Northern debt burden unlikely to ignite fire sales

James Nason, 05/07/2012

Terry McCosker, Resource Consulting Services. Rising debt levels and falling land values may be putting more northern grazing operations at risk, but the squeeze is unlikely to ignite a major round of fire sales and bank foreclosures, a prominent rural business consultant believes.

Resource Consulting Services director Terry McCosker believes the sheer number of enterprises under financial pressure is likely to discourage banks from triggering widespread forced sales, because of the impact such an event would have on property values and their own book positions.

A survey by the Queensland Rural Adjustment Authority of rural debt levels in Queensland last week showed that cattle producers with borrowings are now carrying an average debt load of $1.4m, which has risen by almost 20pc in the past two years.

Much of that debt was accrued in the first half of the past decade, when rising property values encouraged many producers to borrow money to increase productivity by expanding land area or undertaking fencing, water and pasture improvements.

Since then overhead costs have continued to rise, while income and productivity levels have more or less stagnated.

Average debt levels per livestock unit have increased by $240 to $647 in the past 10 years, however earnings before interest and tax have not risen in the same period.

The response by producers has been to screw down costs where possible, such as through shouldering all of the property workload themselves, and delaying property development and maintenance work to make ends meet.

Even with those efforts, RCS data shows that in nine of the past 10 years, most northern cattle operations have still spent more money than they have brought in.

The answer in many cases has been to extend borrowings against the underlying asset to cover the annual shortfall between money coming in and money going out.

While that worked when property values were rising, falls in land values over the past five years have changed the picture. Many that were in a sound position a few years ago are now finding themselves in a tighter situation, with dramatically increased debt levels as a proportion of their total asset’s value.

Mr McCosker said it was fair to say many operations were facing a crisis, and while he was not surprised by the fact rural debt levels had risen, he was surprised by the magnitude of the debt situation revealed by last week’s debt survey.

Fire sales unlikely

Given the number of operations experiencing financial stress, an unpalatable but relevant question is whether a round of forced sales and a possible property market meltdown is likely.

Mr McCosker's answer is a guarded “no”, based on the widespread nature of the debt situation and the credit stalemate that has now emerged.

Banks were having difficulty selling money, because their credit managers were only willing to lend on cash-flow. With most operations achieving a return on capital of just over 1pc, cash flows were too small or uncertain to support lending on that basis.

Property values had to come back by almost 50pc on 2008 levels to present a viable proposition for credit managers to support new borrowings. However, such a drop in values would be detrimental to the banks.

“I think the banks are between a rock and a hard place,” he said.

“If they let values go down too much, their whole book goes down, which changes their loan to value ratio on everyone, so they can’t let that happen.

“It has already wandered down I would say 20 to 30 pc already, and some have been more than that when they have done their reviews.

“If you knock 20pc off a $5b portfolio, that equates to a loss of $1b from your asset value as a bank.

“I don’t think the banks can afford to let it meltdown. I think that they what they will do is just keep people there, and have very, very few fire sales.”

Mr McCosker said that while some operations still had room to increase productivity through improving reproductive rates and using water and wire to improve utilisation of available feed, the longer term solution would have to be an increase in prices.

“And that will happen, commodities go through cycles and then they bounce up and find another level and stay there for a while.

“When the world starts to get a little bit more short of food we will see that happen, but I can’t see it happening for another five years because a lot is going to happen between now and then.”

He said the operations that were doing well in the current environment tended to share the same characteristics: they had good control over their overheads and costs in general, they typically had slightly bigger operations, had improved their property to maximise utilisation of their entire pasture resource and had breeding and trading animals, instead of just breeding.  “There is a swing back to breeding being more profitable occurring now and businesses need to assess what is best for them.”

Lift producitivity, watch costs

The main message for producers was to focus on increasing productivity and watching overheads and other costs where possible. “Producers need to know where their best margins are, and how to increase them.  It is their margin, or combination of productivity, price and costs that creates profit, not one of these factors by themselves.”

Mr McCosker said that while smaller operations faced high overheads in relation to turnover, larger corporate scale enterprises also had significant issues with overheads.

Beyond a certain point, economies of scale were overtaken by ‘diseconomies’ of scale.

This relates to the challenges large-scale corporate enterprises face in getting the timing of their farming operations right – getting calves off when they need to come off, pregnancy-testing at the optimum time, putting bulls out when they need to go out.  The more extensive the operation, the harder it was to fine-tune operations to achieve the timing that is required to maximise productivity gains.

“The sweet spot seems to be somewhere around 7000-10,000 head of cattle,” Mr McCosker said.

“If somebody is in that range, and doing that well, then they’re at the top of the game.”


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