Khan Horne (pt 1) Lending to Australian agriculture -- facts and insights

Thanks Leigh and good afternoon.
A big thank you to ABARES in particular Philip and
Paul for an opportunity to speak here this afternoon.
Now back to business.
We're a division dedicated to finance and the
financial services to the Australian agribusiness.
It's in our DNA.
It's part of our heritage.
We've been doing it for 154 years.
We're market leaders in terms of lending to
agriculture so hopefully today I'll be giving
insights into that.
I'll be talking about industry data with a few
references to our own, we don't have industry data.
Today we'll be talking about three topics.
Effectively what does the lender look for?
There's a lot of urban myths around this.
Secondly lending to agriculture,
what does the book look like?
The growth, it's been referred to this morning
but also the composition and more importantly tenor
as we go through the crisis.
And thirdly agribusiness deposits.
We don't hear about them enough but farmers are
making money.
Our deposit books are growing and the best data
we can use today will be the farm management
deposit data.
They are indeed making money.
So the first slide.
Financing the farm.
What does the banker look for?
It's a bit like going to the dentist sometimes
isn't it?
But I think there's a lot of urban myths.
It's quite straightforward.
I call it the Five "C's".
Character, Capital, Cash flow,
Capability and Collateral.
Indeed in the first slide here I put character first
and collateral last.
Security.
It's often asked a question but it's indeed about the
integrity of the individual and of course
security and collateral comes last.
I'll just quickly run through some notes on the
Five "C's."
The first "C", character.
It's the integrity of the individual.
It's not inclusive or it's not limited to but it's an
extension of that gut feel,
that gut feel around honesty,
openness, transparency.
It's the people factor, the human capital.
We haven't heard much of it today but it's around
that management.
And of course there's many factors relate and feed
into character, motivation,
passion, drive of the business owners,
management, to see the business succeed,
and of course retiring and paying debt.
The second "C," capital.
This is the amount of capital invested both in
terms of absolute dollars but also the proportion of
overall asset base.
The mix between debt and equity thus the related
interest costs is fundamental to any lending proposal.

There's no silver bullet.
It's been referred to about the leverage and
equity ratios.
Look 70%, 75% even 80%'s been thrown around for
many years.
They're great traditional numbers.
But 70%, 75% may be overly reached for some producers
and indeed underly reached for others.
This varies between [inaudible] of course due
to different production systems,
different mix, management and capability.
The third "Cî," cash flow.
Cash is king.
Surplus cash after operating expenditure,
after capital expenditure, after tax,
after drawings is what repays debt.
Revaluations, updated valuations of the country,
water, etc. The top price paying of steers,
crop competitions, etc, etc, etc.
They're all great, don't get me wrong.
But it's actually surplus cash after operations,
after tax, after drawings which is what retires and
repays debt.
Lenders look for updated cash flows,
forecast cash flow budgets,
what's the peak debt?
When and how will we fund it?
What's the optimal time to align our principal
interest repayments?
How much interest is needed after expansion?
What term is required for the core asset?
We are funding long-term assets require long-term liabilities.

Lenders do look for business plans.
They work through options with the owners around the
enterprise mix, the type and finally the revenue
maximising, cost minimising strategies that
drive the strongest and largest bottom line but of
course in a sustainable manner.
The fourth "C," capability.
The world is not equal.
Lenders look at the physical capability.
The capability of the business model,
the farming capital we call this.
It's the quality of land, stock,
water, access rights, genetics etc, etc, etc.
It's a combination of these
efficiencies of those assets which can be
achieved plans in a given set of conditions.
It's imperative that a banker understands the
industry, understands the business and naturally
understands the people.
But also what is the core business?
He or she must ask the questions of the core business.

Is it robust to the current debt levels?
Is it robust at the proposed or forecast debt levels?

The final "C" the fifth, collateral, security.

This is the security lenders look for.
In Australia we have full-recourse agricultural lending.

There'll be many textbooks written about what's
happening in the U.S.
This is a key fundamental aspect underlying the
banking system in Australia.
Essentially collateral security is what can be
called upon to support the excess debt such as
livestock, mortgages, crop lands,
of course first regions mortgage over land,
access water rights when prime exits may falter or fail.

