Remarks by

John D. Hawke, Jr.

Comptroller of the Currency

Before a

Conference on Agricultural Credit Risk Management

St. Louis, Missouri

February 17, 2000

Ever since its founding, St. Louis has been the gateway between urban
and rural America. This is where the west \-- and the farm belt \--
begin. And so it's fitting that we launch our discussion of agricultural
lending and risk management in the 21^st^ century here, too.

As a business and as a way of life, farming in America has never been
for the lazy or timid. The risks are great; the rewards at best
uncertain.

The risk/reward ratio for farmers has been most unfavorable of late. At
a time of remarkable growth in the nonfarm economy \-- with most
Americans enjoying record prosperity \-- net farm income was down last
year, for the second year in a row. Too many American farmers are
hurting today.

Their pain stems from some familiar factors \-- and some not so familiar
ones. Recession in East Asia. One of the worst droughts on record.
Foreign competition. A strong dollar. Silos bulging with years of
surplus.

Not surprisingly, people are wondering aloud whether a repeat of the
early 1980s is in the offing. Then, too, we saw declining crop and
livestock prices, shrinking foreign markets, and a rising dollar. And
the cost \-- to individual farmers and the financial institutions that
served them \-- was immense.

Between 1980 and 1988, some 200,000 to 300,000 farmers underwent
bankruptcy, foreclosure, or financial restructuring. Agricultural banks
failed in numbers not seen since the 1920s, when they were harbingers of
the more widespread financial devastation of the Great Depression. Three
hundred and four ag banks went under between 1984 and 1989, representing
at their peak nearly 60 percent of all bank failures \-- at a time when
there were many.

So it's natural that questions should be raised about the current
distress in the agricultural economy, and whether it points to another
bitter harvest of ag bank failures to follow.

Like most questions about the future, it's not one that can be answered
easily or definitively. But the evidence gives us real basis for
optimism that the financial system may well be spared the spillover
effects of the current farm distress.

That would be a great blessing, and not only for the ag banks
themselves, their owners, and employees. During the 1980s, ag bank
failures made the farm crisis more painful and more personal. Fewer
lenders meant fewer choices and higher costs for borrowers. That was
often enough to spell ruin for farmers who were already operating close
to the edge.

Credit availability could prove just as decisive today. Farmers may be
able to ride out the hard times if they are able to obtain the financing
they need to tide them over until better times return. If not,
heartbreak may once again become a commonplace on our farms. It's an
irrefutable fact: the condition of our agricultural banks is
inextricably linked to the health of America's agricultural economy.

One of this great city's most famous adopted sons, Cardinals' pitcher
Jay Hanna Dean \-- better known as Dizzy \-- was sometimes accused of
tooting his own horn too loud and too often. He saw things differently.
"If you've done it," he reasoned, "it ain't braggin.'"

Ag bankers today [can]{.underline} brag, about the successes they've
achieved to date and the things they're doing to safeguard the future.
Many of the traditional benchmarks of bank health look good right now.
In 1998 \-- the last full year for which reliable statistics are
available \-- farm banks reported increased earnings, strong loan
growth, good asset quality, and capital at historically high levels,
both in absolute dollar terms and as a percentage of assets. Preliminary
1999 statistics show only a slight deterioration in these numbers.

Yet these trends tell only half the story \-- and that story demands
both qualification and explanation. First, we cannot ignore the fact
that some indicators of ag bank health [are]{.underline} trending down
\-- only slightly, in most cases, but down nonetheless. The proportion
of farm banks that had nonperforming loans greater than 25 percent of
capital increased from three and a half to five percent between 1998 and
1999. The OCC's most recent survey of credit underwriting practices
predicts rising credit risk in ag lending for 2000. Farm loan
restructurings and renewals are up. More and more commercial lenders are
resorting to subsidized Farm Service Agency financing to cope with a
rising number of weakened borrowers.

Like bankers all over the country, ag bankers have to deal with
dwindling core deposits and a growing reliance on higher cost wholesale
funds in order to sustain loan growth. And, while ag banks \-- defined
as banks with ag loans to total loans greater than 25 percent \-- have
made some progress toward product and geographic diversification in
recent years, they are still inordinately exposed to the perils of
concentration inherent in their business.

