Agricultural Lending

Collateral Valuation and Documentation

Bank guidelines for collateral should include procedures for determining collateral values and perfecting the bank’s lien.

Collateral Evaluation. The current values of all collateral should be established during the underwriting process. Thereafter, stored crops and livestock should be re-evaluated on a periodic basis, with the frequency increasing during periods of price volatility. Real estate, machinery, and equipment should be re-evaluated whenever market conditions or other information leads the lender to believe the collateral’s original assigned value may have become impaired. Independently derived values usually provide the most objectivity, but regardless of who provides them, the individual should be thoroughly knowledgeable about the type of collateral being reviewed. Among the critical information that should be documented in all collateral valuations are the:

• Location and identifying details about the collateral.

• Fair market value estimate as of a specific date.

• Source of, or basis for calculating, the value estimate.

In assessing the value of cash crops on hand, normal practice is to include all harvested crops being held for sale and stored in the farmer’s storage facilities, in an elevator, or elsewhere. These crops should be valued using the current market price, unless there is documented evidence that the borrower has a firm, contracted price for the crops, in which case the contracted price normally must be used. While valuing crops at the current market price will generally provide an appropriate current value, current market price may not always be an accurate measure for determining the collateral position due to the volatility of some commodity prices. It may be appropriate to employ some level of historical averaging while also considering current market conditions and future projections. Crops for feeding the borrower’s own livestock, and seed intended to be used for the borrower’s own planting, should be treated for underwriting purposes as operating expenses, not as liquid collateral. The location, amount, and condition of all harvested or “finished” crops should be verified by the lending bank. In addition, when crops are stored away from the borrower’s own premises, the bank should be especially careful to confirm the borrower’s rights of ownership and possession.

Livestock may be located on the farmers own premises, at a third-party feed lot, or elsewhere, and, as with crops, the lender should confirm the borrower’s rights of ownership and possession. Values can be obtained from numerous providers; however, trade publications and purchase bills from sale barns are the most often used sources. Because livestock values may fluctuate dramatically depending on factors such as the animal’s age, health, breed, sex, and reproductive capacity, the individuals performing livestock inspections should be capable of recognizing these issues, making appropriate adjustments, and documenting the results.

Some farm machinery and equipment are adaptable to a wide variety of uses, which improves their marketability by increasing the universe of potential buyers in the event the collateral is liquidated. Conversely, other machinery and equipment may be highly specialized or not commonly used in a particular area, and thus not as readily saleable. One generally used valuation source for major used equipment is the Official Farm Equipment Guide Book. Also, local auctioneers and equipment dealers frequently are reliable sources of information.

The appraisal or evaluation techniques used for agricultural real estate are essentially the same as those used for other types of real estate. Real estate collateral must conform to the regulatory agencies’ appraisal regulations, which, for national banks, can be found in 12 CFR 34.43(a). In those cases where the regulation does not require an appraisal performed by a state certified or licensed appraiser, the collateral must be supported instead by an evaluation that complies with the agency’s appraisal guidelines. Such an evaluation may be performed by a qualified bank employee; however, that person should not supervise the credit to which the collateral is pledged. If a bank’s limitations prevent this separation of functions, the completed evaluation should be reviewed by someone other than the person performing the evaluation. When reviewing real estate collateral, it should be noted that in order to qualify for the “abundance of caution” exemption provided in 12 CFR 34.43(a)(2), the bank must clearly document how the loan is wellsupported by income or other collateral of the borrower and that the real estate is taken merely as additional collateral.

Subsequent events or economic changes may cause real estate values to fluctuate. When this occurs, collateral valuations may need to be updated. Depending on the relative financial strength of the borrower and the bank’s reliance on the underlying collateral, an approximate market value based on the banker’s knowledge of local market conditions may be adequate. In other instances, a new appraisal will be necessary.

During periods of escalating values for farm land, both the economic value and market value of the land should be considered. The economic value of the land is based on the revenue the land will produce when operated as a farm, given expected crop yields and current crop prices. It provides an indication of the amount of debt the land will support. Differences between the economic value and the market value of the land should be reconciled.

