Drought Forcing Tough Calls on Ag Loan Modifications

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The worst drought to hit the Midwest in more than 20 years is forcing bankers to make tough calls on how to handle delinquent agricultural loans.

Banks with big ag exposure have been fortunate in recent years. A drought of this magnitude hasn't hit taken place since the 2008 financial crisis. Agriculture had been booming, and family farmers who make up the majority of ag loan borrowers at small banks have been in high cotton.

That's why regulators should refrain from giving banks hell if they're lenient with farmers, says Roy Dean Schwartz, the president and chief executive of Campbell County Bank in Herreid, S.D.

"They better not give us crap, because these farmers make a lot more money than me or you," he says. "When you're getting $8 for a bushel of corn … you don't need a bailout or disaster payments. Farmers are going to be fine."

Corn prices hit an all-time high of $8.49 a bushel on the Chicago Board of Trade on Friday, according to Bloomberg News.

The $104 million-asset Campbell County Bank has a large percentage of its loans tied to agriculture — about 81% — or more than any bank, according to SNL Financial. With deep ties to farming communities, ag lenders hope regulators will acknowledge that banks know the best way to handle distressed borrowers, says John Blanchfield, a senior vice president at the Center for Agricultural and Rural Banking of the American Bankers Association.

Bankers will renegotiate the terms of loans tied to farms hit by the drought, "if they believe the customer has the ability to recover," Blanchfield says. "You can't be in ag banking and not be willing to work with customers because of extraordinary circumstances."

Many banks prefer to avoid classifying such loans as troubled-debt restructurings because it will change how the asset is treated on their books.

"Bankers are not going to be thinking of [drought-affected loans] as TDRs," Blanchfield says. "That's where the problems will come, the bank's opinion of the quality of the credit versus" a regulator's opinion.

Kreg Denton, a senior vice president at $79 million-asset First Community Bank of Western Kentucky in Fancy Farm, Ky., says he likely would not count an ag loan as a TDR this year, if it was modified because a drought hurt a farmer's livestock or crops.

"If have to restructure based on weather-related issues, I don't see that as troubled assets at this point," Denton says. "But if you put two droughts back-to-back, that's a different story."

Some bankers say they would record modified ag loans as TDRs, including Keith Geis, the president of $206 million-asset Platte Valley Bank in Torrington, Wyo. "If we give concessions outside of what are our normal underwriting standards, it's our position that it would qualify as a TDR," he says.

The Federal Deposit Insurance Corp. has not issued new guidance on ag loans stressed by the drought, says FDIC spokesman Greg Hernandez.

Iowa does not have a standard policy on how to treat modified loans following natural disasters, says Jim Schipper, the state's superintendent of banking. Iowa has not developed new policies for treating loans modified because of the 2012 drought. "Farmers have had really strong earnings and have built a lot of equity over the last few years," he says

While corn fields are being burned to a crisp, the drought will deliver the hardest hits to livestock farmers. About 80% of crop farmers have federal crop insurance, Blanchfield says.

That's not the case for livestock farmers. "How the examiners will look at the rescheduling of principal payments on livestock loans, that's a new regulatory concern," Blanchfield says.

The drought could cause other issues for small banks. Some crop farmers may face long waits for payments on crop insurance claims, Denton says. If that happens, banks would have to carry unpaid loan balances for a longer period.

First Community Bank may decide to approach ag clients about bridge loans to cover a waiting period. "We could pull [the bridge loan] out of their existing line of credit," Denton says.

A lack of rain has forced farmers to push irrigation systems to maximum capacity. Many farmers may need to make repairs, or replace entire systems sooner than expected, says Jeff Gerhart, the chairman and chief executive of the $37 million-asset Bank of Newman Grove in Nebraska.

"This drought has opened issues with the center pivots that irrigate crops," says Gerhart, who also chairs the Independent Community Bankers of America. "There are a lot of repercussions from the drought that we are learning about every day."

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