Road Warrior

Shock and Stress Testing: Analysis by Lenders

RSS

 

My last column was devoted to discussion of financial shock tests lenders conduct on agricultural customers’ financial statements. Cash flow, liquidity and asset value changes were highlighted along with breakeven analysis. These are all components of financial shock testing in a highly volatile economic environment.  Now let’s put on the lender’s hat and examine some of the financial shock tests and analysis they must perform to ensure that the overall loan portfolio is sound.

One of the major financial shock tests that a lender must perform concerns concentration of credit. Regulators and oversight specialists are very concerned about this component as agriculture consolidates with fewer producers generating more of the revenue and carrying a larger proportion of the debt.

Lenders often have constraints on the percent of the total portfolio that can be loaned to a certain industry, for example, a maximum of 30% to the hog or the dairy industry. Speaking of concentration, lenders will analyze their largest customers to determine what percent of the total portfolio is made up of these large borrowers.

Lenders also shock test for interconnected risk or third-party counterparty risk, that is, business arrangements between customers. If one business fails, it could be detrimental to other customers in the portfolio. This is often the case when producers have contractual arrangements or deal with vertical integrators, feedlots or hay growers that have a contract with livestock producers.

Sitting on the other side of the desk, lenders are frequently asked by regulators to determine what impact a 1% or 2% interest rate increase or a decline in land values up to 50% would have on their customer base. On the grain side of the business portfolio, many lenders are shock testing for $3-4/bu. corn and soybeans in the high single digits.

Regulators are asking more lenders for higher-quality financial information; that is, up-to-date balance sheets and accrual adjusted or accountant prepared income statements. Loan covenants are being examined and scrutinized. For example, limits on capital purchases without the permission of the lender or working capital and debt level restrictions.

Lenders are under much more pressure to sensitivity test not only individual loans and borrowers but also the total portfolio. This is the new world lending after the financial crisis and it will be in the forefront if economic adversity is observed in agriculture.

Discuss this Blog Entry 1

on Mar 24, 2014

Really great post, Thank you for sharing This knowledge.Excellently written article, if only all bloggers offered the same level of content as you, the internet would be a much better place. Please keep it up!
http://www.ismemoryfoamtoxic.websiteworks.com/

Post new comment
or to use your Corn and Soybean Digest ID
What's Road Warrior?

Dave Kohl is an ag economist specializing in business management and ag finance. He can be reached at sullylab@vt.edu.

Blog Archive

Sponsored Introduction Continue on to (or wait seconds) ×