Portfolio Analysis LESE 306 Fall 2008 Reading the

Portfolio Analysis LESE 306 Fall 2008

Reading the Road Signs in Agricultural Lending

Some Signs Are Confusing…

Some are Hard to Read. . .

What we saw when things become clear over time

Portfolio Analysis

Externalities Affecting Portfolio Performance…. ü Macroeconomic policy ü Farm program policy ü Trade policy ü Weather and disease ü Ability to pay in client nations ü Competitor nation actions

Macroeconomic Conditions § § § § Expensive imports (bad for Ag!) Gains in productivity (great for Ag!) Expensive fuel (bad for Ag!) Rising inflation (bad for Ag!) Low interest rates (great for Ag!) Low unemployment (great for Ag!) Strong stock market (great for Ag!) Federal budget deficits (bad for Ag!)

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 rise with client nations rise?

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? üAd Hoc stress testing üWhat is it? üStrengths and weaknesses üSystematic event stress testing üWhat is it? üStrengths 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? ü Pro forma analysis ü Impact of future events: § Farm policy § Macroeconomic policy § Events in client nations § Competitor nation actions ü Looking down the road

What are the differences? Ad Hoc Stress Testing ü Assume a change commodity prices ü Assume a change in input prices ü Assume a change in land values ü Assume a change in wages and salaries

What are the differences? Ad Hoc Stress Testing ü Assume a change commodity prices ü Assume a change in input prices ü Assume a change in land values ü Assume a change in wages and salaries Event Stress. Testing Event Stress ü Use projections from econometric models that have significant probability of actually occurring ü Can address “What if” questions associated with potential events

PRESENT PAST Rear View Mirror

PRESENT PAST FUTURE l. Historical analysis l. Comparative analysis l. Credit scoring models l. Ad hoc stress testing

PRESENT PAST FUTURE Rear View Mirror Windshield

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

PRESENT PAST FUTURE 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

Why Event Stress Testing? üTied to specific events that have a reasonable likelihood of occurring. üManagement can respond to likely events rather than hypotheticals!!! üConsistent accounting of impact on all economic variables. üLooking beyond the current year when assessing term debt repayment capacity.

What to Watch For. . . üNature of global economic bounce and what this means: üAgricultural export demand üCost of imports üCentral bank reactions to any buildup in inflationary expectations. üRising input costs as suppliers pass on their costs to producers.

A Portfolio Analysis Model

Purpose of Modeling üAssess portfolio’s performance at the segment level. üIdentify problem loans within that segment. üDevelop 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 Choice of crop yield shocks 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

Design of Multiple Criteria Segment

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

Focus on one primary commodity…cotton Simulation done in 2000

Loan quality indicators settings 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