The year of the ‘Yes’

Farmers seeking extra finance from banks stand a better chance this year, Phil Edmonds reports.

$hould I borrow, can I borrow, and if I do, how much is it going to cost? These may have been three questions farmers contemplated as the year kicked off. If this was the case, the first question was likely the easiest to answer, the last probably the hardest while the second, might well have provoked a disgruntled “who knows these days?”.

Although not specifically relevant, answering the middle question will no doubt have been influenced by hearing the daily stories of rejection being faced by borrowers following the implementation of Credit Contracts and Consumer Finance Act (CCCFA) at the end of 2021. But it will also have been prompted by the experience many farmers have now become used to when dealing with banks – the longer list of boxes to tick and criteria to meet.

There is however the potential for that to change – ironically, due to the introduction of the CCCFA – and farmers could well now be courted by banks in a way that hasn’t been the case for some time.

First though the questions again.

Should I borrow? Well, right now there’s plenty to encourage a positive response. Farm revenues are manifestly higher than they have been for some time, and broadly predicted to remain that way for the next 18 months. This should provide farmers with some confidence in their ability to service that debt (in the foreseeable future).

Many farmers will also have spent the past few seasons chipping off existing debt and at a macro level the sector has continued to deleverage from unsustainable highs. With those conditions in mind, now is as good a time as any for farmers to invest in future-proofing their businesses to an extent that may not have been possible in the recent past.

Next. Can I borrow? A trickier one, which has a potential bank answer and a farm answer. In theory, the bank answer should be increasingly yes. Because banks have been forced to curtail lending to house buyers with modest deposits and particular spending habits, they’ll be losing business.

Banks need to keep lending in order to make money, so logic suggests they will need to look to other sectors. Surely agriculture. Andrew Laming, director of rural financial advisory firm NZAB, thinks the CCCFA should probably be a net positive for farmers with the sector’s overall debt level now more manageable and business viability (at least in the near term) looking more prosperous.

“Agriculture lending is now being repaid as fast as it is being lent out (making this unique compared with other sector lending). By default, banks need to ‘run to stand still’ which means continuing to write new loans.”

Bank lending data and a survey of credit conditions released by the Reserve Bank in the final quarter of last year also suggests farming is better placed than it has been in the recent past to encourage banks to continue capitalising the sector.

In October the Reserve Bank noted “demand for agriculture lending has proven resilient throughout Covid-19, due to strong commodity prices and low interest rates. These conditions have allowed farmers to increase their principal repayments, providing confidence in the sector and helping banks to become more comfortable pursuing quality growth in their agriculture portfolios.”

It also reported that credit availability to the agriculture sector has increased slightly over the past six months, with some easing in lending terms due to strong commodity prices, low interest rate environment and increased cashflow.

As a result, it said banks were expecting around a 25% increase in demand for credit from the agri sector by March 2022, and that expectation would be broadly met by banks. In terms of the ‘easiness’ of accessing credit compared to the previous three years, banks were reporting that it had become ‘somewhat easier’ although a slight majority reported ‘about normal’.

That said, a sector lending summary released at the end of December showed that for the month of November, total agricultural lending had fallen by $187 million, and dairy lending was down for the sixth consecutive month, by $175m. In fact, agri lending ‘growth’ had not moved out of negative territory since the end of 2019.

Taken together, the ‘feel’ for the sector and the actual lending numbers perhaps reads as optimism lies ahead, but there’s no evidence of it yet.

The most recent ANZ New Zealand Business Outlook cautiously points to a near future that reflects what banks are anticipating.

While overall business confidence was reported to be falling (understandably given the Covid-19-related uncertainty), the monthly trend for agriculture showed its level of confidence to be improving. The sector’s activity was identified as having risen sharply, as was profitability. But the sector’s own view on ‘ease of credit’ was however thought to have worsened.

This discrepancy between what appears to make sense (banks loosening their purse strings for farmers given their improved bankability) and what farmers are thinking (banking is getting harder) is what makes the question of ‘Can I borrow’ a difficult one to definitively answer.

Andrew Laming says that as ever, banks will want to make sure farmers have good financial history and good governance. They’ll also be increasingly wanting to know if farm resources are well known and certain (land use consents are in place), the production system being employed is relatively ‘normal’, and the farm is not in a naturally sensitive area.

Laming says where lending can be a problem is when a farm might have a high stocking rate which the banks might view as likely to be creating less-sustainable nutrient losses and unsustainable GHG emissions. The best answer then, maybe yes and probably yes with a capital Y – as long as you’re thinking what the banks are thinking. How much is it going to cost?

The final question – How much is it going to cost? The hard one, but potentially solvable. Multiple interest rate hikes are expected this year to quell inflationary pressure. The Reserve Bank’s official cash rate sits at 0.75%, but economists are variously picking it could end the year more than twice as high – above 2%.

The arrival of Omicron could stifle that though, if NZ’s economy mirrors what has occurred in Europe and Australia since the variant emerged. For farmers though, it’s not just looking at OCR moves that make it difficult to determine the cost of borrowing.

Andrew Laming says that despite farm financials looking rosier, banks are pricing other sector risks beyond income into their interest rates, which are effectively pushing fixed rates higher for longer than they might otherwise be set. Banks are managing the risk they foresee (regulatory changes having impacts on farm returns) by setting rates with a margin buffer.

“It’s noticeable that some banks are uncertain about how much additional capital they might have to hold against loans in the future, so they are making up for that by pricing the longer-dated fixed interest rates higher.”

The answer to the ‘How much is it going to cost?’ question might then instinctively be ‘Too much’. But Laming suggests farmers might think a bit more deeply on this, which involves calculating whether that cost (albeit elevated) is still manageable, and particularly what they can do to reduce the uncertainty on what that looks like.

“If, for example, an average farmer was geared at $20/kg milksolids (MS), a 2% rise (as economists are anticipating) would just add an extra 40c/kg MS. Farmers should be in positions to manage that if their farm systems are agile (flexible enough to reduce variable costs) have supportive balance sheets, and able to deploy product price hedging.”

The last point – hedging (beyond fixing interest rates) – is something NZ farmers are coming to see as a useful tool, and there’s plenty of scope for it to play a bigger role in de-risking financial decision making.

NZX dairy insights manager Stuart Davison says as interest rates as well as feed and other costs climb, there are more and more conversations about how farmers can create some safety buffers for their businesses.

“Most farmers that feed palm kernel or maize silage look to forward contract their required volumes, but fewer have been willing to realise fixing their milk price has the same benefits.”

That’s changing, however. There has been a massive increase in the use of NZX Milk Price Futures – up 33% on last year, with 20,868,000kg MS more milk contracted via the market. And a similar trend is holding for milk price futures for the 2023 season.

Farmers see the opportunity to lock in milk price for next season at about $8.70/kg MS already. There are already 5714 lots of open interest in the September 2023 contract, 169% more than at the same time the year before.

Davison says this trend represents a change in mindset where farmers appear to be starting to lose their fear of missing out on the highs in favour of more certainty. This will inevitably appeal to banks, who like known quantities more than anyone. 2022 could be the year of the yes.