Of the recommendations made in the Royal Commission report into Misconduct in the Banking, Superannuation and Financial Services industry (FSRC), four pertain to the management of leveraged agricultural assets by the banking industry.
Enquiries into the conduct of Australian banks and their agents in rural Australia has been considered in the public domain extensively prior to the FRSC. The reports by the Parliamentary Joint Committee on Corporations and Financial Services (May 2016) and the Senate Select Committee on Lending to Primary Production (December 2017) considered the regulation and practices of financial institutions in relation to primary production industries, with particular reference to the lending, foreclosure and default practices, including constructive and non-monetary default processes utilised by financial institutions. Accordingly, these matters were not part of the terms of reference of the FSRC.
The nation’s farmers are constantly subject to hardships beyond their control. As farmers in Queensland are currently experiencing flooding, Tasmanian farmers face threats from bushfires, and New South Wales farmers are fighting off one of the worst drought in generations, it is timely to consider what positive impacts lenders and their agents can (and do) provide rural Australia.
Agriculture recommendation 1 – Federally legislated Farm Debt Mediation
Farm Debt Mediation is legislated in Victoria, New South Wales, Queensland and South Australia, and voluntary in Western Australia. While the legislated schemes all require a lender to offer mediation services to a borrower prior to taking enforcement action against the property of a farmer, the process is inconsistent from state to state.
The Commissioner states that lenders should offer farm debt mediation as soon as a loan is classified as distressed, noting “early farm debt mediation should allow wider and better choices for the lender and borrower about servicing, and ultimately repaying, the loan.” When early proactive action is taken in dealing with distressed loans, more options are generally available to a lender and a borrower. In this regard, early mediation should be encouraged.
The implementation of a national legislated mediation scheme would allow the banking and farming industry to apply one set of governance policies on a consistent scale. Similar recommendations for a nationally consistent framework for Farm Debt Mediation were made by the earlier Parliamentary and Senate inquiries. Application of a national scheme may present challenges where individual states continue to have similar, but not standardised, legislative frameworks, particularly in respect of real property and land tenure rights. Noting the state schemes are relatively recent legislative instruments, information received from a national scheme would allow for greater monitoring to measure the success of such a policy.
Invariably, banks and their customers enter Farm Debt Mediation in circumstances where the primary issue is a lack of capital or financial reserves to deal with the challenges and ongoing funding requirements of primary production businesses. The paradigm faced is whether providing more funding to a business that is already leveraged makes good business sense. The parties on both sides must be willing to recognise that the shared outcome is dependent on the willingness of each to agree to compromise.
Agriculture recommendation 2 – Valuations of land
The Australia Prudential Regulation Authority (APRA) Prudential Standard APS 220 governs credit control and risk policies. APS 220 does not contemplate the treatment of agricultural assets any differently to those of non-agricultural assets and the Commissioner recommends this be amended.
The Commissioner recommended that internal valuations of land (agricultural or otherwise) by a lender, be conducted independently of loan origin, loan processing and decision processing. Further the FSRC recommends a change to APS 220 to provide for valuation of agricultural land in a manner that will better recognise:
- the likelihood of events outside a farmer’s control affecting realisable value; and
- the time that may be taken to sell the land affecting realisable value.
A challenge presented by the recommendation is a valuation is prepared at a specific point in time based on available information and data. The dynamics of Agribusiness are such that external factors, be they environmental, regulatory or commodity based, are constantly at risk of changing, and actual events may not reflect those that were assumed to take place.
For a majority of primary production businesses, their key asset is the rural land from which they operate. Valuation principals primarily focus on arriving at the capital value by comparing sales of other similar properties. As new capital and investor markets are expanding, they will view agricultural assets not through what was paid in the past, but what the land can generate as a business.
Agriculture recommendation 3 – Charging default interest
Default or ‘penalty’ interest are interest costs above a loan’s headline rate, charged as a result of the default on a loan by the borrower. APRA standards require Australian financial institutions to take steps to ensure they have sufficient capital reserves to offset the likelihood that the loan may not be recovered. These standards are to ensure that Australian financial institutions remain financially sound and costs are incurred by financial institutions in managing and complying with the standards that apply relate to loans in default.
The Commissioner stops short of recommending against the charging of default interest however, recommends the Australian Banking Association (ABA) provide better protections for farmers in crisis by amending the 2019 Banking Code, so that default interest on a loan is not charged in an area declared affected by drought, flooding or other natural disaster.
Agriculture recommendation 4 – Treatment of distressed loans
In managing distressed agricultural loans, the Commissioner recommends banks:
- ensure the loans are managed by staff experienced with agricultural banking;
- offer Farm Debt Mediation as soon as a loan is classified as distressed (as outlined above);
- manage the loan on the basis that a ‘work-out’ is the optimal outcome, and enforcement (i.e. by way of appointment of an external administrator) the worst;
- recognise that the appointment of an external administrator is a remedy of last resort; and
- cease charging default interest when there is no prospect of recovery.
While the recommendations associated with the handling of distressed farming loans are focused on providing better protections of borrowers, it represents the possibility (with a long term view) of better outcomes for lenders as well. Identifying key issues and risks, developing early work-out strategies and Farm Debt Mediation can result in a better result for a bank and the customer. Not only does the implementation of early work-out strategies increase the options for the repayment of a loan, it provides for the continued stability and contribution many farmers make to the social and economic wellbeing of their local communities.
Submissions and testimony to the Commission also highlighted that a great many small businesses in local rural communities are also directly impacted by the underlying agronomic conditions affecting farmers in their regions. The recommendations do not extend to the ‘downstream’ impact.
The range of issues faced by agribusinesses are diverse. While the recommendations suggest that loans are “managed by experienced agricultural bankers”, it may be unreasonable to expect that banking staff must be experienced with the particular issue, in the specific industry, faced by the client. The skills and experience to assist with solutions can come from many sources, and focusing on maximising the outcomes for all parties should be the primary goal.
Documenting best practice already implemented
Practically, Australia’s major lenders have already taken steps in recent times to address many of the recommendations highlighted in the FSRC, and from previous Parliamentary and Senate Inquiries.
Pleasingly, the FSRC does not highlight any widespread malpractice of any bank in particular in the Agribusiness sector, rather recommends amendments to legislation and practices to provide for better outcomes for Australian farmers, particularly those battling crises beyond their control.
While the response from the Australian financial sector regarding these recommendations will take some time to play out, it is apparent that the corporate governance, experience and skill of bankers and their advisers in dealing with agricultural assets in distress has never been more crucial.