Agricultural production requires large amounts of capital- everything from land to equipment to seed, livestock or other inputs- to operate, leading many producers to borrow money and incur large debts. Producers may finance their operation with loans from commercial banks, processors, equipment dealers, input suppliers, the Farm Service Agency (“FSA”), or the Farm Credit System (“FCS”). Despite receiving financial assistance, a producer may still experience financial difficulties due to rising input costs, market changes, weather events, or disease outbreaks. These financial stressors may leave the producer unable to generate enough revenue to pay off their loan.
When a producer fails to repay their loan or violates their loan agreement, the path from loan default to collateral foreclosure may depend on the type of loan, collateral, loan agreement, or lender, as explained in the first article of this series. For example, FSA is considered a “lender of last resort” because the agency extends credit to borrowers unable to receive a loan from traditional sources. As discussed in the second article of this series, FSA provides notice to a “delinquent borrower” when the loan payment is 90 days past due, describing loan servicing programs to help the borrower get back on track. However, the statutes and regulations governing the FCS detail different loan determinations and loan servicing options as compared to FSA. This article examines how lenders in the FCS determine when a loan is “distressed” and thus, susceptible to a foreclosure proceeding.
Background on Lending
To put the process of securing a loan into perspective, consider Polly the Peanut Producer. She wants to purchase an additional 50 acres of land, so she goes to her local Farm Credit office and applies for a loan. Assuming she meets all the eligibility and creditworthiness requirements, the loan officer agrees to give her the loan.
When a lender issues a loan to a borrower, the goal is to assist the borrower by providing financing while at the same time recouping that money plus interest through scheduled loan payments. A loan is considered “secure” when the borrower pledges collateral in exchange for the loan funds. In other words, this security interest gives the lender the right to take possession of the collateral and foreclose or sell the collateral to pay the debt if the borrower cannot pay. Therefore, Polly must pledge some type of collateral in exchange for the funds from Farm Credit. Collateral in this situation may include her existing land, the new land, or her peanut crop.
To formalize the lending agreement, the parties enter into legally binding documents that provide for the repayment terms, remedies for default, and terms and conditions of the loan. In this example, Polly will sign a promissory note with her local Farm Credit, which will detail the specific loan amount, interest rate, term, and repayment schedule. Additional legal documents, other than a promissory note, may also be needed. To learn more, click here to read “Financing the Farm: A Law Bulleting Series on Legal Arrangements for Farm Financing.”
Loan interest rates can increase the overall cost of a loan for producers. Under the Farm Credit Act (the “Act”), Farm Credit lenders are directed to issue interest rates and charges for borrowers “at the lowest reasonable cost on a sound business basis, taking into account the cost of money to the association, necessary reserves and expenses of the association, and services provided to borrowers and members.” 12 U.S.C. § 2075 (c)(2). Polly will have to keep in mind the additional cost that interest rates add to repayment.
The Farm Credit System
The FCS is the largest agricultural lender, comprised of a nationwide network of cooperative banks and institutions, established by the Farm Credit Act of 1971 (the “Act”). 12 U.S.C. §§ 2001-2279cc. The FCS is a government-sponsored entity and receives regulatory oversight from the federal Farm Credit Administration (“FCA”). FCS lending institutions are not government agencies. Instead, each is a member-owned cooperative that is governed by an independent board of directors. This means that each lending institution operates under their own internal policies, and their membership is made up of borrowers that must purchase stock in the cooperative to be eligible for a loan.
FCS lending institutions are statutorily mandated to serve the needs of farmers and ranchers by furnishing “sound, adequate, and constructive credit and closely related services to them, their cooperatives, and to selected farm-related businesses necessary for efficient farm operations.” 12 U.S.C. § 2001(a). They are also directed “to be responsive to the credit needs of all types of agricultural producers” while “taking into consideration the creditworthiness and access to alternative sources of credit for borrowers.”12 U.S.C. § 2001(b). FCS lending institutions provide loans to creditworthy farmers, ranchers, producers, or harvesters for agricultural or aquatic purposes, rural residents for rural housing financing, and individuals supplying farm-related services to farmers and ranchers. 12 U.S.C. § 2019. For example, a row crop farmer wanting to purchase a new combine may be eligible for a loan from their local Farm Credit office.
When a borrower enters into a loan agreement with a Farm Credit lender, they are legally obligated to follow the repayment schedule and pay back the loan principal and accrued interest. Unfortunately, situations may arise that cause the borrower to miss a loan payment, or to fall behind in their payments.
