New capital ratio requirements
On December 5th the agribusiness sector will find out how the new capital ratio requirement will play out for New Zealand’s biggest banks. My agribusiness clients in the central North Island who bank with ANZ, BNZ, Westpac, ASB and Rabobank will be affected by the Reserve Bank of New Zealand’s new requirement for first tier banks to lift their capital ratio requirement to 16 percent (and all other banks 15%). In effect this means banks need to hold more funds in reserve and will have less to lend, and they may ask borrowers to repay more.
As funds from Australia are comparably cheap, NZ first tier lenders will be forced to look further afield for cash that inevitably is more expensive. With the banks declaring a sizeable profit, pressure is on for NZ banks to “Take a haircut”, however since when have banks not passed on all costs arising from complying with regulations? It is more than likely the banks will pass on the costs to the consumers in the form of higher interest rates. Banks will still need to show sizeable profits to attract investors to help support their balance sheet and thus maintain a 16% capital ratio. At this point many of us are asking which came first…….the chicken or the egg?
The second piece of news we are passing onto our central north island agribusiness clients is the impact of changes made by the Australian Prudential Regulation Authority. Most people are aware New Zealand’s big banks are owned by parent banks in Australia. Now the Australian regulator has said the parent banks will also be subject to capital ratio rules and are proposing a cap of 25 percent lending to their New Zealand banks. This will come into effect from January 2021. This means NZ banks will be limited to the amount of funds from their parent companies and may have to send funds back to Australia or source funds from elsewhere at a higher cost.
Keeping an eye on the detail coming out of the Reserve Bank is integral to our clients at BFA, a farm business advisory and accounting firm in Taupō. These new rules around sourcing capital are going to affect all our clients. Of particular interest from the Agribusiness perspective is how the Reserve Bank has rated industries by type, and how agriculture has been rated as higher risk.
It is apparent to me that some banks are exiting their higher risk farming clients. Already some lending institutions are aggressively changing the makeup of their lending profiles.
How this all plays out for the farming industry will be made clearer in December, when the RBNZ stumps up with the detail, but an obvious outcome is an interest rate hike for farmers. Banks are already becoming more particular about who they lend to. As the first-tier banks exit the Agribusiness sector, second tier lenders will fill the space. We may even see situations where first and second tier lenders work together to share the risk. We may see two banks involved in some larger businesses.
Those Central North Island farmers requiring capital can prepare for the changes ahead by instigating new systems now. The good news is that a farm business advisor or farm accountant can influence the Mum-and-Dad farmers to make positive change fairly quickly. No matter your farm business structure, the following points are worth noting.
- Banks are looking for high-quality information and reporting. Be sure to give them what they want.
- When it comes to lending, the banks give each agribusiness client what’s called a Risk Rating. This is like a performance score, and the good news is that a Risk Rating can be changed and it’s not all about the financials.
- Other than financial metrics, the banks are looking at things like a proven track record. Are you a good employer? Do you have an awareness and understanding of your business environment? Do you have a business plan? Is your business environmentally sustainable?
- Obtain independent advice when preparing budgets and sense test them against benchmarks. Gone are the days when your bank manager will prepare your budget and ask you to sign it off.
- Have a five year detailed cash flow, clearly showing ability to service debt, and ensure principal repayments are included as a cost of business. Be realistic and use long term landing and productivity prices.
- Demonstrate your cash surplus, take the focus away from capital growth. Your business must return cash to reduce debt.
Farming is always evolving and clients I see are performing well on most levels, they may just need to focus on a few minor things to ensure their risk rating remains favourable or improves.
Nick Hume is a Client Advisor at BFA in Taupō. He is a Taupo Chartered Accountant with a postgraduate degree in Accounting, as well as a Bachelor of Business Studies from Massey University. As a farm accountant, much of his 17 year career has been spent working with Agribusiness clients and he has some thoughts for those concerned about what major changes in the industry will mean for their profitability and livelihoods.