Andrew Laming, Director, NZAB

By now you will have probably heard about the RBNZ’s “funding for lending programme” (“FLP”).   Put simply, this is a mechanism the RBNZ is going to use to allow the banks to borrow new (freshly minted) money directly off the RBNZ at whatever the OCR is at the time.    At time of writing this is currently being forecast to drop to as low as -0.5%.

 

The reason RBNZ wants to do this is to stimulate growth in the economy with lower rates.  

 

At present our Reserve Bank Governor cannot guarantee that low OCR levels will be effectively "passed on" with current RBNZ tools.

These days the OCR rate is not linked to the cost of bank funding as it depends on where the market for customer deposits is at.  Which have of late been much higher than the OCR– driven by the laws of supply and demand and the regulations that require banks to seek most of their funding from NZ customer deposits or longer dated offshore lending.  

So a currently low OCR does not equal a banks own funding costs.   Which means it does not equal low cost lending (well, not “low enough”). The FLP is designed to get cheaper funding directly into the market, which by default should lower all forms of funding for the banks.

 

So in short, Mr Orr wants cheap money out in the NZ economy to get things humming again.   Sounds great right?

Well, that depends on where it goes.

So far, the RBNZ has been deliberately non-descriptive about where banks have to place that $50bn .   FLP programmes around the world are not uncommon and learning has shown that the less rules placed on the banks for the “direction of funds”, the more likely that bank’s will use it ( a recent example of this going wrong was the govt guarantee scheme for bank funding -too many initial rules meant very little was leant out initially ).

The FLP may include incentives to encourage banks to use the funds to expand new lending. In other countries, banks have been given a more favourable interest rate or higher funding caps if new lending growth expands. However, the risk of the RBNZ being too prescriptive is that Banks see too much red-tape or complexity making access to the new funding too onerous.

 

In order to predict where funds might flow, let’s step back and consider all the current elements of our banking system in NZ.

1. We have central bank rules that mean home lending is much more profitable for banks than Agri or commercial loans (Banks have to put far less capital against a home loan = much better return on this investment)
2. We have banks that are looking to lower overall costs, in particular the cost of their processing.   More, simple deals, more deals that fit into a box, less analysis of complex P&L statements all mean lower cost AI type lending decisioning.
3. We have banks that are commercially owned. Naturally they want to maximise profit and return to shareholders.

 

So put these elements together with $50bn of newly minted low cost funding thrown into the mix?   I think we can already see that the vast majority of the new funding will be going directly to new house loans.

We’re already seeing this happening in the market, before this scheme has even started.   We can see it in the streets and in the news.   Lines of people at open homes, frequent outlandish examples of auction prices going for above CV and a real air of FOMO with buying houses again.

It's self-perpetuating- more lending to a sector in itself makes the initial lending less risky for the bank.   Chuck more capital liquidity at a market and asset prices will rise.     NZ housing has benefitted significantly from this over a very long time - no different to what Farmland values did when we had double digit increases in farm debt over 2000-2014 (with a break in between for the GFC).

Don’t get me wrong, higher house prices will stimulate the economy.   Higher house prices will make everyone feel better again, spend money, keep jobs. It’ll encourage the construction sector plus all those allied to it. Also, many businesses borrow against their homes as a cheap source of funding.  

 

But can’t we do a little better than this?

Come back to Agri.   This is a sector that is currently experiencing near record profits. Farm cash yields are now averaging 6-8%, way above their long-term trends and way above alternative investments.     Its exporting real stuff.   Stuff that other countries buy and give us money for.   Export receipts. Absolute gold in a world with significant domestic consumption risks and where our key tourism sector looks like it will be in the doldrums for some time to come.

But guess what – Asset prices in Agri have fallen.   And guess why?   In large part due to reticence from Banks to provide more capital to the sector, due to banking regulations that have been inadvertently set up to discourage lending to the sector because of a perception of higher long term risk.  

And just like the housing market, this becomes self-fulfilling, but in a negative way. Less capital to the sector = lower asset prices.

