Wednesday, December 6, 2023

Farm borrowers will find lenders

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This week the Reserve Bank will finally announce the outcome of its review of minimum capital requirements for trading banks. Nigel Stirling asks who will fill the gap in the rural lending market if the banks carry out their threats to pull the rug from under farm borrowers.
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FEAR and loathing have been in the air since a proposal for the trading banks to find up to $20 billion in new capital was floated a year ago.

The Reserve Bank claims doubling existing capital reserves is needed if the banks are to survive a 1-in-200 economic meltdown and not leave taxpayers with an almighty mess to clean up.

But the banks remain adamant the proposal is nothing short of economic sabotage.

A report commissioned by the New Zealand Bankers Association forecast a $2.7b annual cost to the economy from higher interest rates and lower investment if the blueprint for new capital is adopted.

And the costs will be disproportionately felt by small businesses and rural borrowers.

Banks say they already have to set aside more capital to match the higher risk of those loans compared to mortgages on houses.

Westpac chief executive David McLean in April warned lending rates will need to rise by 120 basis points to maintain the bank’s return on its farm loans and not be forced to redirect lending to lower risks.

Federated Farmers estimates, replicated across the industry, that could cost farmers $800m a year in higher interest payments.

But Reserve Bank governor Adrian Orr has dismissed the estimates.

Orr says they are overblown and a fig leaf for banks suddenly aware they are exposed to too much rural debt.

He has repeatedly told farmers already under pressure from lenders to shop around for better deals.

But what choices will farmers be left with if the banks dramatically scale back their $63b exposure to agricultural borrowers?

The alarm bells were set off in September when ANZ confirmed it had been approached by foreign hedge funds interested in buying farm loans.

Westpac treasurer Jim Reardon said it is hard to see how such a sale could benefit either farmers or the banks. Without a network of rural bankers the funds would struggle to manage the loans.

“Vulture funds just do not have those people to bring any sort of value-added judgement to the loans they are taking on.”

Reardon believes the funds would have looked for a quick exit and possible fire sales if the market turned down.  

“I would have not thought that was the outcome the banks would have wanted if they just wanted to get rid of a few loans they no longer see as desirable and still want to preserve the rest of their portfolio.”

ANZ said it didn’t take the talks further and is committed to remaining the country’s largest rural lender.

Despite that commitment its head of commercial and agri lending Mark Hiddleston had already warned farmers in April that change is coming.

“We think it is prudent to help you plan to reduce your debt as much as you can, restructure your facility limits or pay down where you may have credit funds elsewhere.

“You should also think carefully about your borrowing requirements in the near future, including factoring in potential increases in borrowing costs.”

Unfortunately, for ANZ’s indebted farmer clients, the big banks are all in the same boat when it comes to having to dig deep for new equity.

That was made worse in August when Australia’s prudential regulator cut in half the amount of capital they can allocate to foreign subsidiaries.

It is hard to see any of the Aussie-owned banks increasing farm lending if it means having to fork out even more capital to do so.

But what about second-tier banks and provincial stalwarts such as TSB, SBS and Heartland Bank?

Could they be the salvation for farmers no longer wanted by the big Aussie banks?

With its existing network of provincial branches and rural managers Heartland ticks a couple of boxes.

Its capacity to fund an expansion of its rural lending business big enough to make up for any significant credit squeeze is another question, however.

Heartland’s total assets of $4.13b pale into comparison to the ANZ’s nearly $18b in farm loan assets (see panel).

Even 10% of those loans would seriously stretch Heartland’s balance sheet without a major slug of new capital from shareholders.

TSB, with $7.9b total assets, and SBS, $4.8b, are larger in size but are owned by a community trust and their customers respectively and severely limited in their ability to raise capital for major acquisitions.

Not lacking in access to capital however is the NZ arm of Dutch agribusiness giant Rabobank.

In June chief executive Todd Charteris said the bank’s NZ board was in talks to tap into its parent’s €590b balance sheet as it sized up opportunities to increase its 17% share of the market.

But it is not prepared to do so by lumbering itself with its rivals’ dud loans.

It has picked up some customers but there has been no discussion about acquiring portfolios of loans.

“This is an important market for us and if there is an opportunity to grow organically through other farmers wanting to come and bank with us we will look at all opportunities but it is not acquisition.

“It is really about balancing our priorities to our existing customers and supporting them,” Charteris said.

As well as the big four Australians and Rabobank there are 11 other foreign banks registered in NZ.

High-profile fund manager Sam Stubbs expects more to arrive in the next six to 12 months.

He says the 13-16% return on equity earned on average by NZ banks is extremely high by global standards.

Even if those returns are dented slightly because of higher capital requirements they remain extremely attractive.

“We know that at 11% return on equity the foreign banks, most notably HSBC and Bank of America, are moving capacity into the Australian market.

“So, if they can get 13% in NZ then it is not too short a hop across the Tasman.”

And though returns from farm lending are lower Stubbs expects them to still to be too good for the global heavyweights to pass up if they can get their hands on large enough parcels of existing loans.

“If you have interest rates tracking at 1% or 1.5% and a return on equity of 8% or 9% on a rural lending book then I promise you money is going to find it.

“It is too lucrative for them to ignore.”

Stubbs sees another home for the loans if the banks don’t want them.

There will be a ready market among Kiwisaver funds for farm debt packaged up as securities. That would be achieved by a bank pooling its loans and repackaging them into bonds.

Each bond would be backed by a mix of high and lower-risk debt and would have the added attraction of being able to be traded but still have the underlying loan managed by the originating bank.

“If it’s a large enough book and diversified enough it would probably be enough to be investment grade credit rated.

“It would fly out the door.”

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