Portfolio Analysis Agribusiness Finance LESE 306 Fall 2009

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  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  Declining farm land values reducing loan to value ratios fall.

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 Assume a change commodity prices Assume a change in input prices Assume a change in land values Assume a change in wages and salaries Ad Hoc Stress Testing

What are the differences? 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 Use projections from econometric models that have significant probability of actually occurring Can address “What if” questions associated with potential events Ad Hoc Stress Testing Event Stress Testing

PAST PRESENT Rear View Mirror Rear View Mirror

PASTFUTURE PRESENT l Historical analysis l Comparative analysis l Credit scoring models l Ad hoc stress testing

PASTFUTURE PRESENT Rear View Mirror Rear View Mirror Windshield

PASTFUTURE PRESENT l Historical analysis l Comparative analysis l Credit scoring models l Ad hoc stress testing l Pro forma analysis of “likely” trends over time FUTURE

PASTFUTURE PRESENT l Historical analysis l Comparative analysis l Credit scoring models l Ad hoc stress testing l Pro forma analysis of “likely” trends over time l Event stress testing designed to address key “What if” questions FUTURE

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 bounce 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

Purpose of Modeling Assess portfolio’s performance at the segment level. Identify problem loans within that segment. Develop benchmarks for use in evaluating new loan requests and performance of existing borrowers against the benchmark.

Building segments representing specific groups of accounts in the agricultural loan portfolio 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 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 Bringing up the results screen to view results of scenario

Design of Multiple Criteria Segment Design of Multiple Criteria Segment

Cutoffs for Indicators of Liquidity, Solvency and Debt Repayment Capacity Cutoffs for Indicators of Liquidity, Solvency and Debt Repayment Capacity Maximum Ratio of Carryover Debt-to-Equity: set by user Maximum Ratio of Carryover Debt-to-Equity: set by user Searching for those loans that do not meet these standards…

Simulation done in 2000 Focus on one primary commodity…cotton

Loan quality indicators settings Loan quality indicators settings An account falling below lender set indicator levels An account falling below lender set indicator levels

Farm Credit System Loan Classification 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.

Portfolio Analysis Process