Well… that depends on your situation. If you are a well performing, profitable farming business, it will be business as usual.
On the face of it, if your farming business is a struggling a bit and not sure of its future, then the report and its recommendations should be reassuring to read. It’s the unintended consequences that may or may not play out that concern me.
One thing is for sure, with banks providing finance for 95% of agricultural business’s needs, the continual flow of funds is vital for the sector.
Below are the key points relating to agri-businesses from the report.
Definition of small business
An incredibly relevant but little-known document is the “Code of Banking Practice”. It’s written in plain English and pretty easy to follow. It’s the rule book of principles the banks are required to follow, and it does hold some weight if it is pointed out that they are not following the principles. There is a new version of the Code coming out in 2019.
The definition of small business has a few requirements, and the most important one relating to agri-businesses is the quantum of borrowing. The current code specifies a limit of $3 million. The Commissioner is recommending to lift this to $5 million. An increase in the threshold will bring a lot of agri-businesses under the definition of a “small business”.
Other changes to the Code:
- A longer minimum period of notice of any change to loan conditions. The Commissioner recommends 90 days, as does the new Code. This minimum period gives the business (hopefully) enough time to make other arrangements or negotiate suitable arrangements with their current lender. Previously there were no mandated minimum notice periods.
- Restriction of non-monetary default clauses. These clauses give banks a lot of power. Even if loan repayments were up to date, the bank could still act to the detriment of the business. For example, in the event of a reduction in the value of the secured land, the loan may be pushed to a value ratio outside the preferred level. Consequently, the business would have previously been at risk of defaulting on their loan, even if it had met its repayments so far on schedule.
The Commissioner did not recommend any material changes to existing laws, or legal principles. However, there are two High Court cases that the Commissioner referenced that prevent exploitation of borrowers by the banks. Those cases being Commercial Bank of Australia Ltd v Amadio,and Garcia v National Australia Bank Ltd. These principles concern unconscionable conduct and clear and proper explanation of providing a guarantee.
Farm Debt Mediation
Four states currently have legislation regarding mediation (including South Australia). The Commissioner formed the view that the banks treat mediation as a step in the process of collecting unpaid repayments and the security offered to secure the loan (almost always land). I think that is a reasonable conclusion for the Commissioner to make; I have seen this happen previously.
The Commissioner also said that the loan parties should use mediation much earlier in the process. I agree wholeheartedly with this statement! Sometimes it is inevitable that the property is sold to satisfy loan obligations, but if this is not voluntary, the full value of the asset is rarely realised.
Sometimes it takes a while for business owners to fully realise the extent of their financial issues. It can be very stressful. If there is an avenue to seek professional advice much earlier in the process, there is a much better chance of a positive outcome.
The Commissioner recommends that the banks offer Farm Debt Mediation as soon as the debt is classified as distressed.
Dealing with distressed assets
All banks have a separate department to deal with distressed loans. When a loan is classified as distressed, the day to day contact ceases to be with the original manager that the business was dealing with. In relation to agri-business, the distressed asset banker may or may not have an understanding of farming businesses. I have seen this first hand, where someone had to give a basic explanation of how a cyclical agri-business operates to the banker.
The Commissioner has recommended that bankers with agricultural knowledge take charge of the file. I can’t agree more with this one.
Further, the Commissioner also recommended that receivers come in as an absolute last resort. Again, I completely agree with the Commissioner here.
Almost every banking contract has default clause, where a higher interest rate is charged under certain circumstances. The default interest rates are normally much higher, and this only exacerbates the problem, and allows overall debt to accumulate much more quickly. The Commissioner has recommended that the banks do not charge default interest in areas declared as drought affected. He has also recommended that the banks do not charge default interest when there is no realistic prospect of recovering the full amount of the loan.
I think most would agree that the Commissioner has thoroughly examined the issues and has made some really sensible recommendations. Lending to agri-business has always been good for the banks, and it is in the national interest for agri-business to operate, grow and expand.
Hopefully this will shine light on some issues, particularly for those businesses that are in the early stages of decline. Maybe they will seek advice earlier in order to turn their business around, or even make a viable exit plan.
Hopefully credit availability does not slow down due to over caution by the banks. For the top performers this is not an issue. However, for those at the margins, or looking to expand quickly, it may be a different story.
Agriculture is always going to be at the mercy of weather and cyclical commodity prices, but at least there are elements of the report that should provide some level of certainty in how agri-business is treated.