If this occurs, several actions may be taken by the lender to help get the loan back in repayment. Initially, the lender may contact the borrower, directly, to determine why payment was missed and to work out a solution to help the borrower get back on track. For example, a producer may have forgotten about a payment due to a death in the family, but because the lender reached out, the borrower was reminded and able to make the payment without further delay. In other words, some repayment issues can be resolved by communicating frequently with the lender. However, if the outstanding loan payments are symptomatic of the borrower’s financial stress, and a solution cannot be worked out to bring the loan current, the lender must begin to categorize the state of the loan.
Distressed as Defined by the Farm Credit System
Lending institutions in the FCS do not explicitly define when a loan is in “default” but rather examine certain factors to determine if the loan is “distressed.” A “distressed” determination triggers certain borrower rights, loan servicing options, and has the potential to lead to acceleration, liquidation, or foreclosure actions by the lender. FCS defines a “distressed loan” as a “loan that the borrower does not have the financial capacity to pay according to its terms and that exhibits one or more of the following characteristics:
- (A) The borrower is demonstrating adverse financial and repayment trends.
- (B) The loan is delinquent or past due under the terms of the loan contract.
- (C) One or both of the factors listed in subparagraphs (A) and (B), together with inadequate collateralization, present a high probability of loss to the lender. 12 U.S.C. § 2202a (3).
Clearly, a loan may be considered “distressed” if the borrower is “past due” or “delinquent” on their payments as defined by the terms of the loan agreement. While the definitions of “past due” or “delinquent” may vary from one Farm Credit institution to another, FCA regulations define past due as a “contractually scheduled loan payment has not been received in full on or before the contractual due date and remains due.” 12 C.F.R. § 621.2. Traditionally, lenders have considered “delinquent” to mean at least one day past the due date or maturity date of the loan. For example, a borrower fails to make their scheduled loan payment on Monday, so on Tuesday, the loan payment may be considered “past due” or “delinquent.” At that time, the loan may be susceptible to a distressed determination and late fees according to the institution’s internal policies and the borrower’s individual loan agreement.
However, a “distressed loan” determination may also be triggered by actions that do not include missing a payment. For example, if the lender knows a borrower has defaulted on other loans currently held by the institution, that may be a sufficient factor to make a distress determination. Or consider a loan secured by a herd of cattle, where the borrower has taken the cattle to the sale barn without notifying the lender. In this situation, the lender may determine the loan is “distressed” because that demonstrates “adverse financial trends” and the loan now lacks adequate collateral. Finally, consider a borrower contracted to the only catfish processing facility within reasonable driving distance. The processing facility goes out of business. That borrower might now be considered distressed because- even though they have not yet missed a payment- the lack of a commodity market may have triggered an adverse financial and repayment trend.
In other words, FCS has a very broad definition of what may be considered a distressed loan. While the classic example signaling financial distress is missing a payment, it is not necessary for an FCS borrower to be delinquent or past due on their loan payments for the loan to meet the definition of a “distressed loan.”
However, the Act does provide additional protection for borrowers that have met all their loan obligations but are still designated as in distress. First, a lender is prohibited from foreclosing on a loan because the borrower did not pledge additional collateral if the borrower is current on all their loan payments. 12 U.S.C. § 2202d(a). Additionally, a lender is not allowed to force the borrower to make additional payments toward the principal of the loan that “exceeds the regularly scheduled principal installment payment (when due and payable) unless- (1) the borrower sells or otherwise disposes of part or all of the collateral; or (2) the parties agree otherwise in a written agreement entered into by the parties.” 12 U.S.C. § 2202d(b).
Moreover, if the borrower has made all their accrued payments toward their loan, but is late on one or two payments, the Act states “the lender shall not enforce acceleration of the borrower’s repayment schedule due to the borrower having not timely made one or more principal or interest payments.” 12 U.S.C. § 2202d (c). Therefore, borrowers who keep up with their loan payments are entitled to protection under the Act if they are unable to post additional collateral, fail to pay on time, or are asked to pay beyond what is set out in the repayment schedule.
Nonaccrual
Distressed loan determinations are made by each individual lending institution on a case-by-case basis, considering the financial risk of the borrower to the lender, the state of the collateral, and any past due or delinquent payments. Furthermore, Farm Credit associations may categorize a loan as high-risk, leading to a “nonaccrual” categorization which means “there is a known risk to the continued collection of principal or interest.” 12 C.F.R. § 621.6(a). When a loan is in nonaccrual status, the loan is not accruing any interest on the principal balance.
