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Chris Laming


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Banking is trending towards deals that only fit in boxes. But when has an Agri finance arrangement ever fit into a box?

Oct 19, 2020 9:28:44 AM / by Chris Laming posted in Debt, Action, Planning, Budget, Banking, Strategy

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Chris Laming, Client Director, NZAB

 

A new “Great Rate”

 

This week, Heartland Bank rocked the market with a new Headline residential mortgage rate of 1.99% for 1 year. This is the first time we have seen a mortgage rate at sub 2%. The market has been clearly signaling a coming drop in the OCR, leading to lower wholesale interest rates to banks. Rates dipping below 2% won’t come as a surprise. Although most of the market were picking that we wouldn’t see it there until early next year.

The interesting part is the criteria attached to Heartland’s offering to qualify for this market leading rate. I think it signals exactly where the banking market wants to go in the coming the years. The deal is simple:

  • Apply and approval online
  • Minimum of 20% deposit
  • Living in the property
  • Wage earner
  • House located in a major centre
  • Standalone, single house
  • Owned personally or joint personally (no trusts or companies)

The deal is simple, fits into a straightforward box, and means the deal origination and approval process can be easily automated.

 

Why can this bank offer this low rate?

 

Ultimately its due a lower cost of the delivery of lending.

The origination and approval process is completed online, and therefore a banker is not required to assess the deal. There is no branch required to house the staff and the customer. There are no additional securities like personal guarantees, and there are no trustees to deal with. The house is located in a main centre which presumably means it’s easier to liquidate if need-be.

Furthermore the lower RBNZ capital requirements already motivate banks towards home lending.

Very simple. Very fast. Very cheap.

The process looks great to the bank’s leaders too, and you can just imagine the conversation “So we can originate deals faster, cheaper, from anywhere, and we can use a smaller labour pool to do it?” It’s a no brainer.

Sounds Great! Surely this must now start having a positive impact on other loans made by the bank?

Wrong!

 

This is going to drive some unintended consequences

This process is driven by the bank’s desire to increase market share in housing, with cost at a minimum, and deliver that strategy through a market leading rate.

This is the start. Simple and easy to manage customers is what they want, and the concept will be adopted by all the major banks.

So what if you live in regional New Zealand?

So what happens if the customer has received legal advice to put the family home in a trust? What happens if the customer is a self employed plumber? What happens if the customer’s situation is slightly more complex than the above?

If you’re outside of the box, you’ll have to pay for that.

 

Implications for the Agri Debt Market

 

NZAB focuses on Agri debt and the best way to obtain and manage it on the best possible terms and interest rate, to suit the customer-led strategy. Agri debt is what we live and breathe, so our major concern is the implications on the Agri debt market.

The Agri debt market is trending the same way as the housing market above. Banks want simpler businesses that fit into boxes. This means lending decisions can be automated and costs less to deliver, and ultimately, if it doesn’t fit, it doesn’t fit. The theory is bankers will be able to service larger numbers of customers. Bringing down the cost of lending.

The problem is, I cannot remember the last time I came across a “Vanilla” farming business. Every single farming business is unique, with its own strengths and its own weaknesses.

 

And furthermore, businesses are only getting more and more complex

 

So the very real implication is this:

If you don’t present your business or your request in a way that the bank understands, its going to be more expensive (at best) or declined (at worst).

Alignment of what a bank is looking for in a credit submission is critical here, and the ultimately the onus will fall on the farmer to make sure the bank understands the transaction or request.  

And guess what; asking for credit is not a process you get a second chance on if you get it wrong. There are real people that sit in credit, they form opinion on what they see first and changing that a second time around can be difficult.

 

Too often we see that process happen badly.

 

In previous articles from NZAB (Click here for further insights), we have talked about credit requests being not just about a budget and some financials.  Its much wider than that and is evolving continually from the banks as they assess the risk of your business in line with changing perceptions.  

One such example amongst many factors, is the accurate assessment of ESG (environmental, social, governance) considerations in each business.  

 

Don’t leave this process to chance, you’ve got too much riding on it.

 

It might mean the difference between acquiring that next farm or not, facing principal repayments that you might struggle to meet, or an increase in interest rate when it should be going down.

Get it right and you'll get your money, get great terms and see your interest rate at near home loan rate levels.

 

Talk to one of our experts today to find out more.

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So you want a better interest rate?

Sep 18, 2020 2:33:01 PM / by Chris Laming posted in Debt, Action, Planning, Budget, Banking, Strategy

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Chris Laming, Client Director, NZAB

Fair enough, interest is your biggest cost and you know there is a wide range of interest rates out there. There is nothing wrong with asking for better terms from any of your suppliers.

 

You’ve been to the bank and asked the question, can I get a better rate? Am I on the best possible interest rate? Can you sharpen the pencil?

 

The issue with these questions is that they require a yes or no answer. Obviously, you would like a yes, but in the current agri debt market, with a lack of liquidity, there is greater power with the bank. That means the default answer is likely to be a no.

