Commerce Commission 'assessing' bank interest rate swap agreements with farmers, and ANZ National Bank's Rural Growth Fund against Fair Trading Act

By Gareth Vaughan

The Commerce Commission is "conducting an assessment" of whether some bank interest rate swap agreements with farmers, and ANZ National Bank's Rural Growth Fund raise issues under the Fair Trading Act.

A Commission spokeswoman told interest.co.nz the "assessment" comes after the watchdog received complaints. Under the Fair Trading Act, if a court decides a company or individual has broken the law, it can fine a company up to NZ$200,000 and an individual up to NZ$60,000 per breach. Courts may also award compensation to those affected by any breach of the Act.

The Commission's comments come after a series of articles about interest rate swap agreements banks entered with farmers between 2007 and 2009, a period where interest rates were mostly much higher than today, in both Straight Furrow and the Sunday Star-Times. The reports said the swaps were sold by banks including ANZ National, Westpac and ASB to farmers as insurance against interest rates rising.

Then when interest rates actually fell, farmers were left locked in to high interest rates they couldn't escape from, unless they paid pricey break fees. The SST said the deals had helped send some farmers to the wall and left some with the choice of coughing up something in the vicinity of NZ$1 million in break fees, or of paying interest of around 10%, significantly higher than the about 6% for a standard floating rate mortgage.

According to the SST, a major gripe some farmers have is they didn't realise the swap agreements had provisions allowing the banks to increase their margins.

The Commission spokeswoman wouldn't provide any details of the complaints, nor how many there had been.

"We are not prepared to disclose the details of those complaints at this stage. In withholding this information we rely on:

· s 9(2)(ba)(i) of the Official Information Act (OIA), as complaints were provided to the Commission under an obligation of confidence and providing details of the complaints 'would be likely to prejudice the supply of similar information, or information from the same source'.

· s 6(c) of the OIA, as providing the details of the complaints 'would be likely to prejudice the maintenance of the law, including the prevention, investigation, and detection of offences, and the right to a fair trial'," the spokeswoman said.

Banking Ombudsman investigations 'don't suggest widespread issue but do suggest some customers & their advisers didn't understand the product'

A spokesman for ANZ National Bank said the bank gives customers general information on how interest rate swap products work and advises them to seek independent advice before entering into a swap to ensure they fully understand the product and its suitability for their business.

"We're not commenting further on swaps or the Rural Growth Fund," he said.

Banking Ombudsman Deborah Battell said her office had completed five dispute investigations involving interest rate swaps.

"When you look at the disputes and the causes of them, nothing really suggested a more widespread issue," Battell.

"One concerned the quantum of a break fee associated with the interest rate swap product, one concerned delays in effecting the product, another complained that the product they purchased was not the same as a similar product they had had at another bank. In the other cases, the complainant withdrew their complaint after receiving an explanation, and the final case involved a dispute about the length of the swap rate agreement, whether it was to be three or five years."

"It is, however, evident from our complaints that the product was complex and that some bank customers (and even their legal and accounting advisers) did not fully understand what they had signed up to and how the product worked. In particular, it appears that customers did not understand how the product would work if interest rates dropped, as they did in late 2008, after the start of the GFC. This is relevant because interest rate swap products were generally being sold in an environment of increasing interest rates," Battell added.

'Innovative' capital source for farmers

The Rural Growth Fund was launched by the National Bank five years ago. In a press release issued on May 15, 2007 the bank said its Rural Growth Funding initiative would provide farmers seeking additional capital with a new funding option. This "innovative" way of providing capital for farmers would complement traditional capital sources such as borrowing through mortgage finance and personal or family equity, the release quoted Charlie Graham, then National Bank general manager of rural banking, as saying.

The release went on to say that a special purpose company owned by the National Bank (Rural Growth Fund Ltd) would invest in preference shares in farming companies for up to 20 years with capital provided on the basis of a property's potential value and a farmer's proven ability to realise that potential. The preference shares would have no voting rights, meaning farmers kept managerial control and paid a pre-arranged dividend.

Farmer-shareholders would have the right to buy the preference shares after 10 years, and the bank company would have the right to require the farmer-shareholder to purchase its shares in some circumstances, such as default. The price paid for the preference shares by the farmer would be based on the change in the Quotable Value All Rural Land Index, not the individual farm's value at the time.

"By linking the exit price to the QV index, the farmer has an incentive and an opportunity to outperform the national average growth in rural land values. The farmer can then capture a far greater share of the capital gain he or she has built up in their own farm," Graham said.

'Higher risk'

The release noted that Rural Growth Funding would take a higher level of risk, with the lower running dividend yield on Rural Growth Funding lower than the cost of debt, thereby allowing the farm cash flow to service a higher level of external funding.

The latest financial statements filed to the Companies Office for Rural Growth Fund, covering the year to September 2009, show interest income of NZ$1.98 million, versus NZ$2.4 million the previous year, and profit after tax of just under NZ$1.5 million down from NZ$1.6 million. An ordinary dividend of NZ$2.2 million was paid and the venture had equity of NZ$26.5 million. Loans totaled NZ$15.4 million.

News of the Commerce Commission's "assessment" comes with agriculture sector debt having recently topped NZ$49 billion for the first time, according to Reserve Bank figures, as Fonterra's annual payout falls 19%. Rural debt is up NZ$17.9 billion, or 57%, from NZ$31.5 billion in January 2007 with monthly year-on-year growth rates having peaked at almost 23% in January 2009.

Back in June 2007, when the Rural Growth Fund launched, the Real Estate Institute of New Zealand (REINZ) said in its monthly Rural Report  that the national median farm price had reached NZ$1,262,125 in May, second only to the record median price of NZ$1,425,000 recorded in December 2006. REINZ National president Murray Cleland was quoted saying: "The dairy industry is starting to look like some sort of economic miracle, sustained prices and returns for more than a decade underwriting what is now the shining example in the primary sector."

(The chart above was sourced from the Reserve Bank).

The latest REINZ figures, for August 2012, show 106 farm sales that month, compared with 266 in May 2007 and a monthly low in between of just 46 in both January and October 2010.

(Updated after Banking Ombudsman Deborah Battell came back with some additional comments).

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