The second caveat concerns the future. There is simply no guarantee that
ag banks will continue to perform as they have should farm conditions
worsen \-- or even if they get no better. If we should experience still
another year of declining farm income \-- which is exactly what the
official projections call for \-- then all bets are off.

The USDA estimates that government payments to farmers \-- which reached
a record \$22 billion in 1999 \-- will drop by almost 20 percent this
year. New production capacity is coming on line from countries like
China and even India \-- countries that not very long ago were big net
importers of grain. The possible combination of lower government
payments and still-depressed crop prices will surely test the
resourcefulness of farmers and farm lenders. With all of these trials
looming, the worst thing we could do today is to get caught up in an
excess of self-congratulations.

Yet some cautious optimism [is]{.underline} in order. That the future is
unknowable and that significant risks lie ahead does not change the fact
that ag banks have shown much greater resilience during this
agricultural downturn than in previous ones. The question we want to
consider is why.

There's no short answer. A long list of macro and micro factors have
helped blunt the impact of today's farm income shortfall. As analysts
have noted, the parallels between agricultural conditions in the early
1980s and those of today are valid only up to a point. In the earlier
period, many farmers were undone by rising interest rates, which doubled
or even trebled the cost of financing and automatically deflated the
value of the land that secured that debt. By comparison, largely as a
result of today's benign interest rate environment, land values are
holding firm, despite depressed commodity prices. That's a big reason
why farmers' total equity rose last year for the tenth straight year
even as real farm income was trending downward.

Farmers are also benefiting from the general economic prosperity and low
inflation of our times, which stand in sharp contrast to the deep
recession of the early 1980s. Credit is just one farm input whose cost
has been stable of late. In 1998, total farm expenses dropped for the
first time in more than a decade, and the preliminary 1999 data suggest
an increase for last year of barely one percent. Even the recent run-up
in energy prices should affect operating balance sheets only at the
margin.

But perhaps the key variable is the fact that, no matter how you choose
to measure it, farmers today are substantially less leveraged than they
were in the early '80s. In 1981, farmers carried debt equal to about
five and a half times their cash income. Today the ratio is about three
to one. Adjusted for inflation, farm debt today stands at about the same
level that it was in 1965. And farmers' debt-to-assets ratio, which
peaked at 23 percent in 1985, is now about 16 percent. If one of the
lessons of the farm crisis of early 1980s was to avoid excessive debt,
it's a lesson that American farmers have clearly taken to heart. It's a
lesson that other Americans businesses and consumers could benefit from,
as well.

That's not the only lesson farmers have had to internalize in order to
stay afloat. In today's challenging environment, they're learning to be
just as attentive to their finances as to their fields and crops. That's
why the most sophisticated farmers are increasingly taking advantage of
forward sale and marketing arrangements for their crops and livestock,
as well as hedging, production controls and other stratagems to help
offset price volatility and assure themselves a predictable income
stream. Indeed, the most prosperous farmers today are those who had the
acumen to lock in grain prices at a profit. By contrast, today's most
troubled farmers are those who decided to operate on a current basis, in
hopes of a price recovery \-- a recovery that obviously hasn't occurred
and, frankly, is unlikely to occur any time soon.

Farm lenders deserve considerable credit for the relative health of the
today's ag balance sheet \-- and for their customers' more sophisticated
approach to risk management. After the experience of the 1980s, many ag
bankers vowed to change the way they did business. Many have. There's
proof of that to be had in the terms of the loans they make \-- as well
as in the loans they refuse to make. Ag bankers today are more likely to
insist on higher down payments and extensive financial analysis to
determine the borrower's ability to generate adequate cash flow. No
longer are bankers so willing to extend a loan based on collateral
values or speculative expectations. No longer are they so quick to offer
new loan products \-- or to enter new markets \-- without having the
necessary managerial expertise on board. They increasingly use external
risk reviews to augment internal risk identification procedures. More
and more, they've become leaders in the use of government guarantee
programs to control credit risk while allowing their weaker borrowers to
continue farming.

