Tracking the winds of change for an Agricultural Credit Association

RMA Journal, The, March, 2005 by Brian Berseth

The author, who leads the portfolio management function at AgStar Financial Services, presents a portfolio tracking system that has performed well for his institution. He cautions that each institution's system will vary based on credit culture, but all institutions are challenged to continually monitor and reevaluate their systems parameters.

What key credit indicators need to be tracked on an ongoing basis so our board and management know where the portfolio is headed? At AgStar, we monitor these indicators on a regular basis and perform a formal analysis at least annually.

AgStar Financial Services' $2.7 billion credit portfolio is based primarily in Minnesota and Wisconsin. The portfolio contains loans and leases to agricultural producers, agribusinesses, and rural home loans.

Each month we generate numerous credit reports to track activity within our credit portfolio and provide a comprehensive report to our board. Probably the most encompassing of our reports is portfolio parameters tracking, because it relates to the state of the portfolio.

The board's Credit and Member Services Committee meets four times per year. During the fourth quarter, I meet with our CCO to consider possible revisions to the portfolio parameters. We identify recommended changes and also discussion items to bring before the committee's December meeting as it establishes AgStar's portfolio parameters for the upcoming year.

Figure 1 shows our existing set of portfolio parameters. We use a green/yellow/red tracking system:

* Green indicates "safe and sound" levels.

* Yellow advises closer scrutiny to determine whether a given situation is temporary or requires corrective action.

* Red should be avoided and requires corrective action.

The setting of the green, yellow, and red ranges for each parameter is based on an evaluation of past experience--comfortable, somewhat challenging, or somewhere we just don't want to go. These ranges are occasionally tweaked during the annual reevaluation. Ranges that may be appropriate for us may not be appropriate for other institutions and depend on differences in credit cultures. The keys are to identify key credit indicators and to be willing to modify the parameters as circumstances dictate.

We define the measures shown in Figure 1 as follows:

* Non-adverse credit quality (as a % of the total portfolio). Non-adverse classification categories include both "acceptable" and "other assets especially mentioned" (special mention or OAEM). Acceptable credits are non-criticized assets of the highest quality; OAEM assets are currently protected, but potentially weak. OAEM assets constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of "substandard."

* Adverse assets as a % of risk funds. Adverse classification categories include "substandard," "doubtful," and "loss." These assets are generally inadequately protected by the borrower's current worth and paying capacity or the collateral pledged, indicating well-defined weaknesses that jeopardize debt liquidation. Total adverse assets are compared to risk funds (net permanent capital plus allowances) as one measurement of credit risk relative to AgStar's risk-bearing capacity.

* Criticized assets as a % of risk funds. Criticized assets include the adverse classification categories plus the special mention assets. Once again, the comparison is made to risk funds to reflect the ability of the company to withstand adversity.

* Nonaccrual volume (as a % of the total portfolio). The primary reason for an asset being categorized as nonaccrual is that we do not expect to collect the full amount of outstanding principal and all past and future interest accruals. An asset is generally placed in nonaccrual status as a result of the borrower not complying with the repayment contract to the extent that the loan/lease becomes 90 days delinquent.

* Credit administration (% of "A" grades YTD). The quality of credit administration is graded on loans reviewed by our internal audit team. This evaluation encompasses credit/collateral analysis, loan documentation/closing, risk identification, and compliance with credit policies, procedures, and regulations. Credit administration grades include: A--correct decision with insignificant errors; B--correct decision with significant errors; and C--serious errors or poor decision.

* Unsecured volume as a % of risk funds. Unsecured loans represent additional risk to the lender in the event that they default, since there is no collateral to fall back on as a secondary source of repayment. We compare unsecured volume to risk funds to ensure that the concentration of unsecured loans does not become excessive.

* Industry A, B, or C concentrations as a % of the total portfolio. These concentration limits are intended to represent the types of opportunities that exist within the market area while ensuring that the portfolio is diversified. For example, an agricultural lender might serve a market area where the breakdown of farming enterprises is 25% grain farms, 25% hog units, 25% dairy farms, and 25% diversified farms. In this situation, it may be unwise to establish a 50% portfolio limit for any one of the enterprises.