Andrew Gawith from Gareth Morgan Investments looks at the return on investment in farming and blames the banks for lending on overpriced farms and inflating land values.
He argues if bank lending was based more on ensuring farms income returns, matched the cost of capital this may create a more robust and vibrant farming sector.
In the adjusting period this would cause a huge amount of pain for those retiring or exiting the industry.
What he does not explain in this article is family farm succession which often allows farms to inject young blood at discounted land values.
These agricultural investment return issues are not unique to NZ, but need to be solved as farming needs youth and energy to generate better profits and production
One of our most important industries, agriculture, appears to be one of our least commercially rational writes Andrew Gawith in the NZ Herald. The idea that businesses should generate a return sufficient to cover the cost of capital doesn't seem to apply to farming. Why does this situation prevail and what changes would need to occur to bring a little more sanity to this important sector?
There are two earnings streams from farming: the income return and the capital return.Typically farmers and their funders (mainly the banks) focus solely on the ability to service the debt raised to fund the business.So let's say the farm is worth $2 million and the bank lends the farmer $1 million, then all the bank is interested in is whether the farm can generate a net profit big enough to meet the interest payments on $1 million. Interestingly, farming is the most popular business for banks to lend to. While other areas of economic endeavour are starved of capital, banks have very nearly drowned farming with debt. The ease with which farmers can get capital has helped push up the price of land.
Now banks are generally reluctant to force a sale - they don't want to spread panic and undermine the value of their collateral. So why do farmers take such big risks for such pathetic income returns? The answer: capital gains. The value of farmland has risen even faster (10.7 per cent a year) than housing over the past 20 years. That's a very healthy return given there's no tax to pay. Farming may not be as commercially inept as it first seems, but it is speculative.
A portfolio of world shares over much the same period would have yielded a real post-tax return of between 4 per cent and 5 per cent a year. The rationale for investing in farms becomes clearer and stronger, but heavily dependent on rising land prices. Given land's credentials as collateral, banks are unlikely to abandon farming as a major lending market, though there's some evidence they have pulled their heads in a bit over the past year or so.
The value of farm land is also underpinned by an impressive track record of productivity growth.Another factor likely to stimulate land prices is the rise in demand for food from the rapidly developing countries such as China and India and the growing world population - it's expected to increase by about 50 per cent over the next 40 years.
Capital returns seem likely to remain the mainstay of total earnings for farming but the industry is vulnerable to falls in land prices (which is happening now).A combination of falling farm equity and pitifully low income returns quickly make farming an unattractive banking proposition. More focus by banks on ensuring income returns at least match the cost of capital would help shift the balance between income and capital returns as farmers would find it more difficult to get funding for over-priced farms.
23 Comments
I guess it's a good question, "Has bank lending pushed farm prices up?" Plus all the other obvious issues and questions hanging off this one. However consider these:
Which government agency has indicated a recognition that is has a role in reducing the damaging dynamics involved by the use of PRUDENTIAL measures?
Which lobby influenced that agency to "slow down" on it's proposals to address the problem? *
Did the government agency in question recognise the problem far, far, far too late before it attempted to act?
Would this government agency most likely say, "Yeah but, it's the same everywhere else and we operate "world best practice" policies, and so much better than everywhere else"? [ As Tony says above, "These agricultural investment return issues are not unique to NZ ..." - and neither is the Basel II risk-weighting regime that supports the lending behaviour, but ... ]
As we know Basel regs are not set in stone, because said government agency says it will only adopt the parts of new Basel III regs as it sees fit for NZ - so why didn't they act/REGULATE more PRUDENTLY in only adopting parts of Basel II as appropriate for the CONTEXT of NZ - before the horse bolted the stable and the cows bolted the haddock? (Just checking to see if your'e still awake.)
The banks were just being banks, but what was said government agency being - "world best practice"?
Dismal.
Cheers, Les.
* 'You cannot implement a problem – only a solution'
http://www.infonews.co.nz/news.cfm?l=1&t=0&id=53064
"We have worked with the [said government agency] to ensure that the speed of implementation has been slowed down on their new “prudential measures” and capital asset ratio requirements of banks. While there has definitely been a tightening on availability of capital, the implementation of these new policies will now be at a far slower pace than originally planned, thus reducing even more stress among the farming community. We argued that speed on implementation was not the solution New Zealand needed."