A loan is considered nonaccrual if one or more of the following conditions exist:
- “(1) the loan may or may not be past due, but the institution has determined collection of the outstanding principal and interest, plus future interest accruals, over the full term of the loan is not expected because of a documented deterioration in the financial condition of the borrower;
- (2) the loan is 90 days or more past due and is not otherwise eligible for categorization under paragraph b of this section;
- (3) or legal action, including foreclosure or other forms of collateral conveyance, has been initiated to collect the outstanding principal and interest.” 12 C.F.R. § 621.6(a).
For a nonaccrual loan to be reinstated to accrual status, the “loan must be current on contractual payments and the borrower offered servicing in accordance with the institution’s policies.” 12 C.F.R. § 621.9(a). If the loan was current when it was placed in nonaccrual status, then the loan “may be reinstated to accrual status if the known risks to the continued collection of principal or interest have been mitigated.” 12 C.F.R. § 621.9(a).
Additionally, when the loan is placed into nonaccrual status, the lender must notify the borrower in writing. If the borrower was not delinquent on the loan at the time it entered into nonaccrual status, and their request to be reinstated in denied, they may obtain a review of the denial by the credit review committee. 12 U.S.C. § 2202d(d).
After a Distressed Determination
Once the Farm Credit lender has made the distressed determination, the lender must give the borrower a “reasonable opportunity” to meet with a representative of the lender, like a loan officer, to “(1) to review the status of the loan, the financial condition of the borrower, and the suitability of the loan for restructuring; and (2) with respect to a loan that is in nonaccrual status, to develop a plan for restructuring the loan if the loan is suitable for restructuring.” 12 U.S.C. § 2202a(c). For example, after the borrower receives notice the loan is in distress, the lender should offer the borrower a chance to meet to discuss the next steps. As a result, the borrower and the lender may be able to work out a solution for repayment by collaborating on a restructuring plan that works for both parties.
Notice & Borrower Rights
Farm Credit borrowers have statutorily protected rights that attach once the loan is declared to be “distressed.” These rights are called “Borrower Rights” and were created by the Farm Credit Administration following the 1980’s farm crisis. For example, when the lender determines the loan is in distress, the notice requirements and restructuring rights under “Borrower Rights” will attach until the loan is no longer distressed or has been liquidated. In other words, it is important to note when a loan is declared to be in “distress” because that will impact when certain “Borrower Rights” are triggered.
According to FCS borrower rights, once the lender has determined the loan is distressed, FCS is required to provide written notice to the borrower stating the loan is distressed, that the borrower has a right to request restructuring, and that the lender might move forward with foreclosure. 12 U.S.C. § 2202a(b)(1). The written notice must include a copy of the lender’s distressed loans policy and information to allow the borrower to submit a restructuring plan application. 12 U.S.C. § 2202a(b)(1).
Although the Farm Credit lender must send a notice to the borrower explaining the loan may be ripe for restructuring, it is up to each specific lending institution as to which type of notice they wish to send. A non-foreclosure notice must state that the lender has determined the loan is distressed and the borrower has a right to request a restructuring. 12 C.F.R. § 617.7410. For example, if the lender has determined the loan is distressed based on the borrower’s potential for non-repayment due to an outside event such as the loss of a contract, then the lender could send a non-foreclosure notice. In that situation, the notice is not notifying the borrower of a foreclosure action but rather only providing the opportunity to cure the distress through a restructuring plan. If the lender later wishes to start foreclosure proceedings on the loan in this situation, then they must send a second type of notice at least 45 days before beginning the foreclosure process. 12 C.F.R. § 617.7425(a).
The second type of notice is a foreclosure or “45-day notice” that notifies the borrower that the “loan may be suitable for restructuring” and the lender will review the loan for restructuring purposes and include copies of the policies and other information. 12 U.S.C. § 2202a(b).
It must also stipulate that “the alternative to restructuring may be foreclosure” and must be sent at least 45 days prior to the start of foreclosure proceedings- hence, the name. 12 C.F.R. § 617.7410. This type of notice must specify that if the loan is restructured and the borrower fails to perform under the agreement, the lender may start foreclosure proceedings. 12 C.F.R. § 617.7410. For example, a borrower that has been nonresponsive to all contact from the lender regarding a missed payment may receive this type of notice. The foreclosure notice meets the Borrower Rights requirements to notify the borrower of their right to apply for a loan restructuring, but also preserves the lender’s right of foreclosure on the collateral to pay off the debt if the restructuring application is denied or the borrower fails to submit an application prior to the deadline.
