A HANDBRAKE on borrowing levels may impact the amount of money primary producers can borrow to purchase additional country, but the good news is industry experts claim strong commodity prices and low interest rates will continue for the next three to four years.
In a bid to take some heat out of the housing market, the Australian Prudential Regulation Authority (APRA) recently lifted the minimum interest rate buffer it expects banks and other financial institutions to use when deciding whether a new borrower can repay a loan.
So, why did the APRA raise the buffer instead of increasing interest rates?
It believes the interest rate serviceability buffer is the most appropriate tool to use because it acts as a cap on leverage, is relatively easy to implement and will not have any impact on mortgage interest rates.
When it comes to interest rates, Brad Sewell from Robinson Sewell Partners explained that there were two competing forces at work.
“There are international pressures recommending interest rates should rise, and domestic pressures suggesting they should stay roughly where they are,” Mr Sewell said.
Worldwide, there was an underlying fear of inflation, he said.
“If it doesn’t happen in Australia, it will certainly happen in the United States. The US is under significant pressure from both inflation and interest rates.”
Mr Sewell said countering that, was the sheer amount of household debt in Australia.
“There is $3 trillion worth of home loans in Australia and most borrowers could not support an interest rate rise of one or two percent – typically aligned with inflation.”
On the other hand, he said most primary producers would be largely unaffected by such a rate rise.
“Pressure would be felt by a lift of three to four percent, but this would create serious issues in the rest of the borrowing market, in particular home loans, forcing the federal government and the Reserve Bank of Australia to intervene.”
Mr Sewell believes the Reserve Bank is in a tight spot.
“Looking at Australia’s macro-economics, interest rates should rise. However, the underlying indebtedness of Australians in regard to home loans means any rate rise would hurt the majority of voters.”
He said Australian agriculture would also benefit from steady interest rates.
“While primary producers don’t hold many votes these days, lower home loan interest rates will keep the lending environment competitive.”
Mr Sewell said if interest rates do rise, most primary producers will be able to handle the hike.
“The domestic home loan market is still fragile on the back of the lockdowns in Australia’s two biggest cities – Sydney and Melbourne. There are many home owners and small businesses (that typically borrow against their houses) that are hurting.”
“However, strong commodity prices mean there is potentially some serious money to be made in Australian agriculture, buffering a primary producer’s capacity to absorb an interest rate rise over the coming 12 months.”
David Goodfellow, CBRE Agribusiness
David Goodfellow, who heads up CBRE Agribusiness, has been studying the impact of interest rates in agriculture for many years.
He said the last time Australia experienced a significant increase was in the late 1980s when prices for beef, wool and grain had been steadily rising for almost a decade.
“What we’ve learnt from the history of economics is one of the precursors to inflation in Australia, as measured by the Consumer Price Index, is strong agricultural commodity prices,” Mr Goodfellow said.
“Only after a sustained period of both high commodity prices and inflation have interest rates been lifted by the Reserve Bank to dampen some of the side-effects of high levels of inflation.”
Mr Goodfellow said the current yield curve of future interest rates suggests there won’t be a substantial hike for the next three to four years.
“There may be small increases along the way, and that gives the industry confidence that commodity prices will remain strong during this period.”
Mr Goodfellow’s prediction reinforces Rabobank’s recent annual Agricultural Land Price Outlook which found interest rates would remain at record lows until at least 2024.
Instead of lifting interest rates, he praised the RBA and the federal government for using innovative techniques to slow down the growth in residential housing prices.
“Higher interest rates would affect all borrowers, not just city people wanting to buy houses, but businesses and other forms of real estate investment. Instead, the RBA and the federal government are using alternative mechanisms to monitor and control access to further debt.”
“Now, new borrowers must be able to demonstrate a capacity to pay not only the interest, but the interest plus the principal over a reasonable period of time,” he said.
Mr Goodfellow said primary producers seeking to purchase another landholding must show they can service the cost of the interest and that their cash flow can pay back that new loan over a maximum 20-year period (but preferably 15 years).
“In agriculture, the tests for serviceability are about demonstrating your ability to pay the loan off, while in residential housing the new test invoked by APRA is about serviceability if interest rates rose to five percent per annum.”
Won’t affect land prices
Mr Goodfellow said this ‘handbrake’ on borrowing levels may impact the amount of money primary producers can borrow, but won’t affect land prices.
“It doesn’t change the value per hectare of properties, it may just change the scale of what people are looking for. For instance, a producer previously seeking to borrow $20 million to buy an additional holding may now only be able to borrow, say, $18 million. It just means that producer buys a slightly smaller asset.”
“But that is only for people who are limited by the amount of money they can borrow. What we are seeing in agriculture right now is that balance sheets have substantially improved over the last 18 months,” he said.
Mr Goodfellow said over the last five years, big corporates have had the best access to capital for agricultural investments because they have alternative sources of funds.
“Superannuation funds have different sources of capital, and if they believe there is an opportunity in agriculture, they then choose not to buy equities, invest in bonds or purchase another office tower, and instead purchase a farm or two.”
“On the other hand, farmers have to wait until their own balance sheet, their farm, allows them to borrow money,” Mr Goodfellow said.
In many parts of Australia, the drought impacted negatively on a producer’s balance sheets, but he said after two great seasons in a row, many farming families are now cashed-up and ready to expand.
“They are stepping up to the market where corporates have previously dominated, particularly in areas that were most severely impacted by the drought.”
“The cropping sector is able to access cash more quickly after a drought and is therefore acting first, but in 12 months’ time, livestock producers will likely be the next major player in the rural real estate sector,” Mr Goodfellow said.