Perhaps [said lobby] was referring primarily to this:
Lend lend lend - never mind the cash flow feel the capital gain, the taxpayer guarantee supporting moral hazard, the predictable best practice boys supporting the spread and greed does the rest.
Banks pushed up farm prices alright!!
1. The big four used to (in the '90s) expected principle and interest to be paid back over a 20 year peroid, 25 years at a stretch. Then Rabobank came along offered interest only loans. Obviously if you only have to pay interest, and make no allowance for principle, as a Rabobank customer you can afford to pay more than a purchaser constrained to make principle repayments. The big 4 had to follow suit to retain market share. Farm prices went up.
2. Big land buyers during the peak (Craffer, McViddy etc.) have gone to the wall with their overpriced purchases. Backed by banks who kept say "they're no making any more farmland you know..." . Fundimentals don't come into the equation I was told when I pointed out the fundimental problem that the returns don't support the capital cost of the enterprise..Farm prices went up.
3. Tax deductible expenditure, such as a high levels of repairs and maintence, or high fert applications, can be valued as tax free capital gain. This was very rewarding with equity partnerships and LAQC's. Simply make a tax deductable cash loss (and offset it against other income, and just watch the tax free capital gains go!!!) Not any more though...
Boy is it hurting now. I hear our regional council has %20 unpaid rates suspect local council is worse. Bubbles like this are destructive and need to be addressed before they happen not after. The debt exists, nothing now can stop the destruction of debt by bankruptcy and the pain that goes with it. Lets wise up about bubbles and remember the lesson for more than a generation this time.
Andrew. You and I can remember (just!) the pain of the 'last time" ( I remember Dad having to sell the Anglia and buy a bike to peddle get to work). But as we have seen time, heals (?) all. Only constraint of, and absolute control of, the banking system will help us from here. But the chances....
Stevel, you make some good points especially #3. That is one of the main reasons taxable profits from farming are low. It makes more financial sense to invest money back into the farm during good years on the likes of fert, regrassing, fenceing etc, which can give a higher return than debt reduction, lift future productivity and minimise taxation.
The above article does note the impressive productivity gains achieved by agriculture which are in excess of other industries and the obvious long term population food supply issues that underpin the very bright outlook for NZ ag.
It should also be noted that farm prices have dropped considerably already, unlike residential property and have done so at a time of record high product prices and low interest rates which is unusual. Whats happend, happend and as the article points out its worked out favourably for farmers, we only play the rules to our best advantage like every business person on the planet. Why wouldnt we?
The outllook for our product prices is extremely good at present, probably the brightest in my 20 odd years farming career. Coupled with the extreme uncertainty in just about all other forms of asset class I am more than happy to have my money invested in farmland.
"The above article does note the impressive productivity gains achieved by agriculture which are in excess of other industries ....." A good point, and those productivity gains where diven more by seed and fert companies pushing their products. While productivity has increased PROFITABILITY has fallen over. Farmers just want to increase production so that they can justify an increase in the capital value of the asset. By making an operation profitable the stocking rate may need to be reduced, thus reducing its potential capital value - not what your banker wants to see, but cashflow would be greatly improved.
I am wary of your last comment;
"...banks are generally reluctant to force a sale - they don't want to spread panic and undermine the value of their collateral".....
The bank bosses are now the ones wearing the gumboots and driving round town in 4WDs...only the shit is missing from the rubber and the insides are carpeted....no need to wallow in the effluent when you can sit back at the bank, knowing the farmers are working for you 24/7.
And the dumb govt and RB think this amounts to investment and growth in the export sector.
The best advice to young wannabee farmers is the same as that for wannabee town home owners....give the banks a big two finger wave and walk away from the land...
Steve - your link to the article about the US dairy farmers hurting inspite of (or because of) record milk prices is primarily due to a spike in grain prices. As NZ industry is predominantly grass fed - this shouldn't impact on us. In fact it should be a positive for NZ as the milk tap gets turned off in other parts of the world thus decreasing supply.
