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BOARD OF GOVERNORS

OF THE

FEDERAL RESERVE SYSTEM

WASHINGTON, D.C. 20551

DIVISION OF BANKING

SUPERVISION AND REGULATION

SR 11-14 

October 26, 2011

Revised February 26, 

2021

Clarification on the Responsibilities of the Board of Directors February 26, 2021: As 

described in SR letter 21-4/ CA letter 21-2 “Inactive or Revised SR Letters Related to Federal 

Reserve Expectations for Boards of Directors,” this SR letter was revised as of February 26, 

2021 to better reflect the Federal Reserve’s guidance for boards of directors in SR letter 21-3 / 

CA letter 21-1, “Supervisory Guidance on Board of Directors’ Effectiveness,” and SR letter 16-

11, “Supervisory Guidance for Assessing Risk Management at Supervised Institutions with Total 

Consolidated Assets Less than $100 Billion.” No other material changes were made to this 

letter. 

TO THE OFFICER IN CHARGE OF SUPERVISION

 AT EACH FEDERAL RESERVE BANK

SUBJECT: Supervisory Expectations for Risk Management of Agricultural Credit Risk 

Applicability to Community Banking Organizations: This letter applies to all banking 

organizations with significant exposure to agriculture-related credit risk, including those with 

$10 billion or less in consolidated assets.

This supervisory guidance is intended to serve as a reminder to banking organizations1

and supervisory staff of the key risk factors in agricultural lending and supervisory expectations 

for a banking organization’s risk-management practices. While this guidance is being issued 

largely in response to recent market developments, the risk-management principles are broadly 

applicable irrespective of agricultural market conditions. 

Farm producers have experienced strong profitability over the past three years, and their 

use of debt overall remains relatively low. While these factors have generated optimism for the 

future viability of agricultural producers, risk in the agricultural sector has also increased due to 

volatility in agricultural commodity prices, farmland values, and farm production costs. This 

1 For purposes of this guidance, banking organizations include state member banks, bank holding companies, and 

savings and loan holding companies.
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volatility heightens the importance of appropriate risk-management and capital planning2

practices at banking organizations with significant exposures to the agricultural sector. Farm 

production loans and loans secured by farmland real estate are generally performing well, but 

abrupt and adverse changes in market conditions can substantially affect a bank’s ability to 

withstand a prolonged market downturn. Past downturns in the agricultural sector have resulted 

in borrower defaults and a significant reduction in collateral values.3 Accordingly, a bank’s riskmanagement and capital planning practices should be sufficiently robust to assess the level of 

agriculture-related credit risk and the adequacy of a bank’s capital to withstand potential future 

market and economic distress.

Therefore, the following discussion provides an overview of current and potential 

agricultural market issues and risk ramifications that banking organizations and supervisory staff 

should consider in assessing the adequacy of the risk-management practices and capital needs for 

a banking organization’s exposure to agriculture-related risks. This supervisory guidance also 

addresses factors that examiners should consider in evaluating individual agriculture-related 

credits and the adequacy of a banking organization’s practices to monitor a borrower’s capacity 

to repay given uncertain events. These concepts are based on existing guidance in section 2140 

of the Federal Reserve’s Commercial Bank Examination Manual on “Agricultural Loans.” 

Market Issues and Risk Ramifications

Prolonged and abrupt declines in farm income, brought about by negative movements in 

commodity prices and/or increased production costs, could have serious ramifications for the 

repayment ability of previously sound farm borrowers and could result in substantial declines in 

farmland collateral values. Highly leveraged farm borrowers or those that are in weakened 

financial condition would be most vulnerable to abrupt or prolonged financial distress.

Banks should monitor a number of market factors in order to manage and control the risk 

of their agriculture-related loan portfolio (including collateral values for farmland) and determine

the repayment ability of individual farm borrowers. These factors include:

• Agricultural commodity prices. These prices have experienced unusually large 

swings over the past several years. 

• Production costs. Volatility in costs for labor, feed, fertilizer, seed, land rent, and 

machinery and equipment may challenge farm operators’ ability to effectively 

manage operating profit margins. 