In addition to these five "C's" there are many
associated risks the lender will identify.
For every risk identifiable lenders we
look to what can be mitigated.
Methods to minimise or raise a particular risk.
For example interest rates,
commodity price, foreign exchange climactic and of
course changes to government policy.
The second topic today, lending to our agriculture.

Again those are the myths.
Credit is flowing to agriculture.
We are open for business.
This graph says it all, says a thousand words.
Just focus on the green line.
This is total lending to agriculture.
This is industry not NAB data.
Lending to agriculture in 1994 was 12.5 billion.
This has grown by $48 billion to $60.5 billion in
2011--an increase of 320%.
During this period as we've called out,
with the red line there's three distinct phases or
stages of growth.
First stage steady growth from '94-'02.
Annual growth rates around that 9%, 8.8%.

Then a rapid rise '02-'08, a double digit growth,
circa 12.4%.
And then finally the last three years.
Still growing.
There is access flowing.
But at a slower rate at 3.7%.
The key point that despite the GFC,
the European Debt Crisis cash is flowing to
Australian agriculture.
We predict over the next, I'm calling next 6 months,
12 months, 18 months we'll see a rise of confidence,
acknowledge the challenging prices,
the dollar.
But off the back of pre-seasonal conditions,
water allocations plus the last two years of seasonal
growth sorry growth in deposits we see that
confidence growing.
This graph also highlights the change in composition
of debt.
So in the '90s it was the smaller lending parcels
per customer that is under $500,000
that Mick referred to, that dominated the
composition of the market.
However in the 2000's, this has moved towards the
larger parcels that is over $500,000
making it the larger proportion of overall lending.

This next slide highlights this change in composition.

To really call it out, the smaller parcels in the 90
accounted for 64%.
That is the grey area at 40% and the black area at 24%.

And then look at 2011.
The [inaudible] we're in the blue to 75%,
76% and the smaller end down to 24% a market trend.

We ask why.
I think we could spend the next two days of the
conference discussing.
It's just a simple fact.
I'm proposing a number of I'm calling out a number
of factors, the aggregation of smaller
properties as farmers exit,
the growth of larger farmers,
semi-corporates, corporates,
introduction of non-traditional farm
investment, on-going drought conditions,
we saw in Bruce's slide, thus a requirement for
carry-on and working capital.
Subsector trends so we can all talk about Australian
agriculture but of course it's made with many
different subsectors in many different production
and mark climactic variances.
Subsector trends for example,
the [inaudible] industry, we saw the transition from
conventional to tunnel-ventilated sheds.
We saw different changes, I think Mick probably
nailed it for example in the West the shift between
focus on livestock and cropping to a focus on cropping.

Foreign investment, knowing that not all
foreign investment is debt funded.
There is a lot of 100% equity funds.
And of course at the smallest end of town it's
people opting out of farming,
the aging farming population,
thus downsizing, increased reliance of off farm
income, introducing and entering capital.
The list goes on and evidently varies between
entry, anti types and family structures.
I'll briefly talk through term and tenor.
I've had to use NAB data here.
So what does lending look like?
And this changes right throughout the cycle.
Evidently closely related to the GDP,
weather etc, but termed at approximately 80%
overdrafts fluctuating through the year,
5%-10%.
Asset finance, leasing equipment finance etc.
Again 5%-10%.
As shown here 60% of the book is hedged.
Hedging using interest rate risk management
tools, effectively mitigating against
interest rate rises.
As you can see here one of the five-year money is 45%
of the book.
One to three year money at 22%.
More importantly over five years at 15%.
A lot of sectors cannot attract tenor like that.
Our agribusiness majors work with wholesale
markets, especially so to insure customers are aware
of opportunities, key economic data,
GDP, unemployment, everything we heard this morning.

Also worth noting here is the 41% of the customers
ride the yield curve.
They're comfortable take the 30-90 day roll option
effectively still a hedge but a floating variable hedge.