Banking on the land

Despite some compelling arguments in defence of banks’ being overly watchful with agri lending, there are now some factors that should encourage banks to have lending conversations with farmers. By Phil Edmonds.

As 2021 draws to a close the prospects for farming couldn’t be rosier. But they also couldn’t be gloomier. That’s an interpretation of sentiment in the sector if on one hand you consider export markets signalling a near future of elevated farmgate prices, with ongoing contraction of bank lending to the agri sector on the other. 

The latter is potentially denying farmers the opportunity to capitalise on unprecedented levels of market support, and likely to be the cause for at least some of the gloom. Having farmers and banks able to better understand how they can succeed together might start to reduce those contrasting attitudes. 

The discrepancy between the existence of positive export market conditions and falling confidence among farmers is not new. But the contradiction was especially present in the findings of the Rabobank Rural Confidence Survey published at the end of September, where farmers were more embittered despite commodity prices rising with little sign of downside risk. Indeed, in October both ANZ and Westpac upgraded their 2021-22 farmgate milk price forecasts to $8.20kg and $8.50kg milksolids (MS) respectively and farmgate prices for lambs exceeded $9kg with further firming predicted.

So far banks have not wanted or felt able to go out and assess farms for likely compliance without definitive criteria. Some rules around nutrient regulations are known, and some are still being developed.

Some of the pessimism expressed through these surveys can be attributed to short-term disenchantment with the Government. But the component that specifically considers investment intentions is a more telling assessment of where longer-term confidence sits. 

In the recent Rabobank survey sheep and beef farmers were found to have some increasing appetite for investing (possibly due to a sense of having new land-use options with the rising demand for carbon farming), but dairy farmers (where the majority of the rural sector lending is concentrated, and where revenue growth appears to be more secure), a dwindling appetite.

Is it the farming sectors’ weak appetite to invest, or the appetite of banks with the means to fund capital spending that is causing this sub-optimal situation?

Farmers’ faith in their banks has been waning. The most-recently published Federated Farmers’ Banking Survey found the proportion of farmers satisfied with their banks has continued to fall, part of a steady trend of eroding satisfaction over the past five years. 

One-in-four farmers noted that their lending conditions had changed in the past six months, with more experiencing tougher conditions than easier. This was further evidenced in the ANZ Business Outlook survey for August which showed that despite a small drop, the majority of farmers (65%) still expect it to become more difficult to obtain credit.

That doesn’t square with improved economy-wide lending conditions (until very recently, interest rates at record lows) and more importantly, noises from the top suggesting there are some reasons for banks to become more optimistic in managing their agri portfolios.

In its last six-monthly Financial Stability Report, the Reserve Bank noted strong commodity prices are supporting ongoing debt consolidation and risk deleveraging in the dairy industry. 

“While dairy’s share of banks’ agricultural sector lending remains considerable, it has declined from 69% to 63% in recent years… the number of dairy farmers identified by banks as being stressed or potentially stressed has continued to decline.” 

This trend was evidenced when Westpac identified its stressed exposures as part of its 2021 financial result presentation. It noted the proportion of its agri portfolio considered to be impaired had fallen from 0.48% in September 2020 to 0.29% in March 2021. Westpac concluded its overall dairy portfolio remained sound with risk profiles improving.

At the same time however, Westpac also reported a fall in its agri assets as a proportion of its total tangible capital. This is not only a Westpac phenomenon. Last month KPMG’s quarterly report on banking performance in New Zealand found agricultural lending had further declined as a proportion of all lending – down from over 14% two years ago to 12.5% in June 2021. In its sector lending summary for September, the Reserve Bank reported total agricultural lending fell $57 million for the month, and the annual growth rate for lending to farmers was -1.3%.

This suggests that even though agri lending is becoming less risky, banks are still nervous and possibly looking to consolidate their positions even further.

Why is that?

First off, banks might argue that their hands are effectively still tied. With the new Reserve Bank capital retention rules which will be progressively implemented from next year, incentives to focus competitive efforts on the housing market are unchanged. Housing is considered a safer (less risky) investment and therefore requires less capital to be held by banks. 