So, although much more remains to be done, the best ag bankers have
become some of the best risk managers in the entire banking industry. In
this challenging agricultural climate, they've had no choice. I can tell
you this: tomorrow's challenges will demand no less.

As I've already suggested, one of the most impressive developments of
recent times is the way ag bankers are working with their farm customers
to help them manage their own credit risk. With us here today are
bankers who have adopted a variety of creative approaches to help their
customers become better risk managers. We've heard about one bank that
requires borrowers to develop and submit marketing plans as part of the
loan application process. Loan officers complete break-even analyses on
cattle borrowers, and routinely require hedging as a condition for
loans. This is a bank that even operates its own 80-acre farm to help it
stay abreast of developments in the field.

Then there's the bank that's organized a club for farm borrowers. The
bank brings in local university experts to discuss such topics as
marketing alternatives, price risk, business planning and budgeting,
financial risk management, production risk, international conditions,
and human resource management. And then it makes these university
experts available as a kind of financial extension service to borrowers
who need them. We'll hear more about this innovative arrangement
tomorrow morning.

The OCC applauds these trends, which we view as critically important to
maintaining the health of ag banks in these difficult times and into the
challenging future that we now face.

We support these risk management initiatives in various ways. We believe
that holding conferences such as this will help spread the word about
the exciting developments that we see and promote better communication
between ag bankers and their examiners. For our part, we view your input
as crucial in helping us understand current conditions and the impact of
our policies on your business.

As supervisors, we, too, have tried to make constructive use of the
lessons of the recent past. The experience of the 1980s underscored the
need to avoid broad swings between the extremes of excessive forbearance
and rigor in classifying farm loans \-- or any other loans. It
highlighted the importance of a balanced, flexible, and consistent
approach to supervision \-- one that encourages examiners to judge each
loan relationship on its merits while ensuring that banks adhere to
prudent lending practices and accurate disclosure of the risks embedded
in their loan portfolios. And we also learned from experience that
supervisors should encourage bankers to work with borrowers \-- farmers
and others \-- who may be experiencing temporary difficulties, so that
credit \-- the lifeblood of our entire economy \-- is not unduly
restrained.

The OCC's supervisory policies, recently memorialized in our
[Agricultural Lending]{.underline} handbook[,]{.underline} emphasize
that examiners [must]{.underline} take into account prudent efforts by
bankers to work with their troubled farm borrowers when classifying
credit risk. It advises examiners not to automatically criticize loans
solely due to negative cash flows, or because farmers may need more time
to service their loans, or because previous debt has been carried over.

And it advises examiners to carefully weigh the full range of relevant
factors affecting the condition of the farm credit. Is the loan
performing according to its original or reasonably modified terms? Is
the collateral sufficiently liquid and controlled to protect the loan?
Is the borrower's financial condition \-- and financial track record \--
fundamentally sound?

The answers to these questions \-- rather than some arbitrary framework
\-- are supposed to guide our examiners in determining the appropriate
supervisory response to take. If we get it right \-- and I believe that
we do, most of the time \-- we can avoid both unnecessary overreaction
to adverse conditions [and]{.underline} the excessive latitude that can
lead to more serious problems later on.

Obviously, you and your customers are the two key parties to the lending
transaction. But the law \-- and the needs of our general economy \--
prescribe an important role for us as supervisors, as well. In the
spirit of communication that brings us together here in St. Louis, I
wanted to take this opportunity to explain to you why we take the
approach we do and what we aim to achieve by it.

And what we aim to achieve is this: a safe, sound, and competitive
banking system fully capable of fulfilling its historic role in
financing our nation's agricultural sector. If banks are to remain a
reliable source of agricultural loans in both good times and bad, they
must remain financially strong. That's the goal that I as Comptroller am
committed to achieving.

I want to thank you for [your]{.underline} commitment to that goal and
encourage you to continue working creatively to safeguard the health of
the farm economy and the agrarian way of life. These are things that
mean much to our people \-- all of our people. We're counting on you.