Rural debt is a complicated animal. To plan for the coming twelve months we have completed as many as 4 cash flow budgets, all based upon weather assumptions (wide spread rain, no rain, successful crop, no crop) as all these factors affect our business and all in varying degrees (and no I have not doubled up, each has a separate impact on our business).
By this example I am trying to show that every rural debt owed by a farmer is an individual one, as different as the farming operations responsible for service the debts. Many factors will affect different farm businesses, like the following examples:
1. The Interest Only demon – when people speak of servicing a rural debt, they could be speaking of meeting their interest repayments rather than actually repaying principle on the debt (remember this is not in all cases though). As overdraft limits are exceeded through servicing the interest on the interest only debts (generally Commercial Bill Facilities or Fixed Rate Interest Only or Term Loans), a new higher limit is put in place, using up equity in the mortgaged assets. There is a very high portion of rural debt which would be of the interest only persuasion, and this has not accumulated in the last two years, but over many years and can present a huge problem when it comes to succession planning.
2. Loss of equity – The market value for rural properties over the past decade had been steadily increasing in most areas, yet absurdly the earning ability of the rural properties in most case was not rising at all. So for little or no output farmers were handed an equity windfall that some chose to borrow against. In recent times much of the value of these rises has been trimmed off the value of rural properties leaving debts that exceed the bank value of the property, effectively reducing the security categorisation to partially secured and some institutions have seen the need to call in the loans.
3. Lack of understanding of terms of the lending documents – While we all understand that if we borrow money, we must repay the money plus interest, the conditions attached to mortgage documents, loan contracts and the like are extensive and difficult to understand. Legal protection is offered for those acting as Guarantors as they must seek independent legal advice with most lenders to have the documents fully explained. Perhaps seeking independent legal advice (despite the additional cost) is something more people should do, especially when you consider the amount of money involved with many rural debts.
4. Not enough equity to begin with – Entry into a rural industry is very hard, and can mostly be attributed to the high cost of land. Rural land prices have presented a huge barrier to new entrants to the industry, especially because the value of the land is often not reflected in the earning capacity of the land or the return on Investment. As a result some are highly geared to begin with, allowing little margin for a downturn in their income stream when confronted by poor seasons, a raging drought and/or falling commodity prices. This can also apply to those children of retiring farmers who inherit a large debt along with a farm.
5. A Bad Bank Manager – perhaps he (or she) is the manager who strives to achieve their end of year bonus through growing their lending portfolio and as a result does not investigate the repayment or serviceability capacity of the farm business properly while encouraging the uptake of loans. Perhaps they are simply not skilled enough in being able to manage clients and understand the individual needs or business capabilities. Either way a bad bank manager can be the ruin of any business (not just rural ones), and they can also have long term effects as a farm tries to trade its way out of a poor position (before you add in a drought or poor seasons and commodity prices), even if the next bank manager is one of the best.
6. The personality of the borrower – We of course have our risk takers and our ultra conservative farmers, some who take a gamble on a business decision for their farm which may not pay off. Surprisingly enough though the ultra conservative farmer can also find himself in difficulty when tough times strike, as he did not undertake something he considered too risky but which could have put him in a better position.
7. Previous Banking Practices – during the 80’s and into the 90’s banking practices were very different to what we have today, but for many of our aging farmers that is when the debts were originally taken out and they are still service a debt that would not have been encouraged in today’s financial industry, and which has resulted in making the tough times tougher.
8. Taxation – now this is a contentious issue……..tax breaks for farmers. So I do hope I do a little justice to my explanation as I see it. During the good seasons and when commodity prices are strong, may a farmer has been encouraged to invest in unscheduled repairs and maintenance, purchase new machinery and other various methods to reduce the amount of tax they pay (which can be a lot). There is also a Farm Management Deposit Scheme which allows some money to be locked away in a fixed deposit for a minimum of 12 months and a maximum of 5 years (also the total amount is capped), effectively moving that amount of income out of the taxable year and allowing the farmer to draw on the funds in a time when income will be reduced (usually due to poor seasons). Rarely are farmers encouraged to repay debt as it is not a “tax effective” strategy. There are few other industries that have set historical costs like farming with a volatile income stream that depends on so many factors outside of the farmers control like the weather (drought, flood, no rain when needed for crops or rain when trying to harvest), commodity prices, the value of the Australian dollar, and government policy. A crystal ball can only see so far and the Live Export Ban was an example of a totally unforseen event that is still having ramifications for some. The worst outcome is that all the outside factors present at the one time. If we wan our farmers to fund themselves during extended droughts we need to provide the incentive through tax breaks in good times. If they are encouraged to pay down their debts in good times they will support themselves during the bad.
These are just a few examples of issues that can determine in part the fortunes of rural borrowers.