Arguably, there may now be less motivation to lend to the productive sectors of the economy such as farms. There’s still a sense that in some areas there are no obvious gains to be made by increasing lending to those who are already indebted, particularly without the ‘old normal’ of ever-increasing land prices.

Those latter elements of uncertainty are underpinning banks’ caution. 

But perhaps more than that, banks are trying to work out what a lower-risk primary sector looks like in the future. Much of this relates to how new environmental rules will shape individual farm viability. 

So far banks have not wanted or felt able to go out and assess farms for likely compliance without definitive criteria. Some rules around nutrient regulations are known, and some are still being developed. The measurement and accounting for greenhouse gases (GHGs) is still to come. Some processors have decided how they will financially incentivise farmers for meeting environmental and other standards, while others are considering it. 

The likes of Fonterra coming out with a set of rules around what suppliers need to do in order to obtain a premium on their payout would almost certainly give banks an easier means to assess what a viable operation looks like.

ANZ agricultural economist Susan Kilsby says “As these kinds of programmes evolve, whether it be local government regulation or processing company rules, it will become much clearer for banks to know which farmers are going to earn a bit more, but also be less likely to come up against regulatory problems and become non-compliant. Bank confidence would then likely rise, with a better handle on what the potential looks like for individual farm businesses.”

Elsewhere, some have pointed to signs of a rejuvenated rural property market as a cause for banks to take a more optimistic view of the sector. 

This seems unlikely, at least in the short term. Having been burned in the era of over-reliance on capital gain to assure debt repayment, banks would want to see a booming market, rather than an incubating one. 

The RIENZ farm sales report for the three months to September identified volatility rather than momentum as the key take out. Sales were down against the same period in 2020 but the median price per hectare was up 22%. REINZ Rural Spokesman Brian Peacocke noted the dairy category recorded 31 sales for the 2021 September quarter, up from 11 last year. 

“The numbers in themselves are not too dramatic. Nevertheless, it does signal an emerging degree of support for the dairy industry.”

Equally, though, this uplift could also be simply down to farmers who had wanted to exit over the past few years now doing so with more buyers creating a bit of competition. 

Despite some compelling arguments in defence of banks’ being overly watchful, there are now some factors that should, and will be encouraging banks to have lending conversations with farmers they may not have been proactively seeking in recent years. 

NZ AgriBrokers director Andrew Laming says “Aside from better profitability and results in the sector, we have a feature we haven’t seen for decades where ongoing debt repayments are outpacing new loans being written. This means that banks are seeking more loans to ensure they don’t lose any further ground on their agri portfolios, affecting their own cash earnings.” This development suggests banks have been too cautious for their own good.

Laming also says farmers’ balance sheets are about to turn a corner as well. “They’ve been hit hard with land values down around 10-15% from their peak. But over the last three years farmers have repaid a lot of debt and this will start to repair a lot of previously unbankable positions.”  

It won’t be enough to have paid down debt to bring the banks back to the table though – not least for all the reasons identified above. Andrew Laming suggests times have changed, with two different groups of farmers emerging, one bankable, and one less so. 

“There are those who recognise that running a great farming business is much different than what it used to be where ‘big bang’ capital gain was made. This group of farmers have strategies and forward planning for all eventualities, great people and advice around them, continuous operational improvement, an environmental enhancement mindset and significant retained earnings to cope with volatility. The other group doesn’t have these attributes.”

The first group will now have the confidence of banks, and better still, will potentially be in a position to negotiate across suitors – based on their greater ability to capture the export market price gains identified earlier. Those who have less certainty about their own business operation and are unable to show they fully understand the risks will struggle to sway the banks out of their retrenched thinking.

Does this now mean there is only a partial and defined number of farmers able to fuel growth with bank debt? 

Not necessarily, Laming says. None of the attributes identified in the winners list are unobtainable. “It doesn’t have to be hard for farmers, as long as they have the right advice alongside them. Banking is as much subjective (judgement and narrative) as it is objective (numbers) and understanding what is important to a bank can go a long way.”