I don't think you read the article properly...
"The U.S. herd had almost 9.12 million head in October, or 0.2 percent more than a year earlier, according to the USDA. Milk output will rise to a record 192.8 billion pounds this year, the USDA said Nov. 9. Production per cow in May, usually the peak month, reached a record 1,868 pounds, the data show. Cheese inventories reached 1.037 billion pounds in October, the highest for the month since 1984."
But Rabobank is positive about china;
"The industry is pinning its hopes on rising exports to China, Russia and India, said Hayley Moynihan, a Christchurch, New Zealand-based senior analyst at agriculture lender Rabobank International. The U.S. Dollar Index, tracking the currency against six counterparts, slumped 8.5 percent in the third quarter, the most in eight years."
"A weaker dollar “makes exporting more attractive from a U.S. perspective,” Moynihan said ...."
Hey this is fun!
The US may have increased their herd numbers by .2% but that is after dropping their livestock numbers by 2.7% the previous year. . .
http://www.ruralnews.co.nz/Default.asp?task=article&subtask=show&item=19528&pageno=1
China and India are huge potential markets due to increased demand in protein. Not bad prospects considering the size of their populations.
I must say it again. % 40 of Asians are born with Lactose intolerance this figure rises to %90 buy the end of their teens.
The USA has just had a large increase in production out of less cows. China has some major internal problems and adjustments are coming, as happens in command economies.
India is a mess 700 million peasants they are more likely to get a revolution like the french one than a boom, unless inequality is addressed and soon which is highly unlikely.
Eactly right agridame, alot of commentators here have trouble joining the dots. They are making comments based on the past performance of agriculture not the completely different set of circumstances emerging now. Being able to produce high quality protien from grass is a huge advantage in these times. We get to recieve the record prices but dont suffer the record high feed costs to the same extent. I believe that those that produce food are going to do extremely well in the forseeable future.
I can join dots. High grain prices = more planting, more planting = grain surplus= price falls= cheaper milk and beef. Massive recession= less consumption especially in higher priced foods= price falls.
High cost farming = high risk in volatile times. High production = high costs= more risk. More debt, more costs= more risk. Idiots running the show=unfathomable damage.
The trouble is the dots in the economy look like an ant that walked out of the ink well, good luck joining those.
Aj, you're assuming that increased grain production is a given. We are seeing grain price hikes in a year that supposedly has produced the 3rd highest global grain harvest in history. Kunst had an interesting link to a Forbes article somewhere here yesterday about the looming food crisis and how supply and demand is on a knife edge like never before. My read is that this can only be positive to the long term profitabilty of those that produce protein from grass.
SS, the Government has stepped up to the plate and taken over from private sector as far as spending goes.
This not going to last because,
by Dr Jonathan Wilson
Most are frightened of fiscal tightening because they have made the deeply flawed Keynesian assumption that private spending is replaceable by Government spending – i.e. they assume that private consumption and Government spending are interchangeable.
Why do they make this assumption? – Because they have learnt from the cradle that in calculating National Income, Government spending is added to Private Consumption. In this way the assumption that private demand and Government demand are interchangeable is genetically engineered into their economic reflexes.
However at best this holds true only for a single moment in time and only in an accounting sense. Considered over time the constraints on private consumption are very different to the constraints on Government spending.
These differences in spending constraints means that private and government spending are not interchangeable in the calculation of National Income over time. Indeed this is the error Marxists, Socialists and Progressives make – they assume (to differing degrees) that National Income will remain the same if private consumption is replaced by Government expenditure. At the extreme, set private consumption to zero, take up the slack with Government spending and hey presto you have the same economic output.
So what is the key difference between Government and private spending? And this is essential to understanding why our national wealth is being destroyed at a rate faster than it can be replaced.
The key difference is this. Private consumption is balanced against the market value of what private outputs can be sold for. Government consumption has no such immediate constraint against the market value of its outputs. Thus private consumption results in voluntary transactions between willing buyers and willing sellers where the transaction results in a surplus of wealth for each. Government consumption is based on the coercion of buyers through mandatory taxation. The result is coercive transactions where the market value of the Government outputs can easily be less than the value of the wealth (transferred coercively from taxpayers) used to buy them. Wealth is largely destroyed by Government spending in this way.
