Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

With the ongoing Inquiry into Rural Lending, one of the central themes from both the RBNZ and the Banks is that Agri Lending is ‘riskier’ than Home Loans so therefore a higher margin needs to be charged to justify the lending.

 

Two things have now happened over the last 10 years. Firstly, the Banks have increased the price of their loans, but perhaps more importantly they have also reduced the risk they take at the same time.   

 

Let’s unpack that statement a bit more.

A Bank considers two main factors when looking at a loan. Firstly, what is the likelihood that things will go wrong (i.e. default) and secondly, how much of the loan that they will be able to get back if things do go wrong. When a loan does go wrong, the Bank assesses how much they might lose on the loan, and this is referred to as a ‘credit impairment allowance’ or an ‘individual provision’.  

Now, it’s very important to note that an individual provision (an ‘IP’) doesn’t necessarily turn into an actual loss, the Bank just thinks it might.

From experience, banks prefer to budget or ‘provision’ a higher number than they actually do lose, as they don’t like surprises.

Banks don’t publicly report the actual losses they make so we can only use the IP data as a proxy for this detail. However, it was telling when Antonia Watson, CEO of ANZ, was asked at the banking inquiry how many defaults they were running in their Agri loan book. Her answer - “Just two” – in over $15bn of loans.

So, let’s look at the data. The graph below shows the level of total annual bank Agri IP’s (Main banks + Rabobank + Heartland) as a percentage of their total advances since 2018.

 

 

Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

When we made our submission to the Rural Banking Inquiry, we went back into the RBNZ data to look at how each main banks' Agri Lending market share has changed over the last six years.

The changes in market share are really telling, but what’s more interesting is the actual dollars that have been lent (or as the case might be, haven’t been lent) when looking at other sectors such as home lending.

Let’s look at the graph of the market share first:

 

Nicola Willis announced in June that the Finance and Expenditure Committee would be adding Rural banking to the inquiry into banking competition in New Zealand. In particular she noted that: "growing the rural economy is critical to rebuilding New Zealand's economy and with farmers satisfaction with banking services dropping in recent years, its critical we better understand the role of bank competition in that sector".

This followed an earlier process run by the Primary Production Select Committee to which NZAB was asked, among others, to provide a submission and subsequently present in person.

As part of this new inquiry, the New Zealand Government wants to delve deeper into the reasons why the cost of banking is much higher for business and rural borrowers and examine the effects it's having on the New Zealand economy.

NZAB recently made the below submission to the Finance and Expenditure Committee.  As this is a public process, we thought it would be useful to share our submission with our wider farming and farm professionals’ audience.

It covers a brief summary of some of the issues as we see them, but also offers some practical solutions that the committee might consider to improve farmers access to capital and have a positive impact on New Zealand’s ability to increase exports, close the current account deficit and continue to maintain New Zealand’s relative GDP vs its peers.  

If you have any questions on any part of our submission, please feel free to contact us.

 

Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

The Problem

Time and time again we hear the challenges of farming in New Zealand, our aging farmers and the need to attract and retain high quality talent to continue to operate these businesses.  

At the end of 2022, the average dairy farm in Canterbury was 235ha, and milked 800 cows. Based on this, total capital employed in the business would be c.$12.500m. When assuming leverage of 50%, a farming business would require equity of approximately $6.250m.

 

Who are the next generation of farmers that have over $6 million of cash?

The answer isn’t land value correction; the best dairy businesses I have seen, with quality assets and quality operational performance, are generating pre-tax cash returns of 15%+ return on equity – very tidy! Who wouldn’t want that? 

New Zealand Agriculture needs to find new ways of attracting and retaining high quality talent.  Additionally, that talent needs to bring in capital, and needs to have a pathway to generate ownership and wealth.  

The equity is there already and sitting in a lot of those existing businesses. For well run, well capitalised businesses, returns are also there. The key is to get better at capturing and protecting that wealth for our retiring/exiting farmers and creating pathways for wealth generation and ownership for our next. Part of that solution is attracting new forms of capital to the market to create more liquidity. You can read more about what NZAB is doing directly in that space here. 

 

But another solution is to consider other exit options like a "Transitional Exit". 

 

What is a Transitional Exit?

