What banks are thinking on farm lending
Interest margins have widened considerably since 2008 and lenders have tightened their loan terms. How can borrowers reduce the burden? Robert Harris reports
Farming has always been perceived as low risk by the banks. Cash poor it may be at times, but it is also asset rich.
Interest margins are the difference between the Bank of England base rate or the cost of funds and the rate charged by lenders. Terms of 1% over base rate were regularly negotiated, even for quite small loans, in the 10 years preceding the credit crunch.
But, after 2008, all that changed. Almost overnight, the obsession with market share that had gripped lenders for a decade was ended by the collapse of the sub-prime mortgage market on which such credit was based. The inter-bank lending that had helped it proliferate also dried up.
“The primary obligation of a bank is to safeguard depositors’ funds by lending those funds with as close to zero risk as possible,” says Mark Ashbridge, director at private client finance specialist Ashbridge Partners.
“Some people had forgotten that. In the 10 years leading up to 2007 the banks adopted a tick-box culture and lost sight of pricing for risk.”
The low interest margins generated by that culture will be seen as a blip, Mr Ashbridge maintains. “Since 2008, margins have increased with a vengeance. Fortunately, the rural sector has been less seriously affected.
Historically in this sector, margins for long-term funding in excess of £1m were typically 2-2.5%, and pricing for such loans has typically returned to a similar level, though it can be much higher depending on the size of the loan and the liquidity of the asset being put up as security.”
Lenders are, however, putting much greater focus on repayment structures, says Mr Ashbridge. “Interest-only loans have all but disappeared – lenders are looking for monthly capital plus interest repayments or agreed annual sums.”
In addition, loan-to-value ratios are tightening as lenders examine closely the ability of clients to service the debt, to ensure the money can be recouped and to avoid the possibility of being held negligent by the courts if the borrower cannot afford the repayments.
“In general, 70% was the upper loan-to-value ratio pre-2007 but this is now rare. Fortunately, most farm work is undertaken at 50% or less so the sector is largely unaffected.”
Lenders are also scrutinising asset security much more closely, says Mr Ashbridge. However, the low loan-to-value ratio of agricultural lending, coupled with rising land values and long-term involvement of lenders in the sector, will help many rural borrowers, he says.
Overall, while the agricultural sector faces some significant challenges it remains in a stronger position than many other sectors. “Although margins are back where history says they should be, at current base rates the overall cost of borrowing money is at an all-time low.
“In addition, farmers have a competitive advantage because many traditional competitors will be unable to raise funds now that lenders have tightened their terms. Even if they could, those competitors might be paying two or three times as much for the privilege.”
Although negotiating loan terms has become much more difficult, a few simple steps can help increase the odds of a successful and potentially cheaper outcome, he advises.
“A banker’s time is valuable. Spend some time convincing banks you are worth that time – present your case professionally to make their job as easy as possible.
“It may not be as easy to obtain a loan as it once was,” says Mr Ashbridge. “But farming remains relatively well positioned and it is still possible to influence the price offering to the borrower’s advantage.”
Loan applications – key points to cover include:
- Brief history of the business
- Business structure – spell out who owns the assets
- Long-term business objectives
- Up-to-date accounts
- Interpretation of financial records to show cash-generating power of the business. For example, highlight exceptional costs. Are property repairs really improvements?
- Sensitivity analysis – can the business cope when the going gets tough?
- Budgets – a lender will be looking for similar trends to substantiate this. If different, explain why.
- Repayments – outline terms you want, and why.
- Security – size of asset(s) is no longer sufficient. What is it, how is it made up, is it saleable even in depressed times?
- Construct a credit report – show you can service the debt.