By Gareth Vaughan
The Reserve Bank's plans to introduce new farm lending capital requirements from June could act as a brake on growth in the rural economy and increase borrowing costs to the productive sector, possibly hampering an export-led recovery, warns accounting firm KPMG.
In its Financial Institutions Performance Survey review of 2010, KPMG notes the Reserve Bank's proposed capital overlay for rural lending, which is expected to force the banks to hold more capital against their rural books, comes at a time of heightened concern about rural debt levels and when many banks have sought to "aggressively" reduce their rural exposures.
This has seen specialist rural lender Rabobank accounting for nearly 65% of new lending to the sector during 2010, albeit during a year of modest growth compared to historical averages. The latest Reserve Bank figures show agriculture lending at NZ$47.48 billion in March, up slightly from NZ$47.45 billion in March 2010, but down from NZ$47.75 billion in February this year.
The Reserve Bank plans to introduce new farm lending capital requirements in June in a move that's expected to see banks assign more equity to the funding of rural loans and probably lead to higher borrowing costs for farmers. Further details are expected in the central bank's next Financial Stability Report due on May 11.
"If imposed, one would expect this will ultimately increase lending costs for farmers and potentially act as a brake on growth in the rural economy, one of the central planks to economic growth in an otherwise uncertain economic landscape," KPMG says.
"(This) will ultimately increase borrowing costs to the productive sector possibly hampering an export-led recovery."
'Expansion should be based on cashflows not land prices'
John Kensington, KPMG's acting head of financial services, told interest.co.nz in a Double Shot interview that historically when farm returns rise farmers take it as an opportunity to expand their business.
"And I think when that expansion happened last time, it was very much based on land prices," says Kensington.
"The amount to be paid was based on land prices, perhaps opposed to what the economic unit (farm) was producing as cashflows. So a lot of farmers went out, bought more land, became bigger farmers, but did so with debt. And when there was a bit of a dip in commodity prices, that caused some of those farmers to be quite stressed."
The latest monthly ANZ Commodity Price Index, for April, recorded a 1.6% gain to 342.5 representing the eighth consecutive monthly rise taking the index to a new record high. The index has now doubled in value since the low point that was reached in February 2009.
Kensington says the rural sector is currently a two speed one. Some farmers have managed to repay debt and are now perhaps thinking about buying another farm because they’re in a good financial position.
"But everyone has had a bit of a fright over this crisis and they’re being very hesitant about doing it," says Kensington. "There are still some large farms, corporate and otherwise, that have extensive amounts of debt. And I think what the Reserve Bank’s saying is that’s not healthy for farmers in such a key sector to carry debt based on ballooning prices."
"The amount of debt they have should be based on the cashflows they can service from their farm. I think it (new farm lending capital requirements) could be a bit of a brake on the rural sector and it could increase farmers' interest costs to do business a little bit."
KPMG says if banks are forced to hold more capital against their rural loan book, this in turn, will increase the internal cost allocation and, ultimately, the banks will look to pass this cost on to farmer borrowers to ensure their return on equity is consistent across loan books.
However, KPMG notes the banks need also to be mindful of farmers’ long memories, saying it took some banks many years to rebuild market share following previous downturns in 1987 and the early 1990s. It points out that a number of the major Australian owned banks were backing off new rural lending during 2010 because of large numbers of non-performing rural exposures.
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11 Comments
"The amount of debt they have should be based on the cashflows they can service from their farm. I think it (new farm lending capital requirements) could be a bit of a brake on the rural sector and it could increase farmers' interest costs to do business a little bit."
How much is a, "little bit"? Is it a lot and worth these assertions?
Will it be anything, net, because relatively speaking less will be borrowed?
Less borrowing would come about with price reductions?
Will it really constrain exports, given most borrowing goes into purchases and (fill y' belly) demand, we are told, is solid?
I agree Les.Land prices will drop."New" lending will be on a cash flow basis.Less will be borrowed and therefore over time will be paid back more quickly.More to spend on productivty gains ON farm as opposed to interest payments OFF farm.All good for the rural sector (Although the banks may have a little less profit(tough)
I agree Les.Land prices will drop."New" lending will be on a cash flow basis.Less will be borrowed and therefore over time will be paid back more quickly.More to spend on productivty gains ON farm as opposed to interest payments OFF farm.All good for the rural sector (Although the banks may have a little less profit(tough)
Indeed Don, the negative impacts caused by a reduction financial efficiency arguement, aka, we'll hit you with increased interest costs, is weak.
I hope RB will do more with this approach in other sectors to support monetary policy objectives (better control non-tradeables inflation), which they can under the present Act.
I'd also like to see them using an LVR regime, and again with different LVRs per asset class, as they have with this adequacy approach.
Cheers, Les.
It is good to see the RBNZ moving in this direction.
