Loan Portfolio Analysis Agribusiness Finance LESE 306 Fall 2009
What is it? Focus is on the lender s existing loan portfolio. Looking for areas of strengths and weaknesses. Data mining at segment level (primary enterprise) to calculate benchmarks. Sort all loans with credit standards falling below benchmark performance. Stress testing portfolio in pro forma context.
Portfolio Segment Analysis
Externalities Affecting Portfolio Performance. Macroeconomic policy Farm program policy Trade policy Weather and disease Ability to pay in client nations Competitor nation actions
Macroeconomic Conditions Expensive imports (bad for Ag!) Gains in productivity (great for Ag!) Rising crude oil prices (bad for Ag!) Rising inflation (bad for Ag!) Low interest rates (great for Ag!) Rising unemployment (bad for Ag!) Weak stock market (bad for Ag!) Federal budget deficits (bad for Ag!)
What Could Go Wrong? Federal budget deficits rise, lead to higher interest rates. Global economic trends, higher crude prices lead to rising inflationary pressures. Eventual higher interest rates and higher input prices passed along to farmers. Higher interest rates, higher input prices and low farm commodity prices lead to cash flow stress and falling land values. Declining farm land values reduce loan to value ratios.
Can You Assess the Impact of the Following Events What if the country s central bank adopts a tighter monetary policy? What if we see a 20 percent increase in crude oil prices? What if exchange rates with client nations rise? What if effective income tax rates increase?
Impact of these events on.. Farm commodity prices Farm input prices Interest rates Net farm income Land prices and other asset values Off-farm income Debt repayment capacity
What is Stress Testing? Ad Hoc stress testing What is it? Strengths and weaknesses Systematic event stress testing What is it? Strengths and weaknesses
Ad Hoc Stress Testing Assume future revenue based upon past prices, costs and yields changes by a certain percent. Assume percent cut in income, land values, etc. One year focus. Easy to do.
Event Stress Testing? Pro forma analysis. Impact of future events: Farm policy Macroeconomic policy Events in client nations Competitor nation actions Looking down the road.
What are the differences? Ad Hoc Stress Testing Ad Hoc Stress Testing Assume a change commodity prices Assume a change in input prices Assume a change in land values Assume a change in wages and salaries
What are the differences? Ad Hoc Stress Testing Ad Hoc Stress Testing Assume a change commodity prices Assume a change in input prices Assume a change in land values Assume a change in wages and salaries Event Stress Testing Event Stress Testing Use projections from econometric models that have significant probability of actually occurring Can address What if questions associated with potential events
Why Event Stress Testing? Tied to specific events that have a reasonable likelihood of occurring. Management can respond to likely events rather than hypotheticals!!! Consistent accounting of impact on all economic variables. Looking beyond the current year when assessing term debt repayment capacity.
What to Watch For... Nature of global economic conditions and what this means: Agricultural export demand Cost of imports Central bank reactions to any buildup in inflationary expectations. Rising input costs as suppliers pass on their costs to producers.
A Portfolio Analysis Model
Portfolio Modeling Assess portfolio s performance at the segment level using mining techniques. Identify problem loans within that segment. Develop benchmarks for use in evaluating new loan requests and performance of existing borrowers against the benchmark.
Segment Design... Size Less than $250K Loan Classification Acceptable Location SE Texas Primary Commodity Wheat
This Segment Represents... Less than $250K SE Texas Acceptable = Loan volume $6,558K Wheat
Building segments representing specific groups of accounts in the agricultural loan portfolio Choice of crop yield shocks Setting loan quality indicators for liquidity, solvency and debt repayment capacity Designing and running of new scenario Bringing up the results screen to view results of scenario
Design of Multiple Criteria Segment
Maximum Ratio of Carryover Debt-to-Equity: set by user Cutoffs for Indicators of Liquidity, Solvency and Debt Repayment Capacity Searching for those loans that do not meet these standards
Loan quality indicators settings An account falling below lender set indicator levels Note existence of short run stress but long run recovery. Decision to stay with Borrower or call in the loan now? Portfolio manager helps make decision.
Loan/Borrower Classification Farm Credit System Loan Classification Special Mention Acceptable Substandard Doubtful Loss The goal of the portfolio manager and credit officers is to make loans that grade out as acceptable, or exceed credit standards. All other classes require additional attention by the credit officer making the loan to determine reasons for weak performance and assess prospects for improvement.
Loan Class Rating A. Acceptable loans: 1. Borrowers of the highest quality national and multinational companies with diverse business assets and sources of income: virtually no lending risk. 2. Borrowers of superior quality same as A.1; little foreseeable risk. 3. Borrowers of exceptional quality Largely national companies with varied business assets and sources of income: very limited lending risk. 4. Borrowers of excellent quality Leverage vary low relative to industry standards. Very strong liquidity with quality earnings. Strong debt capacity. 5. Borrowers of strong quality Leverage low relative to industry standards with strong liquidity. Operations consistently profitable in recent years with excess cash flows.
Loan Class Rating A. Acceptable loans: 6. Borrowers of good quality Leverage favorable to peers in the industry and typically good liquidity. Financial indicators at or above average to peers. 7. Borrowers of average quality average leverage, adequate earnings, cash flow and debt service. 8. Borrowers of adequate quality slightly higher leverage with adequate but inconsistent earnings, cash flow and debt service. Trends erratic. 9. Borrowers of minimally acceptable quality more leveraged than peers in industry; adequate but inconsistent debt service; operations typically profitable but losses may occur due to difficult economic environment; vulnerable to adverse industry conditions. Able to refinance debt with other financial institutions.
Loan Class Rating B. OAEM (Special mention) assets currently protected but potentially weak; constitute an undue and unwarranted credit risk. C. Substandard loans: 1. Viable substandard have well defined weaknesses that jeopardize liquidation of debts; not performing as agreed but currently adequately collateralized; collateral marginally supports credit but collateral values declining. 2. Nonviable substandard probable that ultimate payment in full accomplished only through liquidation, forced or otherwise; usually treated as non-accrual loans. D. Doubtful loans weaknesses make collection in full highly questionable and improbable given conditions. E. Loss loans not considered collectable and of such little value that continuance as asset not warranted.
Migration of Loans Portfolios are examined periodically to monitor outstanding loans falling into lower loan classifications. This can be done in a stress testing context by examining the effects of lower net incomes and land values on benchmark loans in each category for specific pools or loan segments. This helps the portfolio manager to stay on top of changing economic conditions in each of these segments.