I do believe there are some serious issues raising their heads now that can be addressed to make small improvements for struggling farmers, especially those facing the prospect of foreclosure. I wish I had solutions to the larger issues for the here and now, but I can only offer some small suggestions that would be of assistance in the future.
Changes to the FMD (Farm Management Deposit) scheme
When funds are placed into an FMD, they attract a reasonable deposit interest rate, but difference between the interest being accrued on lending facilities and that earnt on an FMD is much greater, easily up to 5% or more. I suggest that the FMD scheme be expanded to include an offset arrangement against a nominated lending facility. And no this does not already exist as suggested to me in the past by a politician. There are no offset arrangements that can be utilised as a taxation minimisation strategy during good times to allow for the retention of funds for the tough times.
Review of rural lending practices of the Banks
Once when I worked in a bank as an Agribusiness Analyst and there was a tough drought underway, that bank quietly decreed that there were to be no foreclosures and that managers were to do their best to facilitate the refinance of clients and to help others weather the drought providing ongoing support in the increase of overdraft limits (to avoid default interest rates). It was a win for both the bank and the borrower as there were no foreclosures and no farms being sold bereft of grass and water, for below market value. I am glad to hear that this policy still remains in place today. This is where I do struggle to understand the current round of foreclosures. Surely the properties are being sold during this widespread drought for below market value and therefore is there not a good chance that the debts owed would not be covered by the sale proceeds? I cannot understand how it could be considered good lending practice and I suggest that the government does need to create a policy for the banks around Natural Disasters (both drought, floods and cyclones) whereby there are no foreclosures unless they had already been underway.
I would also suggest that the banks undertake to employ a specialist team of managers who can take over and manage the whole default process in a way which allows the farmer to process the series of emotions, the first of which is denial, usually followed swiftly by anger and this is generally when communications between the bank and the customer break down. In fact I suggest that one of the team be a counsellor who will be able to understand the farmer’s emotional needs and ensure that any transition to a foreclosure is managed in a way that leaves the farmer’s integrity and dignity intact and also allows them to deal with the grief associated with the loss of their home. Remember that your average bank manager lives amongst the community, has friends in that community and is a part of the community. They are not are not specifically trained to handle the emotional impact of foreclosure. They may only ever experience one or two first hand in their career. The simpler option for many managers is to cease verbal communications or hand them over to another department (a very impersonal one who has no job but to see to the removal of the mortgagee). The communication channel then becomes a series of default and legal notices. There is a more effective way to handle such a sensitive issue than with a police escort and bullish tactics through ensuring bank staff are sufficiently skilled or supported to manage the difficult situation.
Any review should also touch on the disparity in interest rates between farms and businesses and the standard home owner. While the financial market place responds quickly to interest rate falls for personal borrowings, the response is much slower to business lending generally. However should the rates rise, the increase is generally passed on almost immediately to the farms and businesses. There are more risks associated with business lending, although I would love to see a study completed to prove this claim. Additionally there are numerous unnecessary fees that once never existed (I joined the bank a year before account fees were introduced, the following year was hell). As our banks are not struggling I would love to see them offer some waivers in certain fees to any businesses impacted heavily by Natural Disasters, not only farmers during times of drought.
Education
I saw today a comment which was so very true and correct, and I will now paraphrase it:
Farmers have invested heavily in educating themselves about farming practices and how to do things better and more efficiently, grow better livestock, etc. but their financial education has not seen the same investment.
I do think this is a vital and neglected area that could be easily addressed perhaps in conjunction with the Rural Financial Counselling Services but in a proactive manner rather than a reactive manner.
Remember……………
It is important for us to remember that our banking system and our major banks are very sound having survived the Global Financial Crisis reasonably unscathed. Any steps taken cannot undermine the strength of our financial institutions, or foreclosure will become the norm (like parts of the US) rather than occurring occasionally.
A farm is a business and there are many other non-farming businesses out there who struggle through the down turn in an economy, seasonal impacts and other effects, however a farm can experience so many outside forces at once, for such extended periods, leaving little to no income. There are few businesses that can compare in this respect, let alone continue to operate as many farms do.
Diversification is a wonderful idea and practical in some areas, but for many other areas it is simply not a solution.
A farm is a business and must be treated as one financially, otherwise sustainability and longevity is simply not achievable.
The best thing about the current debates, articles and coverage relating to rural debt are the conversations that are occurring. Let’s make sure they are constructive and lead to the development of workable solutions at all levels. We may not be able to make a difference for many currently affected, but let’s make sure that there is not a repeat in the future and let's do this through mature debate and discussion. We don't have to like each other to develop solutions and ideas together.
At the end of the day it is there is a much more insidious problem facing our farmers than the “rural debt crisis”………….declining profits and erosion of farm gate profits. The decline in profits for many has lead to a decline in their debt servicing capability. Without correctly addressing this issue we cannot address our rural debt and that is a whole other story.
