Risk & Reward: The Holy Grail of Agri-Agra Lending

Banko Sentral ng Pilipinas (BSP) has requested an amendment to Republic Act 10000 or the Agri-Agra Reform Credit Act which requires banks to allot at least 10% of its total lending portfolio to agrarian reform beneficiaries and 15% to farmers and fisher folks. They requested to expand the agri business coverage and investment in bonds to be included as compliance to the regulation. BSP Governor Diokno said at a forum in Makati that banks are having difficulty in complying with the law and would rather pay the penalty than lend to farmers. As of end-2018, banks only extended P707.4 billion loans to the agriculture sector, just 56.97% of the P1.241 trillion they should have lent out to beneficiaries, central bank data showed. However, loans to the sector grew from the P573.69 billion booked at end-2017, also roughly half of the P1.034 trillion banks should have offered. Given that lenders are unable to meet the regulation, banks mostly prefer to pay penalties for non-compliance rather than lend to the so-called “risky” segment. Being a “risky segment” is not without basis. Externally, agri- agra segment is volatile  and sensitive to bad  weather, calamities, diseases and other fortuitous events.  Take note of Panama diseases for banana farm, African swine flu for swine or pig farm, fish kill for aqua and bird’s flu for poultry. We cannot ignore the fact that the country is visited by typhoon, at least five times a year. Of course, we cannot discount the seasonal El Niño and El Nina. Internally, the agri-agra segment is dominated by micro, small and medium enterprises. Compared to large corporate entities and urban employed individuals, the segment is more challenging to underwrite and monitor. Co-mingling of business and personal funds are common. Business documentation is more often lacking and financials are under declared. Cash management is poor, usually centralized to the owner who monitors the business day to day operations at the same time handles the issuance of checks. Succession planning is rare and market concentration risk is prevalent. Portfolio delinquency is high and recovery feasibility is low. Innovation is something to be commonly missing. Banks are guided by BSP issued Circular 855 – Guidelines on Sound Credit Risk Management. In spite of compliance and additional tools, which should lessen credit risk – many banks still decided to just accept the penalty rather than lend to agri-agra customers. Such decision means two things: the penalty is too low versus risk of lending and, another meaning is since RA 1000 implementation date banks are not yet able to find the holy grail of managing risk in agri-agra. As there are banks who were able to comply and quasi- banks and informal sectors who were able to profitably support the segment, it turns out that they key success factors are beyond the 5 Cs of Credit. They are: correct risk forecasting, ‘bible studies’ or similar faith & relationship building activities, product customization, supplier -borrower relationships and insurance. Being dominantly catholic, bible studies or an equivalent faith-driven activities among MSMEs has proven to be a significant factor in delinquency management and business performance. A micro lender in Visayas has observed that borrowers who are active in bible studies as compared to those who are not participating, are more timely and diligent in payments. They are more transparent in their finances. They advice weeks ahead if there will be a delay in amortization. Similarly this was observed by a farm owner in northern Luzon. He observed that the farm where the employees has bible studies are more productive and with less incident of spoilage and petty thefts. In Antipolo city a countryside bank owner has the same observation. They lend to group of micro-entrepreneur women through solidarity loan where each members in each group ensure that the loans are paid. Those group who are in bible studies tend to be more close knitted, each of their families tend to be more prudent and delinquency is low. This factor would often address internal challenges and  the typical but not all reasons for MSMEs delinquency. Supplier -Borrower Relationship and Product Value is another success factor. One of the notable loan products supporting agri-agra customers is supplier financing. The product program requires a tripartite agreement between the bank, supplier and borrower/supplier’s customer. A supplier will refer a borrower to the bank.  The bank will finance the borrowers purchases from supplier through an exclusive credit line (solely for the purchases from said supplier). While this is possible without tripartite agreement, on said setup the borrower can use the line for other purposes, thus no longer a supplier financing. In financing agri-agra customers, the bank should consider the product’s impact to the supplier. If the product is a core component then it is worth considering taking a risk.  The financing bank must consider the  stickiness in terms of product dependency. Another is supplier relationship which is often based on product performance and  tenure of relationship. If the suppliers product is 70% of cost of goods sold and relationship is more than 3 years then delinquency is minimal probability. Insurance is common, but often overlooked.  Lending banks should utilize Department of Agriculture – Philippine Crop Insurance Corp.’s Insurance Products. They are rice insurance, corn insurance, high value crop insurance, livestock insurance, non-crop insurance, fisheries insurance and accident and dismemberment security scheme. Aside from credit insurance, life insurance of principal borrower is good risk mitigant for any loan. Risk Forecasting is another tool that can make a difference. This is both for the lender and borrower. The financial institution with correct and more accurate anticipation of risk can provide more appropriate pricing and risk allowance. Comprehensive forecasting can rationalize risk-taking activities so as not to make it constrictive. It can encourage forward-looking opportunities. For the borrower, with correct forecasting the risks in his harvest or any other endeavor can be mitigated. Accurate forecasting helps reduce unnecessary spending. The common mistakes in forecasting is using only the historical rolling average to predict the future and, then estimate & monitor the business. It would be a good practice to consider future events and risks – known and unknown and their probability of occurrence and impact. For instance, in aqua farming, it is necessary forecast the occurrence fish kill, probability of its occurrence and impact amount. In poultry, avian flu and other diseases should be also considered. Risk forecasting must  be used in all facet of the business – in financial planning, supply chain, operations and new initiatives. Just recently it was reported that hog industry losses Php 1 B (US$20 Mio) a month due to swine flu. This should have been included in the forecast and anticipated as it happened already in Europe. The last, but not the least is Product Customization.  It is altering the basic product design to the customers need. Customization is a great way to differentiate your products and services from the competitors. Customization is way of adapting to change before competition compel you to do so. Conditions (term, interest rate, etc.) can be customized to each industry and the segment the borrower belongs. Example for Aqua, to provide a 30 day term would be very difficult because the borrower’s total cycle is typically 90 days. If the borrower is a not well capitalized, it would be challenging to raise funds and pay the loan amortization in between. For plantations, term can be adjusted to the seasonality of the product. There are great success stories of product customization. Example is Muji, a Japanese retailer company whose product is customize to be of no brand and focus on minimalism. Theirs are basic consumer goods and commonly offer in the market. But, by customizing the products become better than branded. Product Customization in a bank involves writing a comprehensive product program. It must consider the existing resources, past experiences, risks, regulations and strategic directions. A good product program involve the thoughts and ideas of business and functions enterprise-wide. ‘Bible studies’ or equivalent faith and relationship building activities. Supplier- borrower relationship and product stickiness. Insurance. Risk Forecasting. Product customization. These five  are some of the factors for successful agri -agra lending. Three of the  tools are for lender, three  for both lender and borrower and the first two are borrowers characteristics or qualification. Just like Coca Cola and Colgate whose mix of ingredients are varied, the holy grail for agri-agra loan is compose of these key components which degree of applications depends on the bank’s management, resources, environment and risk appetite. With the right mixture these would spell success for agri -agra lending which has been so elusive for a long time now. Jorge Dioneda