Learning from Experience


Five best practices in managing farm real estate collateral

By Curt Covington

After a period of exceptional prosperity in agriculture, there are signs that belt tightening in farm country has begun. Agricultural bankers responded positively to the demand from landowners by increasing their lending for land purchases from $85 billion at year-end 2002 to $162 billion at the end of 2014. During this same period banks became major farm real estate lenders with farm real estate lending increasing from $38 billion in 2002 to $84 billion in 2014.

Despite potential challenges confronting banks when funding, securing and servicing farm real estate loans, agricultural lending has become an important mainstay for many community banks. That is why agricultural lenders must be cognizant of the potential peaks and pitfalls that come along with farmland lending.

But how can community banks position themselves to not only survive a possible correction in the farm economy but actually grow in less than ideal conditions?

Most agricultural bankers around the country remember the 1980s farm crisis, and that experience taught them to be prudent lenders when it extending farm real estate loans. However, if agricultural lenders continue to adhere to these five fundamental “best practices,” they can continue to profit in a more challenging lending environment.

1. Conduct thorough stress tests. Unexpected economic downturns and adverse market conditions can significantly harm a bank’s financial position. A well-managed bank always incorporates routine portfolio and commodity segment stress tests. Those portfolio tests are part of a sound risk-management strategy to identify key vulnerabilities to market forces and to assess how to effectively manage those risks should they emerge.

2. Consider limitations. Having conducted thorough stress testing that includes a variety of scenarios, many community banks will set lending caps on real estate (e.g., maximum loan-to-values or maximum debt per acre) no matter how high farmland prices go. And even with volatility in commodity prices, using these practices, smart lenders will be well protected by farmland collateral.

3. Invest in quality valuations. The anticipated tempering of the agriculture climate makes collateral valuation even more important. To ensure an accurate and reliable value of your community bank’s investment, don’t take shortcuts.

4. Shelter from unnecessary risk. In such a prolonged low-interest rate environment, it can be tempting to reinstate the lending practices of the savings and loan industry of old: Originate farm mortgages, fund them with deposits and hold them in portfolio. Unfortunately, banks that operate under this model are restricted in the size and the kinds of real estate loans they can safely offer. Farm real estate lending exposes them to increased credit and interest rate risk. Proper asset-liability management may cost more in the short run, but taking the long-term view can pay dividends when interest rates begin to rise.

5. Leverage the secondary market. In the darkest days of the farm crisis of the 1980s, a group of forward-thinking agricultural lenders created a secondary market for farm real estate mortgages. Twenty-five years later, Farmer Mac continues to offer a mechanism for community banks to increase their product offerings, improve their liquidity and help manage any asset-liability mismatch. Another added benefit: On average, banks that have sold farm real estate loans into the secondary market have actually grown their agricultural portfolios at a faster pace than those that have not.

Farm real estate collateral can be an agricultural banker’s best friend when times get tough or for those who fail to adequately manage the risks inherent in agricultural real estate lending. But if lenders remain pragmatic in their approach and properly manage farm real estate lending risk, they can position themselves to seize farm lending opportunities that others miss during volatile times.

Curt Covington (ccovington@farmermac.com) is the senior vice president for agricultural finance at Farmer Mac.