYMENT ABILITY FROM DR. KOHL (RET.) OF VIRGINIA TECH: (National trends in these 2 Kohl measures unavailable)

17 TRIAGE BENCHMARKS FOR: * COSTS OF PRODUCTION * MARKET RISK MANAGEMENT

18 Beans & rice dominate Ark. crop production (74%)

19 Broilers dominate livestock sector

20 Cost of Production is time-honored basic metric best summed up by the manager of a large U.S. hog operation at one of my marketing workshops: Profitability will always be cyclical in farming. We know that. Our goal is simple: To make sure we re always among the last to start losing money and among the first to start making it again!

21 Available for soybeans, rice, sorghum, cotton, corn, wheat & peanuts Separate budgets for surface irrigation, center pivot or dryland Separate budgets for conventional or GM seeds used Operating expenses broken out line item by line item Available in Excel format for easy comparison to producer data Archive of prior years available for comparing trends to producer data

22 PRODUCER PERFORMANCE BENCHMARKING MOTHERLODE STARTS HERE:

23 Easy as 1-2-3: 1) Choose the crop 2) Choose the water supply 3) See the Benchmark Data 1 2

24 How lenders can find objective performance benchmarks for assessing borrowers in price risk management skills Key source: USDA Monthly Ag Price & Farm Marketings data

25 Arkansas seasonal cycle in soybeans leads U.S. seasonal in timing for both highs and lows for the year 5-yr Seasonal Cycle in U.S. Soybean Price yr Seasonal Cycle in Arkansas Soybean Prices SEPT OCT NOV DEC JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC JAN FEB MAR APR MAY JUN JUL AUG

26 45% of sales made under seasonal price pressure! Little forward pricing during seasonal strength at planting $/ bu yr Seasonal Cycle in Arkansas Soybean Prices SEPT OCT NOV DEC JAN FEB MAR APR MAY JUN JUL AUG Crop sales by month (%) yr avg. % sold by month Sept Oct Nov Dec Jan Feb Mar Apr May June July Aug

27 5-yr avg price midway between high and low; Only 2 of past 5 years was avg in top 1/3 Arkansas Soybean Prices Received vs Season Hi-Lo Range Arkansas Prices Received vs. Top & Bottom 3rd of Range yr avg Farm price Yearly high Yearly low yr avg Farm price top 1/3 > low 1/3 <

28 Cents/lb 14 5-Year Arkansas Seasonality in Rice Mirrors U.S. Seasonal Pattern at Uniform Discount AUG SEPT OCT NOV DEC JAN FEB MAR APR MAY JUN JUL Arkansas U.S.

29 Over half of Arkansas rice crop sold during seasonally weakest periods; Sept/Oct and Mar - June Cents/lb yr avg Arkansas rice prices at farm AUG SEPT OCT NOV DEC JAN FEB MAR APR MAY JUN JUL Crop sales by month (%) 5-yr avg. % sold by month 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Aug Sept Oct Nov Dec Jan Feb Mar Apr May June July

30 5-yr avg rice price less than midway between high and low; Only 1 of past 5 years even near top third; into lower third in Avg Arkansas Farm Rice Price Vs Hi-Lo Range 16.0 Price Received vs Top & Bottom 3rd of Range yr avg yr avg Farm price Yearly high Yearly low Farm price top 1/3 > low 1/3 <

31 Pool ag loan portfolio into three risk categories based on production costs and/or marketing skills: Category 1: Clients with such solid metrics they re unlikely to become problem loans without any special attention or intervention by lender. Category 2: Clients with weak metrics due mostly to early stage in farming career, but solid managers who will likely survive and recover with some special attention, counsel and intervention by lender. Category 3: Clients well into farming careers, but already problem loans, literally burning equity and with little prospect of survival because non-competitive management skills are an evident contributor to their problems.

32 SUMMING UP GENERAL GUIDELINES FOR FINANCIAL TRIAGE APPROACH TO CECL COMPLIANCE

33 First, separate objective and subjective elements of your bank s financial triage process: Objective elements are credit scores, benchmark performance metrics, key financial ratios, payment history, etc. based on accurate records and math and largely beyond dispute. Subjective elements are things like behavioral scoring, professional demeanor, personality, receptivity to lender questions, suggestions, etc. which are a judgement call open to dispute.

34 Apply written bank standards of objective triage elements fairly among all loans involved. Establish metrics that all staff will use to categorize all loans for triage. Establish a weighting system for different metrics and apply uniformly. Have the evaluation system in writing and part of official bank policy.

35 Avoid any written records of SUBJECTIVE elements of triage (those based in judgment, not numbers ) Discuss internally as needed, but verbally only. No s, memos, discussion notes etc. about any subjective comments or judgements about clients. Keep records documenting how borrowers were placed in pools or categories to objective facts and scoring systems or ranges of scores. If internally it s the subjective elements among staff that tips the scale to a category that the scoring system doesn t, then modify or add new elements to the scoring system but for all, not just that borrower.

36 Drivers behind another element of risk assessment: Operations facing generational turn-over Growing impatience of next generation (and their spouses). Growing rivalry among siblings when operation isn t large enough. Precision farming technology has progressed from bleeding edge to leading edge necessity to stay competitive. Modest decline in land values from 2014 peak seen by next generation as their temporary window of opportunity.

37 Risks to lenders if no solid, written succession plan (gleaned from a variety of outside experts) No way to monitor management skills among likely successors in their assigned area of responsibility prior to business turnover. No way to know if all siblings are on board with the division of responsibilities, plan of succession, compensation, distribution of equity, etc. High risk of business disruption and drop in performance if succession forced by fate (death, divorce, incarceration, litigation, etc.)

38 Liability considerations should limit lender role in succession planning (also gleaned from variety of outside experts) Numerous elements of any farm succession plan will by nature involve subjective family judgments lender in no position to make. Any element of a plan that leads to conflict and potential litigation will entangle the lender if that lender was involved in the plan. Charges of collusion or favoritism between lender and one or more of parties involved can erupt if lender attempts to reconcile differences among the parties involved. Lender may also become entangled in family estate planning (also with litigation risks) by becoming involved in succession planning.

39 ISU Professor Emeritus Dr. Neil Harl s seven steps to successful succession plans for family farms (SOURCE: Chapter 1 Introduction to book below, available at Amazon.com)

40 THANK YOU! Questions? Dan Manternach Perfect Fit Presentations LLC