For this reason government spending can never replace private spending as a means of generating wealth or even as a replacement for lost private consumption.
The growth in coercive tax based transactions where outputs are worth less than the value of taxpayers’ money spent on them has reached such a crescendo, that the UK is losing wealth at the same rate as if it were fighting an all-out war.
Ambrose, we have in the UK, not in the first instance a crisis of liquidity, but rather a crisis of wealth.
Thankfully Governments have reached the limits of their borrowings in their insane attempt to replace private demand with Government demand. They would be truly certifiable (in a Mugabesque way) if they used QE to support Government spending because they could no longer borrow money.
What we need right now are (1) cuts in Government spending to the point where transfers of wealth from taxpayers is limited to a maximum of the market value of Government outputs (2) significant tax cuts for individuals and households as a priority before tax cuts to companies (3) liquidity managed to maintain price stability
The Banks aren't nervous about farming, Why? they lend to a maximum of 70% (for dairy anyway - 50% for some other types) and even allowing for the correction we have seen in the last few years - many farmers will still have a cushion of equity and a reasonable EFS this year due to lowering interest costs (and an expectation it will rain sometime soon)
I think they will be a lot more nervous about their exposure in housing - where they lent up to 100% in housing to people who may have since lost their jobs.
When working for the NAB in the early noughties - the lending to agribusiness was around $6b and to the rest of business $60b. This mix may have changed (and could be higher ratio in NZ) but illustrates the overall importance within the banks exposure.
p.s. Indian lactose intolerance is much lower than you suggest - especially those from North India (how do I know this? Apart from a quick google I looked in my Punjabi workers fridge last week - 4 x 2 litres of milk). Why then are the Chinese pushing milk and dairy as a health message? and anyway 10% of 2 billion isn't a bad niche market.
My bank will lend %15 against a farm, including livestock. WE have a a debt explosion in farming from memory 9 billion in 1999 to 45 billion now probably higher I doubt a lot of the SCF type deals were included.
No doubt with artificially low interest rates we can keep the party going but the big question is 'for how long'.
We need those home owners to buy our food and lots of the high priced stuff.
Its not only food Aj. As you well know grain is increasingly used for ethonol and if the peak oilers the likes of powerdown and steven are to believed then in the short to medium term there will be furthur diversion of corn from the food chain putting yet more strain on food production. Even the Arch pessimist Ambrose Evans Pritchard from whoms comment steam you link, has recently written that productive farmland with water on site is smart money.
Then again you may be right and an economic catastrophy is eminent and it might be off to the soup kitchen for all but those that put their money under their matteress. So perhaps its not even worth getting out of bed in the morning?
Breaking news, its raining. Sorry, it was raining. Damn, ah well 2 mls is better than no mls. By the way I am with Andrew on this, despite the better so called returns, I am still no better off. Just bought potassic super for over 4hundy a tonne, which is nearly times two what it was. It now costs twice as much to apply as 10 years ago, so my fert costs have doubled in 10 years. Which now over takes the mortgage as a quarter of all my expenses. Add in doubling of ruc, rego, fuel, rates, insurance, electricity and just about everything else you have to have. We may have a great outlook for foreigners wanting our food, but the other half of the equation is keeping costs down. NOT HAPPENING.
I dont know what to make of ethanol. On the surface it looks daft, I dig a little deeper it gets worse.
I think we have a threat to us from the old Soviet block and South America just wish we would look at things with both eyes open. Look what happened to Greece and Italy when USA agriculture came on stream after the war, it makes ugly reading. Its places like the plains in Hungry, the land around the black sea and the Ukraine that will be our competition soon. Brazil will always do us over in the protein race with its chicken and pork as they are %80 more efficient at producing protein than ruminants.
I think that if oil prices rocket then its logical to grow your food closer to home, just a thought.
Look hard at the Globe and there are loads of places to ramp up farming. We are a little pimple compared to Brazil and Russia, and by all reports they are rapidly getting their act together. I know I sound depressing, but its reality, and I am over believing farming will ever make me wealthy in monetary terms.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.