30 Oct Drought Impact on Lending Practise
By Linda Rowley (Article published on October 23, 2019 – Beef Central)
THE impact of the ongoing drought has extended far beyond a simple lack of rain, dragging agricultural risk into the spotlight in the wake of the Banking Royal Commission.
Ian Robinson from agri-financial services firm Robinson Sewell Partners is hearing first-hand about what banks are asking borrowers for.
“Primary producers seeking expansion must show lenders their risk management plans, and more importantly, how they are drought-proofing their business,” Mr Robinson said.
Banks were typically asking for more ‘intricate, technical responses’ on a prospective customer’s drought strategies, he said.
“Most farms that experience dry conditions destock their steers or cull their wethers. It is something they automatically do, but the banks are now asking deeper questions like:
- What is the duration and capability of your cattle herd?
- What feed storage and procurement procedures are in place for core stock?
- What is your pasture management strategy?
- How much water do you have on farm?
- Is it piped or do you rely on ground water?
- At what point do you respond and react to a dry condition to preserve pasture and water, and maintain balance sheet credibility?”
Mr Robinson said banks wanted to ensure that farmers weren’t reacting emotionally to drought, and that they had appropriate lending policies in place.
“A firm and actionable drought policy is about trying to remove the emotional element of decision-making from farming and as a result, proactive borrowers should improve their credit risk rating,” he said.
Mr Robinson believes if banks start demanding greater detail on drought management, there could be natural resistance because every farmer would say they had been through droughts for the last 50 years.
“However, the banks are not trying to undermine the farmers or the borrowers about their capability of handling the drought. They simply want to see what systems are in place so credit can be signed-off and say yes – these borrowers have a system in place for drought.”
Rising costs during drought
Mr Robinson said running a pastoral business became an expensive exercise once a producer went past natural production thresholds and began to purchase feedstock just to maintain production numbers.
“An indefinite cost element creeps into the business the minute a producer starts relying on imported fodder and feed to maintain flocks or herds when there is no defined exit to the seasonality event,” he said.
“The feeding program can be a negative cash flow exercise that can create a deterioration in the serviceability of the borrower’s loan, in the bank’s eyes.”
Normal banking rules don’t apply
Partner Brad Sewell warned that normal rules of banking and finance no longer applied during the extended drought.
“There is a lack of confidence in where the seasons are now and could be heading, particularly in New South Wales and southern Queensland. Banks are now crystal ball gazing out to 36 months in terms of what incomes could be generated, and whether these projected incomes can service increasing debt levels,” he said.
Lenders were now ‘super-cautious’ around taking on new clients, for two reasons:
- Bank resources are at capacity in terms of managing existing ‘drought affected’ loan portfolios.
- Banks want to know what your ‘drought strategy’ is, regardless of past, present, or future income; or even equity and security.
Mr Sewell said producers wishing to refinance or acquire a new property had to add an extra layer of information on how they proposed to deal with, and recover from the present drought.
Banks were also asking:
- What type of water is on hand (eg dams and bores) and how long will it last?
- What feed is on hand; how long will it last; what is the intention regarding future feed purchases?
- How is the client going to manage livestock numbers now, and when the season turns for better or worse?
Banks under pressure
Mr Sewell said on one hand, financial institutions were under pressure from clients wanting more money, and on the other, from regulators wanting the banks to focus on a borrower’s capacity to repay debt – something that has been difficult for farmers to achieve in recent years.
“The Australian Securities and Investment Commission and the Australian Prudential Regulation Authority are continually reviewing the agribusiness books of the banks in the wake of the Banking Royal Commission.”
He said that lending had been largely driven by land values and forecast cash flows, with historical financial performance being important, but less relied-on in recent years.
“The increased regulatory pressure on banks means they must elevate the importance of historical financial performance in their lending decisions, at a time when the rural industry can least show the performance required.”
He said in the present negative environment, banking appetite had waivered substantially as the drought continues.
“Every bank is in the same boat. No bank is any better than any other, no one is performing any better, and bank policy has changed little. However, the banks are interpreting their policies differently, and are seeking more information than asked for in the past.”
Mr Sewell said that when it came to property acquisition, New South Wales and Queensland are at odds.
“Generally speaking, Queensland producers think, act and operate differently to their southern counterparts. Queenslanders are continuously looking to expand, even during adverse seasonal conditions or commodity prices – they don’t see barriers to progress.”
“New South Wales farmers tend to adopt a more conservative approach. They sit tight and wait for the drought to end, go through a recovery period and then consider their options to expand,” Mr Sewell said.
In stark contrast to parts of New South Wales, Mr Sewell said land values remained robust in Queensland despite the seasonal conditions.
“There is a real concern about how long it will take the property market to recover in NSW, as the focus will be on recouping losses from the drought. Farmers can no longer bank on the usual eight to nine percent land value increase to borrow more money.”
“For example, a $5 million property that generated an extra $400,000 a year in capital gain (8pc) at 60 percent LVR (loan to value ratio) equates to an extra $240,000 borrowing capacity per annum. Farmers will unlikely be able to bank on land value increases to borrow more money,” he said.
Mr Sewell said few producers were refinancing in the present conditions and there were far fewer blue-ribbon finance deals for the banks to consider.
“The gap has closed between those properties that were well prepared for drought – even their drought preparedness wasn’t prepared for this type of situation,” he said.
Are big banks too exposed to agriculture?
Several financial consultants approached by Beef Central admitted they were generally surprised by the level of support that the National Australia Bank had given to clients in the current climate.
Large agribusiness lenders (like NAB) were the biggest financial institutions exposed to this current drought.
Some fear a top-down approach of risk assessment towards industry exposure (droughts and climate change) could see a transition in the major lenders’ risk assessment procedures.
NAB agribusiness general manager Khan Horne dismissed any suggestion his bank was too exposed to agriculture.
“NAB has been supporting Australian agriculture for 150 years through price fluctuations, trade challenges and seasonal conditions, and it will continue to do so,” he said.
Also, if it doesn’t rain next year, and with ASIC and APRA reviewing lending policies in the wake of the Banking Royal Commission, banks are likely to come under enormous pressure from both clients and regulators.
Mr Horne said most customers in affected areas had already made the ‘big decisions’ regarding drought management.
“Some producers have sold down stock, moved cattle or bought grass. Every agricultural operation is different and approaches drought uniquely. Each has different off-farm assets, different levels of farm management deposits and different management structures.”
However Mr Horne believes risk should be included in every producer’s forward planning.
“It is helpful for an applicant to show their qualifications, experience, organisational structure and their risk management strategy – including when to sow, their approach to flood, drought and fodder, and whether they should buy grass.”
“It is also a good habit for producers to look at good, average and bad case scenarios as part of projected cash flows for the next 12 to 24 months,” he said.
Mr Horne said the NAB’s policy had not changed and its lending approach remained consistent, despite the drought.
“The bank continues to assess balance sheets, tax structure, previous financial statements and risk management policy in relation to droughts and/or floods, as well as water budgets for livestock and irrigation.”
He urged bank managers to stay close to clients as part of the assessment process.
“With no income from this year’s winter crop for many, barley crop losses and producers selling down their cattle and sheep, now is the time for producers to sit down and have an open conversation with their financial consultants, valuers and accountants. Everyone needs to be actively involved in this tough situation,” he said.