Credit Crunch Ambush caused by high interest and dropping farm values
This month I have again been confronted by the crunch created by a low payout, high costs, high interest rates and a change in how banks operate with a couple of clients. Ironically, it is the seasoned farmers who get caught out by this. They have been with the same bank for years and are used to a relaxed bank manager. Until recently they got an overdraft by calling their bank manager and the overdraft was available within days.
Banks have become much more formal in their processes in the last couple of years, the lending rules have tightened considerably and it is very easy to fall outside the equity percentage and interest affordability criteria with falling farm values, Fonterra share values dropping and soaring interest rates.
Suddenly a loan that was within the criteria last year is no longer okay this year. The bank usually is not very clear about why they are suddenly getting more difficult to deal with until threatening letters appear with looming deadlines, which then does not leave you a lot of options. You have to read between the lines here, banks could be much clearer about this and much earlier too.
Here are some questions to ask your bank manager
What are you using as the value of our farm?|
What is my current equity percentage?
What is my interest affordability score?
If you know the answers to these questions you know the things the bank looks at when they are deciding whether to give you another loan or overdraft, and decide how much principal they want you to repay. You will know exactly how much room there is for you to finance plans.
In general, banks would like your equity percentage to be 40% or higher - they want to lend you a maximum 60% of the value of your farm.
When it comes to affordability they want your trading surplus (Income - minus farm expenses before interest, rent, and tax) to be able to pay the interest on your loan when the interest is at their stress level. This is their stress test - to test that you can still afford your loan when the interest gets high.
Note, currently the interest rate is higher than the stress test interest percentage used by the bank I talked to, so even the banks consider these interest rates higher than normal! They wanted the trading surplus to be at least 1.25 times the interest at their stress percentage.