• Farmland values. Land values, particularly in the central United States, have surged

to record highs over the past several years. Capitalization rates for farmland, 

particularly cropland, appear to be well below historical norms and may reflect overly 

optimistic long-term expectations. An abrupt increase in interest rates, coupled with a 

2 As discussed in SR letter 09-4, “Applying Supervisory Guidance and Regulations on the Payment of Dividends, 

Stock Redemptions, and Stock Repurchases at Bank Holding Companies,” an effective capital planning process 

requires a banking organization to assess the risks to which it is exposed and its processes for managing and 

mitigating those risks, evaluate its capital adequacy relative to its risks, and consider the potential impact on its 

earnings and capital base from current and prospective economic conditions.

3 See, for example, SR letter 84-16, “Farm and Agricultural-Related Loans.”
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decline in farm income, could trigger an increase in capitalization rates, thereby

lowering farmland values.

• Global market issues. Global supply and demand imbalances can adversely affect 

commodity prices and the cost of production. For example, weather events, 

economic conditions, and numerous other factors can impact global supply as well as 

demand and place downward pressure on farm income. Producers of ethanol and 

other biofuels may be adversely affected by the volatility in oil, corn, and other 

commodity prices.

Supervisory Expectations for Credit Risk Management and Underwriting Practices

The potential for volatile market conditions and risk factors raises the importance of 

ensuring that agricultural banks have in place appropriate risk-management programs and 

prudent lending standards. A key component of a sound risk-management program is the 

linkage between an analysis of market conditions and an agricultural bank’s risk-management 

and capital planning practices. The range and extent of market analysis may vary depending on 

the composition of the bank’s portfolio and overall risk exposure. This analysis should provide 

sufficient information on current market conditions, factors that could influence changes to 

market conditions, and possible events that could significantly change near- and long-term 

market conditions. At a minimum, banks with significant agricultural exposure should have 

established risk-management practices that address the following:

• Assessment of the Borrower’s Creditworthiness. A bank should conduct a thorough

analysis of a borrower’s creditworthiness, including assessments of the borrower’s 

projected income and expenses compared to actual results, working capital adequacy, 

capital expense analysis, reliability of supplementary sources of income, and cash 

flow stress test analysis. Current borrower financial information is essential to the 

bank’s ability to evaluate the borrower’s creditworthiness and leverage. A successful 

agriculture-related business should exhibit strong repayment ability and risk analysis, 

liquidity, solvency, collateral, credit management, profitability, and management 

performance.

• Assessment of the Borrower’s Cash Flow. In volatile markets, a highly leveraged

borrower may not have the necessary cash flow to properly service the debt according 

to the loan terms. By reviewing the borrower-prepared cash flow statements, the 

bank should be able to identify potential repayment ability problems, calculate key 

cash flow ratios, and assess the ability of the business to handle risk and uncertainty. 

Risk and uncertainty due to commodity prices, production, and weather are prevalent 

characteristics of most farm operations and should be explained in the cash flow 

projections. A sensitivity analysis that determines a farm operation’s ability to 

withstand risk and uncertainty is useful in analyzing cash flow projections. While 

there is a broad spectrum of agricultural activities (e.g., grain, livestock, and fruit),

there are some key elements of sound financial analysis that should be applied to all 

situations. These elements include

o Reviewing the reasonableness of budget assumptions and projections for 

yield, weight gain, production costs, and commodity prices;

o Comparing these projections with actual performance results;
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o Assessing the impact of capital expenditures; and

o Evaluating significant changes in the borrower’s balance sheet structure.

• Underwriting Standards. A bank should periodically review its underwriting 

standards to ensure loan policies do not become outdated and ineffective. The 

frequency and depth of the review will depend on circumstances specific to each 

institution, such as growth expectations, competitive factors, economic conditions,

and the bank’s overall financial condition. Planned changes to a bank’s lending 

function or business plan should prompt a modification to lending policies. The 

appropriateness of minimum debt-service-coverage ratios and maximum 

loan-to-value ratios should be assessed. Significant criticisms and recommendations 

made during recent audits and examinations should also be considered during the 

updating process.

