Farm finance and footy philosophy

The government should consider direct investment in agricultural land ...

I RECENTLY attended a most significant regional event in search of wisdom and guidance from some of the most astute philosophers, political analysts and business commentators in their fields.

Of course I am talking about family day in a local machinery dealer’s tent at a home game of footy.

I was somewhat surprised that quite a few of my fellow patrons were aware of the fact that I write this blog and even more surprised that some had even read it. This notoriety was cause for some reflection and justification of my previous blogs.

To provide context at this point I should point out that my purpose in writing this blog is to provide a thought provoking point of view that stimulates discussion around some of the critical issues facing regional Australia.

It is not practical to provide a comprehensive solution to these issues in a blog that is supposed to be less than a thousand words, so I settle for throwing a few metaphorical grenades every couple of weeks.

That said, I would like to draw on the most consistent themes from the footy soiree and provide a brief justification for why I think the government has a role investing in agricultural land and providing a more sustainable credit system for industry generally.

A good deal of this narrative is inspired by Neville, who was easily the most venerable of the footy philosophers in the Specialised Farm Machinery tent. In general discourse we conducted a high level review of the finance and banking sector, among other things.

There are many lessons to learn from the banking sector and not all of them are positive. Perhaps the most interesting observation is the great job the banking sector does of belittling its extraordinary profitability, continually crying poor in a bid to justify the need to increase risk margins to protect their profitability. It seems to me that bank interest margins and loan profit margins are all too often misunderstood.

In considering the risk margin issue it is important to highlight that rural debt is increasing steadily while the net value of farm production is relatively stagnant. The graph below is compiled from ABARES statistics and highlights the unsustainable growth in rural debt. The data suggests that the current rural credit system is charging toward a cliff of default.

Source: Rees, B (B.Econ. M.Litt) Submission to the Agricultural Competitiveness White Paper.

Forgive me for crassly assuming that you all have some form of bank debt, but I would like you to ask yourself what is your bank’s lending margin to you? I encourage you to think about this issue carefully.

Today’s cash rate is 2.5 per cent. If we assume that the bank’s cost of funds is about 200 basis points above the cash rate this means that the bank’s cost of funds is about 4.5pc. If you are paying 5.5pc on your agricultural bank loans (I wish), then you might argue that the bank’s margin is 1pc.

However, if you think about in terms of the return the bank gets on its investment then the numbers are a bit different.

Hypothetically, let’s say you borrow $100 from the bank. That $100 is not really the bank’s money because, in effect, it borrows it for a cost of $4.50, being the 4.5pc cost of funds. Now the bank lends it on to you at a rate of 5.5pc or a cost to you of $5.50.

This means that the bank receives a gross income of $5.50 for a cost of $4.50 to nett a $1 profit. This means that in this hypothetical scenario the bank is making a return on its investment of around 22pc. You could argue this is the real lending margin.

Consider the rising level of rural debt. Consider increasing risk margins (much higher than 1pc over the bank’s cost of funds) being assigned to a significant percentage of these funds. Consider the real rate of return the banks are achieving. Finally, consider how much of the financial risk in the rural sector is caused by assignation of high risk margins.

The exploitation of vulnerable loans by lenders through inflated risk margins is in itself a source of the vulnerability of the loans.

I have previously asserted that the government should consider providing an alternative credit mechanism for agriculture and fully support the Australian Reconstruction and Development Bank Bill. Even the Irish Government is now ahead of the Australian Government in this space with the recent announcement of the establishment of the Strategic Banking Corporation of Ireland.

It is essential that the government recognises the inherently high risk low return operating environment for the sector and act decisively on the significant social imperatives around maintaining agricultural productive capacity.

I have also asserted that the government should consider direct investment in agricultural land to then provide affordable tenure to industry entrants, stabilise the equity position of current investors and to encourage new investment in the sector.

Buying land and leasing in effect provides the same kind of return as lending the money that buys the asset. It is a good investment for government on many levels.

It is clear that subsidising agriculture by giving farmers money through welfare is not desirable and does not offer a suitable return on taxpayer funds or incentivise necessary practice change. However, the real rates of returns in the models I have suggested present opportunity for very healthy rates of return on taxpayer funds, provide real relief in the sector, facilitate generational succession and do not constitute traditional welfare support.

Of course the banking sector would be in uproar at the notion that the government might compete with the private sector in such a lucrative space. There is some evidence that the government’s commitment to provide short term low interest loans under the current drought support measures is already having a desirable impact on some commercial interest rates.

The inevitable assault by the banks is like the fossil fuel power generators attacking the Renewable Energy Target saying it is distorting the market. Meanwhile, the RET is clearly bringing down wholesale energy costs with benefits clearly outweighing the level of subsidies. The only long term beneficiaries of abolishing the RET will be fossil fuel power generators.

In the end the only beneficiaries of continued inaction in the farm finance space will be incumbent providers of farm finance and the receivers closely aligned to them.

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FarmOnline
Pete Mailler

Pete Mailler

is a farmer on the Qld/NSW border and a co-founder of the Country Party of Australia
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READER COMMENTS

Deregul8
28/06/2014 4:27:18 PM

A typical AG Soc is our old Pete. Always expect the taxpayer to cough up. Deregulate and get rid of red tape and watch rural Australia blossum.
wtf
4/07/2014 6:30:47 AM

good on you Pete, I cant understand how the politicians can spruik the free market, yet without all the tax incentives and middle class welfare we would not be seeing the real estate bubble that exists in Sydney and Melbourne. There is no free market, its just taxpayers subsidising the home owner/investors and it stinks. When over 60%of bank lending is residential and just 30%is business an economy is heading for a problem. We are growing no industries and real estate is our phony investment and look around the world to see where that ends up.
Burrs under my saddlePete Mailler is a farmer on the Queensland/NSW border. His perspective and opinions are borne from seeing more than one side of many problems in his various farm leadership roles and in wanting to ensure a future for his children in agriculture.

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