Silly, greedy lending from the banks (read never mind the cash flow how much do you want) flooding the market with debt that seemed cheap in comparison with the tax free gains on offer fuelled the Ponzi scheme around property (productive land and residential buildings) that stands as an example of how not to do it.
It is easy to forget the true value of an asset is based on the cash flow it can generate in the midst of a Ponzi frenzy and it was clear that the cost of funds was insufficient restraint prior to 2007 – other controls are and will be necessary. The RBNZ is starting to think beyond price and use the LVR tool. Good on them.
As for falling prices that is inevitable when the bubble bursts and there is not one more mug who will pay more – the extent of that bubble could have been limited with targetted LVL controls earlier, it wasn’t, but better late than never.
Capital gains and land taxes come next.
The bubble has already burst. Bank lending is already constrained and what the reserve Bank has introduced was delayed from last year.Land values have already dropped particularly in the sheep and beef sector. A large block in the Manuwatu ie the Thurston receivership sale I understand has been bought by Landcorp, don't know what price Tender sale about 3000 acres.
Institutional memory only about 10 years so hopefully these new regs will stop the boom and bust cycle of rural lending.
What needs to be remembered is the fact that Banks were lending to get market share and the lending was incentivised and valuations of land was ridiculous. Valuers have been pulled into line with new rules of conduct and the process of tighter controls re banks starting to roll out . There will be other regulations to be introduced which will impact on the rural sector.
As for farmers spending money on productivity gains that has been done before and until there is more stable pricing of meat and wool that inevestment in increasing productivity could be flawed. The primary sector needs to get its act together and create better certainty for farmers.Costs of production keep going up and also compliance costs partcularly in the Dairy Sector.
Farmers are still being sold up by Banks, many farmers are still trying to keep their heads above the water line.Not all farmers are benefiting from increased meat values for example many farmers in the Taihape region had to unload in Dec because of lack of feed and weather issues, they were lucky to $53 a lamb.
Banks have already done their internal loading in terms of risk and many farmers are locked into Swaps mortgages with interest rates has high as 9.3. When you have supermarket chains in the UK cancelling orders because NZ lamb to expensive and buyer resistance is being met, that just illustrates how vulnerable NZ farmers really are.
The Banks still have a lot of impaired lending to fix up.
So have I got this straight. Banks "manage" the sell up of very high debt farms to maintain farm values which has the added advantage of allowing total debt to stay high so they with the help of the RBNZ can charge all farmers higher interest rates. Is this in NZs best interest? As a sharemilker wanting a farm Id say sellup all the greedy sods that paid way to much and let the vaues crash.
http://www.realeconomy.co.nz/166-action_needed_on_asset_bubbles.aspx
High debt levels in the New Zealand dairy industry remain one of the greatest concerns for the banking sector according to KPMG’s Financial Institutions Performance Survey. The New Zealand Manufacturers and Exporters Association (NZMEA) is supporting moves by the Reserve Bank to increase the amount of equity that banks must hold to cover rural loans and suggests further balancing using capital gains and land taxes to move capital from the tax shelters of land and buildings into productive business.
NZMEA Chief Executive John Walley says, “At $47 billion rural debt is not much less than the total size of the NZX. That says something about why our productivity growth is anaemic.”
“In the midst of an asset bubble it is easy to forget that a true value of an asset is based on the revenue it can earn. The bet on a tax free capital gain to deal with excess debt load is a risky practice for the lender and the borrower – policy should be pushing back against this.”
“It is clear that high interest rates did not stop the frenzy so the Reserve Bank’s moves to introduce farm lending capital requirements must be applauded. Limits on borrower loan to value ratios would also be useful and of course these sorts of restrictions must also be applied to other assets classes.”
“The absence of a broad tax base has also played a big part in the rural debt problem,” says Mr Walley. “Without a capital gains or land tax it is possible to capitalise earnings and avoid tax; that simply adds more pressure to the asset bubble driving values well above the capability of the land to fund the borrowing.”
“To balance our economy the tax burden has to be spread across income and assets, and debt growth controls are necessary.”
(end)
Why did it take RBNZ so long?
What held them back?
What do Federated Farmers think about this issue?
Cheers, Les.
A friend wanted me to post this I was just going to add to your last comment re Landcorp that they only seem to need to achieve about 1% ROA (see latest 1/2 year and previous years results) as their taxpayer bankers subsidise a "real" return. The same applies to overseas land buyers who with their currency hedges and other financial ploys (or ideology) do not have to meet the same requirements as NZ buyers. Hence the gap between them and others in the Crafar bids. Next in line Landcorp with their subsidised "profits" ability to bid. And finally NZers who can afford to pay only "half price" but which in real terms is all that the farms are worth in New Zealand to New Zealanders with the new "cash is king" bank philosophy!!!! ??????????
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