• Credit Administration and Controls. A bank should have appropriate policies and 

controls to monitor and segregate agricultural carryover debt. Bank management 

should understand the fundamental causes of carryover debt. Carryover debt

resulting from the borrower’s inability to generate sufficient cash flow from sales to 

repay the current cycle’s production loans generally reflects a well-defined credit 

weakness. The identification of a troubled borrower does not, however, prohibit a 

banker from working with the borrower. When carryover debt arises, the bank should 

confirm the reasons for the carryover debt (e.g., weaknesses in a borrower’s financial 

condition or operations, inappropriate credit administration on the bank’s part, a poor 

marketing plan, or adverse weather conditions), as well as the viability of the 

borrower’s operation so that an informed decision can be made on whether debt 

restructuring is appropriate. The restructured debt should generally be on a term basis 

and require clearly identified collateral, a reasonable amortization period, and 

payment amounts based on realistic expectations.

• Loan Structure. The structure of a loan will depend on the nature of the borrower’s 

business. To properly structure the borrowing relationship, the bank should be able to

o Project how the borrower will perform in the future, including likely primary 

and secondary repayment sources;

o Anticipate challenges and problems that the borrower may encounter;

o Match the type and terms of the loan to both the loan purpose and the likely 

repayment sources and ensure the loan is supported by sufficient cash flow 

from the expected repayment source;

o Develop a set of loan agreement covenants that protects the bank for the term 

of the loan; and

o Secure the credit facility with collateral and consider requiring loan support 

such as guarantees.

• Reliable Collateral Evaluations and Reasonable Collateral Margins. A bank should 

have a process in place to monitor periodically the value of collateral pledged to the 

debt in order to manage the risk over the life of the loan. Evidence of collateral lien 

perfection and timely collateral inspections should be documented in the loan file 

review. Evidence of declining collateral margins may signify emerging concerns
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over the ability of the borrower to repay and could adversely affect the bank’s 

collateral protection in the event of default.

Expectations for the level of sophistication of risk-management systems will vary based 

on the specific risk characteristics, complexity, and size of the bank’s exposure to agriculture. In 

general, there should be higher expectations around risk-management systems for banks with 

significant exposures to one or several agricultural sectors. An institution should assess the 

effect, if any, of its agricultural credit activities upon the institution’s overall financial condition, 

including capital, the allowance for loan and lease losses, and liquidity.4

Contacts

Questions regarding this letter should be directed to Kevin Bertsch, Deputy Associate 

Director, at (202) 452-5265; Brian Valenti, Manager, Risk, at (202) 452-3575; Robert Walker, 

Senior Supervisory Financial Analyst, Policy Implementation and Effectiveness, at 

(202) 452-3429; John Colwell, Senior Project Manager, Large Banking Organizations, at 

(202) 452-5885; or Donald Gabbai, Senior Supervisory Financial Analyst, Credit, Market and 

Liquidity Risk Policy, at (202) 452-3358. In addition, questions may be sent via the Board’s 

public website.5

 

Maryann F. Hunter

Deputy Director

Cross references:

• SR letter 10-6, “Interagency Policy Statement on Funding and Liquidity Risk 

Management”

• SR letter 09-4, “Applying Supervisory Guidance and Regulations on the Payment of 

Dividends, Stock Redemptions, and Stock Repurchases at Bank Holding Companies”

• SR letter 06-17, “Interagency Policy Statement on the Allowance for Loan and Lease 

Losses (ALLL)”

• SR letter 84-16, “Farm and Agricultural-Related Loans”

• Federal Reserve Commercial Bank Examination Manual, section 2140, “Agricultural 

Loans”

4 See, respectively, SR letter 09-4;” SR letter 06-17, “Interagency Policy Statement on the Allowance for Loan and 

Lease Losses (ALLL);” and SR letter 10-6, “Interagency Policy Statement on Funding and Liquidity Risk 

Management.”

5 See http://www.federalreserve.gov/feedback.cfm.