LAST Sunday 60 Minutes ran a story that touched on the increasing issue of rural debt and farm foreclosures. The segment focused on two farmers in the Western Australia wheatbelt.
Unfortunately, the story focused too much on the behaviour of the receivers and missed the opportunity to emphasise the magnitude of the debt problem in rural Australia.
Rural debt has increased significantly in recent years while the net value of farm production has remained stagnant. The trusty old graph below dramatically highlights this.
Rural debt and NVFP. Source: Ben Rees, ABARES Data
This debt increase has been driven by a number of contributing factors, including declining terms of trade and insufficient productivity growth to ably offset this decline. Agricultural enterprises have been encouraged to increase scale to overcome this problem.
The notion of agricultural real estate as a business model quite separate to agricultural production is a significant contributing factor to the financial stress in agriculture today.
Simply, capital gain on land has been regarded as income by many banks even though there is no cash inflow to a farming business per se.
Mike Carroll indicated this in a presentation to the Grassland Society in 2006, just after resigning as head of agribusiness with the National Australia Bank.
His presentation supported the notion of expansion of agricultural land holdings, based on a commercial confidence in the continued consistent growth in land values, even though finite productivity growth does not support this capital growth.
“However, typically over half the returns from farming are in the form of capital gains and here everyone wins,” he said.
“It is the most profitable farms that are expanding most aggressively and who can justify paying the highest price for land.
“And in setting property values based on operating returns, which are considerably higher than the average, they effectively underwrite the property market for everyone.”
As a result of this misguided perception about perpetual ag land appreciation, many producers were supported and even encourage to expand their land by their lenders in the full knowledge that they probably could not pay for it by production alone.
Any disruption to agricultural production or markets is now unbearable for highly-geared enterprises, yet considerable disruption has occurred and continues to undermine both price and production, and has completely undermined the existing rural finance model for debt-funded enterprises.
There has been a general decline in agricultural land values since 2010 which has eroded equity and the financial resilience of many in the sector.
Agricultural support mechanisms in Australia have also been eroded, shifting all risk in the enterprise back to the producer.
This erosion is a contagion that has affected all aspects of rural economics.
Agriculture has reached a tipping point and is currently undergoing an uncontrolled correction that threatens the future of the sector.
Lending institutions are heavily regulated in Australia under the Australian Prudential Regulation Authority (APRA). In particular, APRA compels lenders to demonstrate default risk management of all loans in a bid to restrict unsustainable lending practices, and is intended to act as a disincentive to lend money to higher-risk clients.
The viability of agricultural business has been assessed based on decline in loan security ratios by commercial lenders.
Subsequently, increasing risk perceptions has led to increasing interest rates applied by commercial lenders that supported the loans and agricultural expansion in the first place. The application of these higher interest rates shifts the risk of default to the producer and insulates the lenders from the increased risk in rural finance that they in fact helped to create.
In effect, this means the customers least able to withstand high interest rates are forced to endure massive penalty rates by government regulation through APRA.
The resulting breakdown of rural financial resilience has impacted all producers, whether their debt to income ratios are sustainable or not, as the prevailing loan security ratios are eroded by falling land values.
The increasing risk premiums on interest rates applied to loans with poorer loan security ratios are in turn adding to the financial burden of otherwise sound producers eroding debt-to-income ratios. The cycle repeats and amplifies to a point that all in the sector are affected.
The notion of a business partnership is broken and increasingly commercial lenders are not motivated to add value to their customers and increasingly motivated to extract as much commercial gain as their customers can bear.
While it may be argued that this is a normal phenomenon in business, there are far-reaching implications for generational succession of the industry and generational productivity trends if the correction is not managed to retain human and social capital in the sector.
Ideally, governments should not intervene in markets except in the situation where those markets fail. Unfortunately, there is compelling evidence of market failure in agriculture and agricultural finance in Australia, and there is a now an unavoidable need for government intervention to stabilise the market and prevent the spread of economic contagions eroding agricultural land values and farm debt security values spreading beyond the production sector.
In February, the Queensland and federal ministers for agriculture acknowledged in a public forum in St George that the financial devastation of the drought were symptoms of underlying structural problems in the sector. Nothing substantial has happened in the past fourteen months and the problem continues to escalate.
The financial situation is acute and solutions need to address immediate financial constraints as well as longer-term structural reforms.
Welfare is not a desirable form of support for taxpayers or agriculturists, but there is an opportunity for financial partnerships in agriculture between producers and government that stabilise the sector, reassure its traditional funders and present real value to Australian taxpayers.
Last week, the government rejected sound legislation to enable the Reserve Bank to establish the Australian Reconstruction and Development Board (ARDB) as an economic development banking capacity. The establishment of a government development bank could provide cheaper and more secure funds to agriculture.
Beyond the obvious idiocy of failing to embrace the ARDB as a sound mechanism to bring down cost of capital in a non ag specific structure, the government must now look to co-investment models to support struggling agricultural production businesses.
The Clean Energy Finance Corporation provides an effective and sustainable precedent that reduces cost of funds to commercial ventures in a cash positive model.
Another idea is a performance-based model for agriculture similar to the Higher Education Contribution Scheme loans, where students pay for their degrees by borrowing money from the government on low interest rates.
These loans are paid back based on the economic performance of the borrowers as assessed by the Australian Tax Office, so that loan repayments are adjusted based on taxable income, avoiding forced payments or default in low income periods.
These examples would reduce cost of funds directly to producers and ultimately improve income, effectively mitigating short-term risk and providing an effective tool to de-risk agricultural loans under APRA.
Resolving the finance model for Australian agriculture should be justified on the basis of the strategic importance of agriculture to regional political stability, and Australia’s need to be seen as the most productive and reliable agricultural supplier underpinning our national security.
It is bigger than just supporting farmers.