With harvest well underway across the state and finished already in some parts, the annual review season is rapidly approaching. This is always an opportune time to assess in a financial sense where things have finished for the current season, but also what do things look like in the year ahead.
The cost of borrowing money will no doubt be an elevated issue for most farmers, particularly in the light of the rapid increase in the RBA cash rate since May 2022. From an unprecedented low of 0.10%, the RBA Cash Rate has gone up by 4.25% in the space of 19 months, to its current level of 4.35%. Not only has the cumulative rise been the most rapid in RBA history, but the pace of the rates rises has also been one of the fastest.
Looking forward, at the time of writing this article, there is a diverse range of views as to what will happen with the RBA Cash Rate. Some banks are anticipating a further rate rise by as early as February 2024, whilst others expect the RBA to remain on hold until late 2024, before a potential rate cutting cycle commences. Naturally, these are only forecasts based on data to hand and an anticipation of what economic and financial influences may be in the future, and these forecasts do change (sometimes quite a lot) as time goes by.
For most, if not all borrowers, this has seen their interest costs more than double over the past 12 months. Add to that varied production results across the WA Agricultural zones, the year ahead may require additional funding for working capital, increasing the financing costs of the business.
In addition to doing your annual review with your Farm Business Consultant, farmers who borrow money will no doubt be having their annual review with the financier. A common question that I’m asked in relation to farm finance is what are good questions to ask the Bank at the review and what things need to be considered in understanding what is an appropriate interest cost.
In terms of your existing borrowing facilities and any increase or new facilities that may be required, it is worth asking a range of questions:
- What types of loans do you offer? You may have had your facilities for a long time, however there may be additional products, changes or features within products that you aren’t aware of, that may suit specific
circumstances. - What are the interest rates for existing and/or new loans? Inquire about the interest rates, whether they are fixed or variable, and how they may be affected by market conditions.
- What if any are the repayment structure and schedule for the loans? Understand the terms of repayment, including the frequency of payments and any flexibility in the schedule to align with the farming season. With regards to fixed rates inquire about the possibility of making early payments on the loan and whether there are any associated penalties.
- What is the loan-to-value ratio for the security that you provide? For real estate loans, understand how much the bank is willing to lend in relation to the appraised value of the agricultural property.
- Is there other collateral (security) outside of the farmland that can be used to support the loan? Find out what other assets, such as plant and equipment, livestock, non-farmland, that can be used as collateral for loans.
- Are there any fees associated with the loan? Inquire about application fees, processing fees, and any other ongoing charges that may be applicable to the loan.
- If you are borrowing new funds or undertaking an increase, how quickly can the loan be processed? Understand the timeline for loan approval and disbursement, especially if the funds are needed for a time-sensitive agricultural activity.
- What insurance requirements are associated with the loan? Understand any insurance obligations, such as insurance on land that is provided as security, crop insurance or liability coverage, that may be required as part of the loan agreement.
- What happens if there are unforeseen circumstances affecting the farm’s profitability? Discuss the bank’s policies regarding loan restructuring, deferment, or other options in case of unexpected financial challenges.
Always carefully review the loan terms and conditions and seek professional advice if needed before committing to any borrowing arrangement.
Managing your overall interest cost on your farming lending can significantly impact your overall cost of borrowing and improve the financial health of your farm. The 3 C’s, of Capacity, Collateral & Character, go a long way to determining what level of risk you and your business presents to the bank. Here are some things to consider that will influence the risk profile and how that may determine what your interest cost may be:
Capacity (or Cashflow serviceability) is a key determinant of risk. Essentially it is a measure of your financial stability and reflects your past history to demonstrate consistent cash flow surpluses and positive financial history. In conjunction with your Accountant and Farm Business Consultant preparing detailed and accurate financial statements for your farm business helps provide a snapshot your financial health. It is also the ability to provide a robust and realistic cashflow forecast for the year ahead, that is supported by current economic conditions/prices and past history (Eg, yield averages). It could be useful asking what key ratios or metrics are important to the bank when they are assessing.
Capacity. Farm Operating Costs to Income, Interest Cover Ratio’s, Debt to Income and Year in Year Out analysis are a few that come to mind. Each bank may have their own level of importance or measurement, so it’s good to know what is important for your lender.
Collateral offers valuable security to support the loan facilities and the higher than value, will lower the risk profile. The Loan-to-Value Ratio is determined by the loan amount against the security provided as collateral. If you can provide assets with significant value, it will strengthen the security position for the bank, lower their risk and may result in a lower overall interest rate. Offering additional collateral such as plant and equipment, and livestock, may also assist with some banks.
Character encompasses several factors, but some key ones include reliability and how you do things (do you do what you say you’re going to do?), the relationship and communication you have with your lender, the timeliness and regularity that you provide up to date financial information, managing your credit responsibly. If you have an existing relationship with a bank, especially one that understands the agricultural sector, leverage that relationship. Banks can provide better terms to established, financially proven customers, but often you may have to be the one to ask. Aside from the 3 C’s above, balance sheet strength will also be a key consideration. This reflects your overall assets & liabilities and will vary from farm to farm depending on who’s involved in the farm business and what non-farm assets are or are not included. Equity is the simple measure of the value after liabilities are subtracted from your assets, and the higher the value the better. In recent times with improving land values, balance sheet strength has risen significantly. It’s important to remember though, that equity helps to mitigate risk, but it doesn’t repay debt (cashflow does), unless you intend to sell assets as part of a debt reduction program.
Remember, securing a better interest rate is often a combination of factors, and it’s essential to tailor your approach based on your specific financial situation and the lender’s policies.
Other things to consider:
Open, regular communication is highly recommended, as it keeps everyone as informed as possible and reduces surprises for both you & the bank. Reach out to your Farm Business Consultant for insight and
support. We’re willing and able to do joint meetings with yourselves and the banker, and it assists in developing the communication mentioned above.
Finally, it’s worth keeping in mind that ‘if you don’t ask you won’t get’! Banks are in the business of delivering profits to shareholders and on loans profits come from the ‘margin’ charged. If you’re the bank employee your job is to generate a decent margin – don’t be offended by this. As the borrower it’s your job to keep them honest with the knowledge that any margin is better than nil margin so within reason the bank will do what it takes to keep your business!
