The interim report of the Financial Services Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry identified three broad issues relating to potential misconduct of banks in agricultural lending.
This Brief Counsel examines the issues raised in the interim report relating to agricultural lending and the possible implications for New Zealand.
The umbrella issue identified in agricultural lending is the way borrowers and banks deal with uncontrollable and unforeseen external events such as drought, flooding and changing government policies. The Commissioner identified three issues from an analysis of case studies and inquiries made by the Royal Commission:
- Revaluation of securities: borrowers experienced situations where land revaluation changed the loan-to-value ratio (LVR) of existing facilities, creating a non-monetary default permitting the banks to require the borrower to sell their land.
- Access to banking services and appropriate support: borrowers had difficulties travelling to the nearest branch and difficulties with staff members failing to recognise the effect of external events when deciding to act on loan defaults.
- Changes to conditions of lending: borrowers experienced detrimental changes in conditions to their facilities, including increased interest rates and conditions in facilities and overdrafts.
The Commissioner also noted that borrowers were unhappy with the practice of banks to appoint external administrators. Often the administrators were unable to realise the full value of the borrowers land. The conduct of receivers is not within the direct scope of the commission, however the Commissioner questioned whether such appointment should be a last resort.
The Commissioner firstly considered the concept of “market value” and what should be done when it changes. Market value of agricultural land fluctuates due to changing external conditions. For example, there may be no market for land that has been subject to prolonged drought or extreme flooding.
The Commissioner questioned whether, in these circumstances, valuations of land were a reliable tool to assist a bank in determining credit decisions. A valuation could cause an LVR breach despite the borrower being able to service their debt. Similarly, an incorrect valuation may result in a borrower borrowing too much, or too little.
Second, the Commissioner considered how banks were valuing land. The case studies revealed that banks did not always use independent valuations and instead, relied on internal appraisals or other valuations. This meant that some borrowers had borrowed an amount exceeding the value of their securities and were forced to sell following a revaluation.
The Australian Prudential Regulation Authority (APRA) reported that it is longstanding best practice to obtain an independent valuation and proposed to formalise this requirement. The Commissioner urged the prompt implementation of this proposal.
Banking service support
The Commissioner considered the difficulty that borrowers experienced in gaining adequate access and support to banking services. Some examples of conduct falling below the expectations of the community include:
- individual frontline staff members engaging in inappropriate sales practices to increase their personal incentive payments
- fee waivers and package benefits being applied incorrectly
- default interest charged to borrowers incorrectly
- staff members inadequately trained
- staff members failing to inform borrowers of hardship policies, even if asked, and
- failing to accepting reasonable offers from distressed borrowers.
These issues were caused by errors in banking systems, internal procedures and inconsistent information provided by staff members. The case studies also revealed that banks provided inadequate support for distressed loans. The Commissioner questioned whether distressed loans should only be managed by experienced agricultural bankers. Borrowers were frustrated with the lack of understanding from banks about seasonal cash flow and the impact of adverse environmental conditions on the ability to service debt. Without specialist knowledge, the bank cannot make timely and informed decisions about the steps that should be taken to rehabilitate the loan.
Default interest and the enforcement of securities
The Commissioner noted there had been an inflexible approach taken by banks towards borrowers in financial difficulty or difficult personal circumstances. Two themes emerged from the case studies:
- the application of default interest, and
- the enforcement of security.
First, the case studies displayed the financial strain placed on farmers in drought declared areas who were charged default interest on their facilities. In one example, a borrower was using 40% of their income on interest payments. The Commissioner questioned whether default interest should be charged in these circumstances and whether banks should implement policies to that effect.
Second, the case studies displayed examples of farmers being required to sell their land in unfavourable market conditions and off-season demand, rather than waiting a few months to put the property to market. The Commissioner questioned whether requiring farmers to sell their land should be used only as a last resort. The banks were displaying a lack of understanding of the farmers’ emotional connection to their land and not realising the full value of the land.
Hardship policies and farm debt mediation
Two alternative types of support can be provided to borrowers’ who are suffering hardship: hardship policies and farm debt mediation. All banks have hardship policies. These work in the best interests of both the bank and the borrower. However in the case studies, staff members failed to advise of, and implement hardship policies, despite their existence.
Banks and borrowers can engage in farm debt mediation to resolve their issues. In Australia, there are differing versions of this mediation and the Commissioner stated that there appears to be “an obvious advantage, and no evident disadvantage” in making national provision for farm debt mediation. Australian commentators have stated that a national scheme would be one of the most widely supported and least-opposed recommendations in the interim report.
Chapman Tripp comment
Farming and agriculture is the largest sector of the tradeable economy in New Zealand. It is important that New Zealand banks are engaging in conduct that meets the expectations of the community in this area.
The most recent Federated Farmers Banking Survey showed that farmers’ overall satisfaction with their bank(s) dropped since the previous survey, but still remained strong at 79%. This left 8.2% of farmers’ dissatisfied or very dissatisfied and 12.6% neutral. The findings of the interim report could be used by New Zealand banks to reduce these numbers and ensure a high percent of their agricultural customers are satisfied with the service provided.
The following questions could be of interest to New Zealand banks:
How do land valuations influence credit decisions and should land valuations should have less impact in this process?
There has been recent indication from some New Zealand banks that agricultural credit decisions will increasingly depend on considerations such as sustainable farming practices and performance, rather than land value. In light of the interim report, this may indicate a better way to make credit decisions going forward.
Are banks providing adequate support to borrowers with distressed loans?
The proportion of farmers who report feeling undue pressure from their bank(s) in relation to overdraft and mortgages has markedly increased in the dairy industry according to the Federated Farmers Banking Survey. Banks may want to consider whether loans are being handled by staff members with enough knowledge of the agricultural sector.
Should default interest be charged in situations where the bank has knowledge that a borrower is under financial stress due to uncontrollable external influences?
There are many unpredictable external factors that can affect a farmer’s ability to service debt. In New Zealand, farmers are currently concerned about increased regulation and compliance cost including pests, diseases and biosecurity. Farmers also have concerns about climate change policy and whether biological emissions may be included in the emissions trade scheme. Each of these changes could have a significant effect on cash flow and therefore profitability.
It may be beneficial for banks to consider how default interest will be approached in these, or other circumstances, and whether it should be charged at all.
At what point do banks appoint an external administrator and should this be a last resort?
New Zealand banks should consider the process they have for undergoing farm debt mediation and the implementation of hardship policies, and whether these should be used before appointing an external administrator.
Parliament recently considered implementing the Farm Debt Mediation Bill. The bill looked to amend the Receiverships Act 1993 to include a mandatory mediation step before the appointment of a receiver for agricultural debt. The select committee examining the bill recently recommended that the bill not proceed, and noted that it would instead be introduced as a government bill. Banks were generally in support of the bill and if a similar process is introduced through a government bill, this may help to mitigate the adverse results arising from the appointment of external administrators highlighted in the interim report.
Our thanks to Emily McNaughtan for writing this Brief Counsel.