 

Chances are, your banker has said something like: “you are on the best rate we can give you…” “you’re on a pretty good rate now…” “we need to hold more capital against your loan…” “we need to ensure we are getting an adequate return on your loan…” or my personal favourite “well, actually we need to talk about your margin going up…”

 

A bank is a commercial entity, just like yours. It is in its best interests to maximise profit.

 

Banks make money against the capital held against the loans they make. Holding capital against a loan is a cost to the bank. The theoretical cost of that capital is something you have no control over. You do, however, have some control over the amount of capital a bank will hold against your loan.

 

When you have an interest rate discussion with your bank, what are you offering in return?

 

There are ways you can improve the risk profile of your business, and therefore lessen the amount of capital, reducing the bank’s cost of lending to you.

 

Risk pricing is not new and has been prevalent in the agri debt market since the GFC. There are three key aspects to how a bank assesses the risk in your business.

  1. Viability (Probably of Default). This is based on the historical performance and the outlook for the business. This is also influenced by your equity within the business and your ability to raise external capital to meet obligations.
  2. Security (Loss given Default). This is based on the security offered to the bank, and what type of security it is. i.e. A Loan to Value ratio (LVR) of 40% is much more attractive to a bank than an LVR of 60%. In addition, land is more valuable (or less risky) for security than livestock.
  3. You (Personal Factor). Banks are now more than ever making both subjective and objective judgments on you and your ability to manage your business through the ups and downs.

These are the types of questions banks are asking themselves about you and your business…

 

What is the track record of the business? How experienced are the key principals? How well you can articulate your business, what are the strengths and how well do you mitigate any weaknesses? How can you explain your financial performance and how does that link into the outlook for your business? How well do you do typically perform vs budget? What changes have you made in the business to make it more resilient? Do you have a strategy that the bank can understand? How have you performed in a down durn? How did you fund losses? What independent advice do you have for the governance or leadership in your business?

 

If you do not answer these questions, the bank will answer them for you…

 

So, what are you doing to present your business to the bank?

 

Every interaction with the bank is an opportunity to articulate the strength of your business. Tell your bank you want 6 monthly reviews. Align them with key dates in your farming and financial year. They will already be reviewing your business at least annually, so why not take control of that?

 

We typically aim for an annual review with the bank around a month either side of balance date. The topics discussed are along the lines of:

  1. Presentation of Interim Financial Results for the Season vs budget. What went well, what are the work-ons.
  2. Presentation of the Strategy for the season ahead, what are the key focuses for the season, which have been driven from the FY20 results.
  3. Budget for the season ahead, funding requirements and debt repayment goals and any major capital projects for the year ahead
  4. Rollover/Extension of any term lending expiring

Around 4-6 months into the financial year is a good time to have an interim review. That will focus on:

  1. Delivery of the financial statements, which really is a confirmation of the numbers already presented at annual review
  2. Update on any strategy changes in the year as per previous
  3. Any changes to the forecast for the season due to prices, climatic etc

Covenant Reporting

 

Throughout the rest of the year, typically on a monthly or bi-monthly basis, we present variance reporting to the bank which covers off actual results vs budgets.

 

It is common now in Agri Lending to have covenants in place. It is very important to understand covenants on your lending, and the potential consequences of breach of those covenants.

 

Covenant reporting is another opportunity to showcase the strength of your business. Report to the bank need, but take the time to understand and explain any variances.

 

With positive variances, link it to management decisions if that’s how it resulted, and explain how it might improve the budgeted financial position throughout the year. With negative variances, understand and articulate the implications on working capital position or key strategic goals. Discuss what management decisions have been made to mitigate any impact.

 

This will help improve the risk profile of your business as it strongly links to the Personal Factor assessment – your ability to understand and manage the risks within your business.

 

Interest Rate Review

 

Influencing how the bank sees the key management and leadership of your business is the best way to influence funding costs. By providing high-quality reporting to the bank that clearly articulates where the business is going, how it is performing vs budget, why management decisions were made and the progression towards strategic goals is the best way to improve the bank’s view of the business.

 

Let’s be honest, Banks are still banks. Passing on savings from your improved credit rating is still a commercial decision the bank needs to make. When having an interest rate discussion with your bank, spend time setting expectations which link specific credit outcomes and milestones to interest rate savings. I.e. If I achieve x, what will that do to my interest rate?

 

Competition

 

The agri debt market is imperfect and there is clearly a difference in approach depending on whether your business has the ability to refinance or not. Our preference is always to derive gains by improving the relationship your business has with your current bank, because when times are tough these relationships matter. 

 

That is not always possible, so you need to understand different bank credit criteria and how your business aligns with those parameters. Then you will understand what funding options you have available to you, which can balance the power gradient in the relationship. Healthy competition between banks is a good thing and it leads to better outcomes.

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