Broadly speaking, Transitional Exit means the gradual transfer of ownership AND management of your business over time – at market value and when the operator is able. The business employs or contracts proven operator(s) who bring some external capital and the skills that are required to successfully operate the day to day of the business. 

An entity, call it, “the Company”, is created, to own and operate the farming business. The Company raises debt and equity to buy the assets (which may be from the existing farm owner). The incoming operator will use their capital to buy a share of that entity, with the existing owner retaining the balance. In the typical Canterbury example above, assume an operator has $2m of equity. The retiring farmer “leaves” $4.250m in as equity and has a 68% share in the Company. 

In this example, the retiring farmer has sold a $12.5m business and left $4.250m of cash in the Company – meaning they have $8.250m to repay existing company debt, buy a property elsewhere and perhaps surplus for succession or investment or whatever they choose. In addition, they would expect to receive a return on their investment in the new company.  There are plenty of variations on this, but this is one way in which Equity Partnerships (EP) are formed. 

 

Where can it go wrong?

Sadly, there are a few war stories when it comes to Equity Partnerships. Typically, it happens when the strategy isn’t thought through or well understood. A few common examples: 

• Rushed facilitation.  
• Inappropriate leverage for the business strategy -  i.e. the bank may have a differing view on cash dividends if the leverage is too high. 
• Poor operational or poor governance performance – and often the merging of the two. 
• Values or operational strategy misalignment.  
• Inadequate due diligence by all parties to understand how the business will respond when the assumptions change in the negative – and what the expectations on all shareholders are.  
• Growth vs Exit – and differing needs amongst shareholders, how this is captured, communicated and agreed upon up front.  

 

A little bit about strategy 

The best equity partnerships have an appropriate level of leverage, formal governance structures, and a clearly defined and agreed strategy (i.e. how are we going to run this business, distribute or reinvest our profits and maintain our assets) and a clearly defined and agreed exit strategy. 

One of the key fundamentals to a successful Equity Partnership is to understand and agree what the exit strategy is. Critical elements of EP strategy for structured transition should include: 

• An agreed enduring methodology for valuing the business. 
• Structured milestones for exit stages and how they will be executed, including back up plans if those stages can’t be met. 
• How and when profits are distributed or reinvested which need to be aligned to the shareholders needs, and the Company strategy. 
• Definition and understanding the difference between governance and management. 
• Great reporting to all stakeholders so there’s no surprises. 
• Risk Mitigation.
• A governance framework which captures how and when key business decisions are to be made, and by whom. 
  
  

Why would you consider a Structured Transition over a full sale?

Selling your business via a Transitional Exit is certainly not for everyone. It requires relinquishing elements of control, a different type of risk, and trust in other operators to do something you may have done for many years – likely this will be differently to you. 

Many sellers believe their solution will come when they market the property for sale. However, selling a property isn’t easy – it requires planning, preparation, investment and execution to achieve a great outcome via a sale. In addition, after sale, you (hopefully) have surplus funds to invest. That can be a whole new set of variables to understand. 

If well planned and considered, a Transitional Exit can mean you stay invested in an asset class you know, enjoy and can take pride in. You can also structure it in a way that lessens the burden of operations (admin, staff, compliance, etc.) on you and is taken up by the incoming operator. In addition, a talented operator can bring a fresh perspective on the business that could be of benefit to the Company and to you both as shareholders. 

Taking the time to ensure alignment on values, strategy and exit is critically important to the ongoing success of the venture. At NZAB, we are collaborating with farmers who are considering whether this type of exit is right for them, and with our next generation of farm owners who are ambitious in their goals and have the proven track record to back it up.  

 

If any of this sounds like you, then please get in touch with chris.laming@nzab.co.nz we are more than happy to have a no-obligation introductory chat to start the ball rolling. 

 

 

Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

We’ve dived back into the RBNZ data to see all the main bank movements over the last six months- all the changes in lending, who’s winning market share and who’s losing it- in both the Agri and Business Lending Sectors.

