Squeeze on farm loans bad news for regions

It began in Uruguay. In 1986 that tiny country – one of the few in the world with a population smaller than our own – fired the starting pistol on a series of trade negotiations that would change our country forever. The Uruguay round of international trade talks, which finished in 1996, dramatically liberalised trade in agriculture. It was agreed that tariffs would be reduced by an average of 36 per cent to developed countries and 24 per cent for developing countries.

There was big money to be made overseas and our farmers wanted to be there to make it. They found a friend in New Zealand’s banks, which were more than happy to lend to farmers to help convert sheep and beef farms to dairy.

In June 1992, agricultural lending was growing at an annual rate of 5.2 per cent, less than half the rate of housing and consumer lending, which grew at 13.2 per cent.

By 2002, new rural lending was growing at a rate of 25 per cent a year, far ahead of housing and consumer lending which grew at a third of that rate.

The good times seemed unstoppable. Even during the global financial crisis, when business lending went backwards and mortgage lending grew by just 3 per cent a year, rural lending continued apace, growing by more than 20 per cent a year until 2009, when it started to pull back.

This lending precipitated a wave of expensive dairy conversions. Between 1994 and 2017, dairy cattle numbers increased by 70 per cent nationally, whilst the number of sheep shrank by 44 per cent.

The expansion has been particularly marked in the South Island, where the number of dairy cattle rose from 0.6 million to 2.6m in that time Nearly half of that increase was in Canterbury alone.

But the good times had to end eventually, and end they did. Agricultural lending grew by 2.4 per cent in the year to September, while mortgage and business lending grew by 6.5 and 6 per cent respectively.

The message from the banks is clear: the party is over.

Banks feel they’re overexposed to the rural sector. That, of course, is largely their fault. They lent too much during the boom times.

There’s also a chance the big four banks are listening to their Australian-based parents, which are facing pressures in the rural sector as drought takes its toll on farms. In October, the ABC reported that the Australia Talks National Survey found more than 40 per cent of rural Australians are struggling to pay off debts, with much of the pressure coming from droughts.

The biggest threat to rural lending will finally be revealed in November, as the Reserve Bank outlines the conclusion of its two-year review of how much capital banks should hold. The current proposal is for the minimum level of capital held by the Australian-owned banks to rise 70 per cent.

The banks say it’ll increase their costs dramatically (the Reserve Bank disagrees). The consensus of commentators is that the rural sector will be hit hard by the changes. Rural lending is far less competitive and profitable than housing. If banks have to reduce the ratio of lending to capital, they’re likely to start on the farm.

This is deeply concerning. Farms are not up to their eyeballs in debt like they were a few years ago, but many farmers struggle to secure new loans at a time when they’re being asked to make big changes. The Government’s emissions pricing and Essential Freshwater packages will require farmers to wear some costs, which are significant, whilst not being punitive. Environment Minister David Parker was the founding CEO of A2 milk – his overriding ambition is to drag the sector up the value chain, not to shut it down.

Calculations released by the Ministry for the Environment estimates a sample lowland dairy farm would have to absorb an extra $93,500 of costs over the next 10 years to meet the freshwater requirements. That’s equivalent to 0.8 per cent of that farm’s revenue each year. It’s about 3 per cent of revenue for a hill country sheep and beef farm.

The problem, of course, is that much of this investment needs to happen upfront, which is difficult to do at a time of little rural lending – and that’s about to get worse.

A solution could be lurking across the ditch in New South Wales. The A$1 billion farm innovation fund offers individual loans of up to A$1m at an interest rate of 2.5 per cent to farmers to improve infrastructure on properties and better prepare themselves for future droughts. There’s nothing to stop a future Provincial Growth Fund from issuing similar loans, to help farms adapt.

There could be positives to come from this, if the changes force an end to a long period of farmers essentially farming for capital gains. It’s no secret that farmers’ profits ebb and flow significantly from year to year, with the real rewards coming when the farm is eventually sold.

Banks feel they’re overexposed to the rural sector. That, of course, is largely their fault. They lent too much during the boom times.