 

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.

Andrew Laming, Director, NZAB

Last week I was fortunate enough to have a week off with the family and we thought we’d do our bit for the South Island tourism sector. Although this meant a different thing to our three girls who thought that retail therapy was their part in the revival!

We went to Queenstown for a few nights before hopping over to Doubtful Sound for an overnight trip and then onto Milford sound for a similar experience.   Queenstown was nicely busy (without being frantic) and the tills and restaurants were ringing.  

However it was a much different experience in Te Anau and Fiordland where the customer numbers were clearly a shadow of their former selves.   Whilst it was nice to have more space, it did fell a bit eerie at times.   If you get a chance, get out and spread the business around NZ, you will not be disappointed!

 

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.

Tom Laming, Client  Director, NZAB

If you are anything like most businesses – farming or otherwise – you will be hearing the word “strategy” a lot at the moment. Your Bank is probably looking for one, you might need one for your fertiliser company or to meet regulatory requirements, or you might just be wrestling with how to develop a strategy for your own family and business.

Whatever the circumstances, you may well be asking “where do I start?” What exactly is a strategy, what is the process to develop one and what should it look like once I’m done? And most importantly, why will a strategy benefit my business? Why should I get excited about the process?

 

From the biggest corporate on down, businesses through the generations have attempted to develop strategies that clearly capture the needs and aspirations of all key stakeholders – from the biggest shareholder to the family who own and operate the business.

 

Some become clearly defined. I have recently finished a book by Bob Iger, the current CEO of Disney. For context, Disney had revenue of nearly USD70 billion in 2019! His strategy for the business however was simple and was captured in only three key focuses – to increase the amount of branded content the company created, embrace and advance technology, and be a truly global player. Under his leadership Disney has doubled it’s revenue, and cemented a dominant position in the media landscape.

Andrew Laming, Director, NZAB

 

There’s no debating farmers are a vital part of the economic recovery journey for New Zealand, so it’s time they get the lowered interest rates they deserve.

Firstly, a bit of background.

The Reserve Bank of New Zealand (RBNZ) regulations stipulate that banks have to hold significantly more of their own capital in a farm loan than they do in a home loan. They put this differentiator in place after the significant run up in Agri debt prior to the Global Financial Crises (GFC) - as this, combined with the subsequent retraction in commodity prices, caused a near meltdown of the system.

Rightfully so, they wanted to prevent this from happening again.   However, in hindsight, things never really panned out to be as bad as what they thought; whilst non-performing loans ran very high post GFC – they have improved considerably to where they sit today. Banks also didn’t experience the losses they all thought they might.  

Sure, things aren’t perfect out there, but the risk that each bank was facing back in GFC times, versus in real time today is considerably different.  

This graph below is a good illustration of the relative change in risk for the Agri lending sector over this period.

 

Scott Wishart, Managing Director, NZAB

I came across this the other day:

“A company pursuing only profit but not considering the impact of its profit seeking upon customer satisfaction, trust or long-term resilience, could do very well in the short term, but its long term future may be perilous. There is a parallel in the behaviour of bees, which do not make the most of the system they have evolved to collect nectar and pollen. Although they have an efficient way of communicating about the direction of reliable food sources, the waggle dance, a significant proportion of the hive seems to ignore it altogether and journeys off at random. In the short term, the hive would be better off all bees slavishly followed the waggle dance, and for a time this random behaviour baffled scientists, who wondered why 20 million years of bee evolution had not enforced a greater level of behavioural compliance

“Change is the law of life. And those who look only to the past or present are certain to miss the future.”

Even in this ever evolving environment, there is still great opportunity to achieve growth in your agricultural businesses. You just need the right game plan.

The RBNZ has just updated their Bank dashboard data for the quarter ended 31 March 2020.  It’s a chance for us to dive into the numbers and see what’s going on.   Remember, a bank’s appetite can be driven by these numbers (both proactively and re-actively – i.e what they are doing now and what they intend to do) so that’s why we’re across them.