 

In this Issue:

• Whilst the growth in total loans continues for all NZ banks, it remains quite anemic, a continuation of the slowing in credit growth that started in late 2022, but huge overall growth for Kiwibank with 8.7% growth
• Westpac Agri lending is lagging the other banks, (even ANZ, who continues to drop) with its' Agri loans reducing by $350m for the year, resulting in a market share drop of 60bps.  Rabobank was again the benefactor, picking up 75bps of market share.  
• ANZ shed a whopping $1.6bn in business sector loans over the last 12 months - one of the biggest retractions in lending over a period we've seen. ANZ now has less business loans than what they had in 2020, and over $2bn less in Agri loans,  However, during this time, they have increased their home lending by almost $20bn
• Dairy loans continue their ongoing repayment profile, reducing by over $500m for the year, going some way to explaining the strong demand for loans in this sector.  
• Horticulture loans continue to grow substantially, up a further 8% for the year despite Agri loan growth being largely flat.  
• Agri non-perfoming loans and lending provisions were largely flat over the year - this is likely to be the balancing of risk between an improving dairy situation, but a sheep and beef sector that remains under pressure.  Additionally, the viticulture sector was under some earlier concerns which has now alleviated somewhat, similar to that in the Kiwifruit sector

As always, please sing out if you have any questions or would like to use the data in your own presentations or engagement with customers.  We would be happy to provide a digital version for sending.  

 

Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

We first started talking about Kiwibank being re-purposed for Agri growth (and more business lending) in this article here

Within that article we discussed Kiwibank’s success, but despite that, capital regulations were preventing them from becoming a meaningful player in Agri lending.

Quite simply, Kiwibank has a limited amount of its own equity capital, and the capital adequacy rules (i.e how much of its own equity it needs to place against each loan) means that it’s more incentivised to lend on houses than it is to an Agri or business customer.  

Now, the future of Kiwibank is again on the table after a speech by Nicola Willis, New Zealand’s Finance Minister, over the weekend. One of the ideas circling parliament at the moment is to expand Kiwibank by allowing it to seek more capital - this might be either from Government itself, or further external capital. The earlier Commerce Commission report on the banking sector actively supported the expansion of Kiwibank as a way of encouraging further competition in the New Zealand banking sector, so any move from Government is likely to be on point with this.  

The only trouble with that approach, is without any change to capital regulation, any non-specific capital introduction into Kiwibank is more than likely going to simply stimulate a further expansion in home lending credit – great for home owners getting access to competitive credit (and also for house values) - but absolutely no use whatsoever to the productive sector.

We saw a version of this during Covid – when the RBNZ introduced the LSAP programme, they provided c. $50bn to New Zealand banks as lines of additional credit. When added to the government’s own stimulus we observed a huge amount of additional liquidity landing in banks. In turn, given their capital settings favoured home lending, the banks did what they did best and fed it down that channel - leading to a significant explosion in home lending, subsequently fueling house price growth.  

If you prefer to see this more graphically, the below graph shows that bulge of new lending going through:

 

Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

 

Are you a Sheep & Beef Farmer looking to step away from the day-to-day operations of the farm and release some capital to support your next step in life?

NZAB is right across New Zealand and we're regularly talking to farmers, banks, investors and other capital providers, matching them with the right capital and opportunities to fit their needs.

We are in constant contact with several aspiring "Equity Managers" from all industries who are looking to pair with existing farm businesses in a new structure or with new investor capital to acquire a new farming business.

Today we feature one example from the Sheep & Beef sector. 

 

We have a progressive and experienced family looking for an opportunity to increase the scale of their farming business.

They have $3m+ equity to bring to the table and would take over full operational control of the farm supported by an appropriate governance structure with the current / new owner.

Ideally looking for a 5,000 – 12,000 Stock Unit Sheep/Beef Breeding Unit located in the Otago / South Canterbury regions. 

Do you want to release capital, pay down debt or execute on an expansion opportunity by bringing in an equity manager?

They are open to opportunities that could include the following:

• Partnering with a suitable investor looking for exposure to the Sheep & Beef industry and purchase a new property.
• Partner with an existing farm owner who is now looking to release some capital from their business and hand over the day-to-day operations of the farm to an equity manager.

If you or someone you know is interested in finding out more then please get in touch with me by email ray.fraser@nzab.co.nz or phone me direct on +64 27 243 0025.

 

Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

With the official announcement from the NZ government about launching an inquiry into Rural banking, we believe it’s an opportune time to share NZAB’s thinking on solutions that would increase the availability of competitive capital to farmers.

