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Farm Service Agency’s Credit Risk Evaluation Methods and Racial Minority Lending Trends

Farm Service Agency’s Credit Risk Evaluation Methods and Racial Minority Lending Trends. Presented by: Cesar L. Escalante University of Georgia

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Farm Service Agency’s Credit Risk Evaluation Methods and Racial Minority Lending Trends

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  1. Farm Service Agency’s Credit Risk Evaluation Methods and Racial Minority Lending Trends Presented by: Cesar L. Escalante University of Georgia (Based on the research work of Rodney Brooks, Cesar L. Escalante, James E. Epperson and Forrest E. Stegelin of the Department of Agricultural and Applied Economics, University of Georgia) Workshop on the Legal Risk Management Needs of the Small Farmer, Statesboro, GA, April 3, 2004.

  2. Overview(Background and Motivations) • Evaluation of Borrower’s Credit Risk • Definition of “credit risk” • Consistent with conventional credit risk measurement methods used by private commercial lenders? • FSA as “Lender of Last Resort” • Federal Lending and the “Equity Principle”

  3. “Racial” Minority Lending Trends • 1997 class action suit by African American farmers • Findings of “isolated” cases of discrimination and “under service” • Five-Year Consent decree (starting in 1999)

  4. USDA settlement • Track A: $641 Million to 12,381 claimants plus $18.5 Million in forgiven debts • Track B: $12.7 Million to 87 claimants • As of Nov. 2003, 97.9% of approved claims already paid.

  5. Focus of this research • The aftermath of the 1997 class action suit • 191 FSA Borrower observations, 1999-2002 TWO ISSUES TO BE ADDRESSED: • Does FSA evaluate credit risk like private commercial lenders do? • Evidence of “discriminatory” lending practices

  6. A. Credit Risk Assessment • The Regular Lender’s Credit Risk Evaluation Method • Survey of credit evaluation systems • Solvency, profitability, financial efficiency, repayment capacity, liquidity, collateral • Experience-Based vs. Statistical Models • Versions of Credit Rating Systems applied to different categories of borrowers/loan transactions • Small versus Large • Term versus Operating Loans

  7. The Non-Conventional FSA Lending Framework • Eligibility guidelines plus “creditworthiness” criteria • Character, industry, and ability to carry out the proposed (FSA-USDA, 1996, May 1997, September 1997); • Realistic repayment plans (FSA-USDA, September 1997, 1998) • Nonpayment of debts or delinquent payments due to circumstances within an applicant’s control as an indication of unacceptable credit history (FSA-USDA, 1996, May 1997, September 1997 ) ; • Falsification of information, intentional omission of important loan information, and evidence of lack of reasonable effort to comply with conditions and terms of proposed loan as grounds for loan denial (FSA-USDA, 1996, September 1997, 1999, 2000, 2001).

  8. Special considerations: • Non-delinquent status: non-payment of debts or delinquent payments due to temporary circumstances beyond borrower’s control such as job loss, loss of benefits or other income, and increase of living expenses due to illness, injury, or death • Nonexistence of credit history could not constitute unacceptable credit history (FSA-USDA, 1996).

  9. Credit Scoring Variables • Solvency: Debt-to-asset ratio • Profitability: Return on equity • Financial Efficiency: Operating Expense Ratio • Liquidity: Current Ratio • Repayment Capacity: Net Cash After Debt Service (“Margin”) • Others: Non-Farm Income

  10. Data (Statistical Analysis) • All Loans • Direct versus Guaranteed Loans • Small versus Large Loans

  11. Summary of Statistical FindingsCREDIT RISK EVALUATION METHOD • Traditional credit scoring variables used by private lenders did not significantly affect loan amount determination • Relative financial weaknesses based on mean financial ratios • “Lender of Last Resort”

  12. B. The Minority Lending Situation • November 2003 FSA progress report • Steadily increasing black participation in loan programs (16.64% vs. 13.20% for minorities in general, 3.68% among white farmers) • 33% growth in current total loans to black farmers since 1995 • Average length of loan processing for black farmers is 17 days (the same for other borrowers)

  13. Summary of Statistical FindingsMINORITY LENDING TRENDS • Non-white farmers had smaller operations (asset- and revenue-wise) and net farm incomes • BUT no significant difference in average loan sizes of white and non-white farmers • EVEN if logical trend noted for all farms is that smaller farms to require smaller loans

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