Further, if the borrower is a debtor in a bankruptcy proceeding, the notice should identify the loan as distressed, state the borrower’s right to apply for restructuring, and “restate the language from the automatic stay provision to emphasize that the notice is not intended as an attempt to collect, assess, or recover a claim.” 12 C.F.R. § 617.7410. The impact of a bankruptcy proceeding on the ag lending process will be examined in a later article.
Application for Restructuring
After a borrower receives a foreclosure notice, they must submit an application for restructuring to the lender within the predetermined time frame. If they do not do so, the lender can pursue foreclosure after 45 days have passed. The application for restructuring is a written request made by the borrower to the lender that contains a “preliminary restructuring plan proposed by the borrower” along with “financial information and repayment projections.” 12 U.S.C. § 2202a(a)(1). The term “restructuring” includes actions such as “rescheduling, reamortization, renewal, deferral of principal or interest, monetary concessions, and the taking of any other action to modify the terms of, or forbear on, a loan in any way that will make it probable that the operations of the borrower will become financially viable.” 12 U.S.C. § 2202a(a)(7). In other words, the proposed restructuring plan details how the borrower will cure their financial difficulties and continue payment on the loan. In situations where the borrower does not apply for restructuring, the FCS lender may voluntarily propose restructuring to the borrower on their behalf.
The lender decides whether to approve or deny the application for restructuring of the loan. FCS will consider certain factors when making a determination, one of which is whether the cost of restructuring the loan will be equal to or less than the cost of foreclosing on the collateral. 12 U.S.C. § 2202a(d). Additionally, the lender will consider the borrower’s financial capacity, managerial skills, capability to work out current financial issues, and whether the borrower is “applying all income over and above necessary and reasonable living and operating expenses to the payment of primary obligations.” 12 C.F.R. § 617.7415.
In the case of a distressed loan that is not delinquent, FCS will consider “whether restructuring consistent with sound lending practices may be taken to reasonably ensure that the loan will not become a loan that it is necessary to place in nonaccrual status.” 12 U.S.C. § 2202a(d)(E). Essentially, the lender will review the proposed plan to determine if it is likely to ensure future success of the operation.
In situations where the lender “determines that the potential cost to such qualified lender of restructuring the loan in accordance with a proposed restructuring plan is less than or equal to the potential cost of foreclosure, the qualified lender shall restructure the loan in accordance with the plan.” 12 U.S.C. § 2202a(e)(1). In most situations, the restructuring will prevent the foreclosure process from continuing. However, a Farm Credit lender still may pursue legal action or foreclosure as allowed by the terms of the loan agreement- even if the loan is in restructuring- “if the lender has reasonable grounds to believe that the loan collateral will be destroyed, dissipated, consumed, concealed, or permanently removed from the State in which the collateral is located.” 12 U.S.C. § 2202a(i).
However, if the borrower’s restructuring application is denied, the lender will provide the borrower with written notice of the reasons why and their right to request review of the decision. 12 U.S.C. § 2201. The borrower can then submit a request no later than 7 days after receiving the written denial notice asking the Credit Review Committee (“CRC”) to review the decision. 12 U.S.C. § 2202. If the CRC affirms the lender’s denial, then the lender may pursue foreclosure against the borrower. The restructuring process, appeal procedure, and borrower path to foreclosure will be examined in greater detail in future articles.
Conclusion
Agricultural borrowers may face financial stressors that impact their ability to pay back their loans. Under the Farm Credit System, a loan may be “distressed” if the borrower exhibits adverse financial trends or is past due or delinquent on their loan payments as defined in their loan agreement. After the lender makes the distressed determination, the borrower is entitled to certain rights under “Borrower Rights” that provide for notice, opportunity for loan restructuring, and review of certain credit decisions prior to foreclosure. If the borrower does not apply to restructure their loan, or the lender denies their proposed restructuring plan, then the lender can proceed with foreclosure, following the borrower’s appeal of the denial to the CRC. The borrower’s appeal process will be discussed in a later article. It is important for FCS borrowers to communicate honestly and frequently with their lender. A strong knowledge of an operation’s financial situation can help prevent a loan “distress” determination.
Upcoming Articles & Resources
The next article in this series will explore the different restructuring options for Farm Service Agency borrowers including the NAD appeal process. To read previous articles in this series, click here.
For more NALC resources on finance and credit, click here.
For more NALC resources on bankruptcy, click here.
For more NALC resources on secured transactions, click here.