In our last article, we shared our submission to the Primary Production Select Committee. We were subsequently invited to present directly to the committee in person alongside Federated farmers and Rural Women’s Network.  

In that submission, we outlined the problems we saw and the reasons behind them. We purposely stayed away from offering any solutions as we thought it was best to focus on identifying the issues first.

But now, we thought it worthwhile to share some of our thinking on what would increase both the availability of capital and the competitiveness of it.  

In this article, we will touch on changes to “capital regulations” as one solution, but we will also touch on another five things that need to be focused on at the same time. The current capital restrictions that farmers' face is a problem due to multiple factors, not just the current bank settings.  

Equally, changing capital regulations alone won’t solve farmers access to capital – it's only part of the puzzle. And it’s inherently risky if farmers' only focus on one area (capital regulatory change) and put all their eggs in that basket only to find that the RBNZ is unwilling to change.

 

The prize here is large.

Make no mistake about it - capital restriction due to regulation causes market harm. In the case of Agri, it can lower a farmer’s confidence in investment and even when investment is chosen, it drives up the cost of the capital deployed with it. It also sends the market the wrong signals, leading to asset price suppression, even when the underlying operating performance of the asset class is doing well.

Conversely, as we’ve seen in the home loan sector, it does the opposite – not just funnelling more debt capital into houses, but also investment capital as investors know they’re on a one way bet with rising asset values.

This regulation is creating bubble and bust situations with the classic case being the New Zealand housing market.  

However, get the regulations right and capital will follow the right economics, rewarding those investments that have good economic returns and strong market fundamentals, consistent over a long period of time.

 

Let’s start with a picture.

As always, we want to start with a graph to paint the picture.

The below graph is the year-on-year percentage growth for Agri Loans, versus Home loans, dating back to 2000.

The point of this graph is to remind everyone that it was commonplace for Agri to have equal access (versus other sectors) to credit. Up until 2016, Agri lending growth closely followed the cyclical nature of all lending in New Zealand, but subsequent to that, you can see the clear re-direction of bank lending towards Home Loans.      

 

New Zealand Agri Brokers Limited (NZAB) was recently invited to make a submission to the Primary Production Committee on Rural Lending. This is a New Zealand government select committee chaired by MP Mark Cameron.

The committee opened a briefing (not a full-scale inquiry) into this topic as they had received widespread feedback from farmers and other industry participants about the apparent disparity between rural and urban bank lending practices.  They are initially seeking to gain a better understanding of the nature of the problem before working out any next steps.

NZAB made the following submission and as this is a public process, we thought it would be useful to share our submission with our wider farming and farm professionals’ audience.

If you have any question on any part of our submission, please feel free to contact us.

Information only disclaimer. The information and commentary in this email are provided for general information purposes only. We recommend the recipients seek financial advice about their circumstances from their adviser before making any financial or investment decision or taking any action.

The recent CPI release of 4.0% for the year ended 31 March 2024 was a step in the right direction, falling further again from the December number of 4.7%. It arrived in line with economists’ consensus levels and slightly higher than what the RBNZ thought (3.8%).

But it was still noticeably above the ‘accepted’ 1-3% target range.  

Consequently, the RBNZ let all parties know it, with a brief statement noting that the “OCR needed to remain at restrictive levels for a sustained period”. Also unhelpful was that despite ’tradable inflation’ printing at 1.6% p.a., non-tradable inflation was 5.8% p.a. (more on this at the end of the article) leading most economists to say “we need to be here longer” and pushing out rate cut forecasts further into 2025.

But are we yet again being over obsessed with looking backwards rather than looking at what’s happening right now?

Let us explain. The latest CPI print of 4.0% is made up of 4 quarters - and they look like this:

Quarter ending June 2023:                         1.1%

Quarter ending September 2023:           1.8%

Quarter ending December 2023:             0.5%

Quarter ending March 202424:                0.6%

Total equals                                                           4.0% for the year

 

So, what if we extrapolated forward the last six months of CPI change and annualised this to the rest of the year?

Well, we would get a 2.2% inflation rate, being (0.5%+0.6%) x 2 which is smack bang in the middle of our target range.

The graph below shows it best by plotting the six-month annualised figure against the annual figure since 2017.