One valuable source for obtaining current real estate values is the state agricultural extension office. Those offices typically have agricultural statistics that will provide the average value of real estate by county. Usually, they can also provide information about the average cash rent paid for real estate. Other sources that provide statistical data and industry ratios include: The Dairy Herd Improvement Association, Doan’s Agricultural Report, the Federal Reserve Bank, local and state colleges and universities, the local agricultural production association, and Robert Morris and Associates (RMA).

Lien Perfection. Complete and accurate lien perfection is crucial to protecting the bank’s interest. Agricultural collateral most often consists of chattel (personal property, such as livestock, crops, or equipment) and real estate. The methods for obtaining and perfecting security interests in each type of collateral are dictated by the Uniform Commercial Code (UCC) and the real estate laws of each state.

• Chattel Liens. The model UCC, which provides the process for securing chattel collateral, has been adopted with minor variations in all states except Louisiana. (Louisiana’s guidelines for securing chattel are primarily outlined in the state’s Napoleonic guide, although certain portions of the UCC have been adopted.) Examiners should become familiar with the relevant state’s securitization and perfection requirements for the collateral being reviewed. In general, such requirements will include obtaining a signed Security Agreement and filing appropriate documentation with either the county or state, depending on the type of collateral being perfected. With some types of collateral, multiple filings may be necessary to ensure lien perfection.

  Lien searches should be completed each time a loan is made to assure the lender of its position relative to other lenders and to identify other creditors. Lenders must also ensure that UCC filings remain current, as they expire periodically and have specific renewal requirement.

  Searches can be performed by attorneys, title companies, or bank personnel, and all findings should be documented in the loan file. Negative findings need appropriate action and resolution.

  Section 1324 of The Food Security Act of 1985 (7 USC 1631) contains additional notification and filing provisions that are designed to protect purchasers of farm products from liens about which they may not be aware. Under this section, a bank may safeguard its interest by providing a pre-sale notification of its security interest in the farm products directly to the farm product purchasers. This section also permits a bank to protect its interest by registering its security interest with the secretary of the state in which the farm products were produced, if that state has established a qualified central filing system.

• Real Estate Mortgages/Deeds of Trust. When considering real estate as collateral, a bank should first determine whether there are any existing liens against the property. As with chattel liens, real estate lien searches may be performed by attorneys, title companies, or bank personnel, and all findings should be documented. Because real estate loans normally are comparatively large and/or the borrower’s interest in the property may be clouded, a bank may require title insurance, with itself as loss payee, to protect against possible undisclosed title defects. Whether insured or not, the bank should review carefully any “exceptions” noted in the preliminary lien search or title insurance binder. If the exceptions are serious, they should be cleared up before the loan closing. Unpaid taxes deserve particular attention, as they normally constitute a prior or superior lien to all others.

  In some small agricultural communities with relatively stable real estate ownership, banks rely on an ownership and encumbrance (O&E) report to determine outstanding liens. Typically, these reports are prepared by in-house or local attorneys, based on periodic reviews of county records of real estate transactions. This is a less costly, but also less conclusive process than a complete search performed contemporaneously with making the loan.

  If the real estate includes a homestead or other buildings which comprise a significant portion of the total value upon which the bank is relying for collateral protection, then hazard insurance (fire, flood, wind, and/or hail) should be obtained, with the bank named as loss payee.

  As with chattel collateral, the bank must ensure that its real estate collateral documents are accurately completed, recorded as necessary, and maintained. A well-documented real estate loan typically includes most or all of the following:

  • Preliminary title opinion (prior to filing the lien for recording.

  • Final title opinion (subsequent to lien recordation).

  • Title insurance, if required.

  • Promissory note.

  • Recorded mortgage or deed of trust.

  • Pledges, assignments, hypothecations, if required.

  • Hazard insurance for significant structures.

  • Fair market value appraisal and/or evaluation.

  • Environmental report, if required.

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