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.

The Submission:

From: New Zealand Agri Brokers Limited (NZAB)

Request: We request the opportunity to present to the committee in person to articulate these issues in more depth.

Overarching Theme

The agriculture sector will need increasing capital investment in the coming 10 to 15 years in order to ensure that we:

• maintain our competitive advantage internationally,
• meet our environmental obligations, and
• enable the transition (sale) of farms between generations.

But along side this we have a heavily regulated banking sector that is resulting in:

• Higher interest rates charged to farmers to derive better capital ratios
• Reducing head count of bank staff
• Reduction in risk appetite for Agricultural loans

The net result for farmers is less competition, higher interest rates, decreasing viability, and an inability to access the right long-term capital for their business.

We see the potential for a significant ‘funding gap’ opening up over the coming years where farmers are unable to access the capital needed to meet these future needs.

NZAB is uniquely qualified to comment on the issues being considered by this committee.

• New Zealand Agri Brokers Limited (NZAB) is an established farm financial and debt advisory business which currently manages the ongoing access to and structure of approximately $3bn of Agricultural Debt. We are the largest independent, specialist Agri Debt advisory firm in New Zealand
• NZAB was founded by three experienced Rural Banking professionals. This paper has been prepared by two of the founders:
  • Scott Wishart was the National Manager / Sector Partner for BNZ Agribusiness for 5 years prior to co-founding NZAB, with direct responsibility for or involvement in the setting and executing of Bank Agri Strategy, loan pricing, credit metrics and regulatory reports.
  • Andrew Laming was a senior Agri Corporate banker prior to co founding NZAB and now heads up NZAB’s Capital division.   He sits as Advisory Board Chair or Member on several of NZ largest farming and processing businesses as well as being a qualified mediator.  
• NZAB has significant experience in navigating the practical implications of how banks provision capital, manage credit risk, and treat borrowers through various parts of the debt cycle.
• We have considerable first-hand experience at navigating the consequences and impacts on farmers of the various issues that we raise in this submission (both from a bank and farmer perspective)

Statement 1: Higher interest rates driven by RBNZ regulation may result in a stronger banking sector but with less competition which will result in decreasing viability for farmers, and less ability for them to absorb economic downturns or invest in future growth. 

• RBNZ requirements for main banks to hold more capital on rural loans to protect the banking sector in the event of wide scale defaults has come at a very real cost to the farmer. These requirements to hold significantly more capital against rural loans was established post GFC in 2011 but were not fully embedded (and effects felt) by the main trading banks until after the dairy downturn in 2015 and 2016 and subsequent RBNZ focus on dairy risk.

• The RBNZ approach is based on their premise that Rural lending risk is significantly higher than home lending risk and therefore to ensure the NZ banking system is resilient towards sector volatility, a bank needs to “buffer” these loans with more of its own capital. The theory being, in the event of a broad sector downturn which leads to loan losses, the banking system would remain functional by virtue of covering any losses that result.
• Broadly speaking, when a NZ registered bank lends to a farming business, it is required to hold at least twice as much of its own capital (tier 1 capital) against that particular loan, than it does for a corresponding home loan.  
• Banks are a return focused business, with a strong interest in overall earnings, and with return on equity (tier 1 capital). Bank equity is not infinite, so at treasury levels, decisions are made about where “bank capital is placed” to get the best possible return on its equity.
• Fundamentally, this means that an agri loan needs to earn at least double the margin of a home loan to achieve the same level of return on equity. In effect, it simply means the banks passing on the increased costs of this capital to the farmer by way of increased interest rates.
• This increased pricing is now also embedded in the origination standards for lending, and this has decreased the viability of the underlying borrowers as a result.
• Perversely, the increased cost of borrowing that rural borrowers face under the RBNZ regulations to reflect the increased theoretical risk, now means that farm lenders are paying more for their lending, increasing the likelihood of default given impacts on viability. This situation is magnified during cyclical (and regularly expected) commodity downturns (*see point further below on this).

Statement 2: Lending to farmers is now less attractive to Banks when compared to Housing Loans. This is impacting on the Bank’s desire to compete for new lending, resulting in less debt capital available to the sector. 

• By their nature, Rural (and business in general) loans are more difficult to originate and monitor than a typical home loan.   They require assessment and monitoring of business performance, markets, farm resources, farm regulation and governance quality.   The “costs to serve” are higher than those faced by banks in the home loan sector.
• Coupled with the need to achieve higher margins (which in turn impacts negatively on bank viability assessments for lending), this has meant that banks have slowly yet materially moved away from Rural lending as a % of their total lending. This effect is also noticed with business lending. Collectively, it means that significantly more lending is going to the home loan sectors and not to the productive sectors.
• See graph below. From 2011, when the new RBNZ capital regulations were enacted, a steady and sustained shift by the NZ registered banks away from rural and business lending is easily observed, to the benefit of new home lending.

• This reduction in availability of rural lending is despite the rural sector maintaining its relative contribution to GDP over the same period
• This is despite actual Bank losses* in the Rural sector to be relatively low       
  (* whilst Agri “non-performing loans” are published regularly, actual bank write offs are not, so this comment is based on our observations across the sector).

Statement 3: Banks now compete intensely for loans that require less capital, and the costs of this competition are borne by the borrowers who now find themselves out of favour.

• The requirement for additional capital has led to decreases in competition for loans that would otherwise be viable, which in turn has led to increased pricing on those loans.
• Where rural loans meet long term bank stress testing criteria (in other words, “viable”), good competition between the banks is observed (where a farmer chooses to interact in a market based approach for their loan), often resulting in better margins, below normal bank “return on equity hurdles”
• However the decrease in risk appetite has seen a material increase in farmers who are ”stranded” with their current  bank (unable to be refinanced to another bank due to long term stress testing metrics not being met)  and therefore unable to negotiate more favourable terms, conditions and price.    
• Perversely, this often means these particular loans are “priced to the risk curve*” resulting in materially higher margins, exacerbating their deteriorating economic position.   (* Each agri loan is “risk rated”. The higher the perceived risk, the higher the level of “theoretical capital” that needs to be allocated to that particular loan, requiring a higher margin to meet bank return on equity hurdles.   Given these loans are “stranded”, a single bank has an effectively monopoly on this type of loan)

Statement 4: RBNZ requirements to increase the capital held on rural loans has had negative impacts on new entrants to the sector, restricting viable pathways for increased competition, which would mitigate some of the issues we see. 

• Main banks that aren’t currently in the agri sector, such as Kiwibank, have little incentive to grow into this sector given high capital hurdles to entrance.
• Whilst there has been a steady increase in new participants in the home loan sector by regulated non bank deposit takers and non-deposit taking lenders, the same has not occurred for Agriculture.
• We understand* that the capital ratio requirements for non-main bank deposit taking lenders when lending to Rural are at significantly higher levels than main bank levels and versus home lending. This provides little incentive for these institutions to consider lending to farmers (*We recommend the PPC seek further clarification on this point).
  
  

Supporting Information

• Our Website - https://nzab.co.nz/
• Our Articles on Banking and Farming - https://blog.nzab.co.nz/. Relevant articles:
  • https://blog.nzab.co.nz/you-are-paying-too-much-interest.-who-is-to-blame
  • https://blog.nzab.co.nz/with-bank-profits-falling-be-very-wary-of-the-2024-response
  • https://blog.nzab.co.nz/why-doesnt-kiwibank-lend-to-nz-farmers
  • https://blog.nzab.co.nz/a-further-look-at-agri-interest-rate-margins

Who is NZAB?