Financial Services Royal Commission: How the Interim Report deals with Agricultural Lending

The Interim Report of the Financial Services Royal Commission (available here) was tabled in Parliament yesterday.

Section 6 deals with Agricultural Lending, and concludes by identifying a list of ‘key questions’ for further consideration.  The full list is reproduced at the bottom of this post, but for me the most important are:

Farm Debt Mediation

• Should there be a national system for farm debt mediation?
• If so, what model should be adopted?
• Should lenders be required to offer farm debt mediation as soon as an agricultural loan is impaired (in the sense of being more than 90 days past due)?

There is mandatory FDM in South Australia, Victoria, Queensland and New South Wales, and a voluntary scheme in Western Australia.  There is no legislative scheme in Tasmania, the Northern Territory or the ACT.

To replace the current patchwork coverage with a national scheme would be one of the most widely supported and least-opposed recommendations that the Royal Commission could make.  It will be easier for lenders to comply if they do not need to manage up to seven different regimes, but there is more to it than that.  Some borrowers will have farms either side of a state boundary, or will cross a State border to sign loan documents, and it will be easier for them too if only one regime applies.

The NSW system is the most well established, and best developed – it is the model that should be adopted.  There is one feature of the Victorian scheme which should be applied nationwide however: assistance with the cost of mediation so that farmers can always afford to engage.

A current problem is that FDM regimes are only available where there is a default.  It would be helpful if mediation schemes could be accessed prior to that point, but the proposed linkage to the loan being ’90 days past due’ does not go far enough.  A better option would be to also allow access to the scheme where a lender has determined that it is not prepared to extend a current loan.

Conduct of valuations

• How, and by whom should property offered as security by agricultural businesses be valued?
• If prudential standard APS 220 is amended to require internal appraisals to be independent of loan origination, loan processing and loan decision processes, when should that amendment take effect?

To those of us in capital cities the answer seems clear and obvious: a banker originating a loan should never be involved in valuing the security.

A farmer west of Longreach however, might be frustrated to be told that their loan approval will be held up until someone can get out from head office, and that they will need to meet the travel and accommodation costs.

There does need to be some allowance for a local banker with appropriate training in remote locations to conduct valuations for relatively small loans or small increases to existing loans.

Should LVR ratios be capped?

• Is the possibility, or probability of external shock sufficiently met by fixing the loan-to-value ratio?

A maximum LVR sounds like a practical way of ensuring that borrowers retain some level of buffer to allow them to cope with external shocks – but it will be a double-edged sword.  A hard-coded LVR limit would also stop lenders from providing carry on funding – potentially forcing the sale of farms.

Enforcement only as a last resort

• In what circumstances may a lender appoint an external administrator (such as a receiver, receiver and manager or agent of the mortgagee in possession)?
• Is appointment of an external administrator to be the enforcement measure of last resort?

Each of the banks that gave evidence would agree that the appointment of an external administrator should be the last resort.  The difficulty arises in practice: what does ‘last resort’ actually mean, and when has that point been reached?

It is significant that all but one of the case studies were either from states without mandatory FDM, or pre-dated the current FDM.  There is good reason to think that FDM has played an important role in avoiding the need to enforce at all.

Not only does FDM provide an unmistakable signal to all parties that the point of ‘last resort’ may be approaching, at the same time it provides them with an alternative to enforcement.

The Next Phase

The executive summary explains that the next round of public hearings will address the questions raised in the interim report.

 

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The Interim Report of the Financial Services Royal Commission is available here.

5.0 Issues that have emerged

All agricultural enterprises are subject to the effects of events beyond the control of the individual farmer. Occurrence of any of these events, let alone a combination of them, will affect cash flow and profitability and, hence, the ability to service debts. Their occurrence will often have profound personal effects on those who conduct the business.

Four issues emerged: about revaluation of securities; difficulties in obtaining access to banking services and appropriate support; changes to conditions of lending; and, enforcement by appointment of external administrators.

The particular questions can be identified as including:

• How are borrowers and lenders in the agricultural sector to deal with the consequences of uncontrollable and unforeseen external events?
• Does the 2019 Banking Code of Practice provide adequate protection for agricultural businesses? If not, what changes should be made?
• How, and by whom should property offered as security by agricultural businesses be valued?
  • Is market value the appropriate basis?
  • Should the possibility, or probability of external shocks be taken to account in fixing lending value? How?
  • Should the time for realisation of security be taken to account in fixing value? How?
  • Is the possibility, or probability of external shock sufficiently met by fixing the loan-to-value ratio?
  • If prudential standard APS 220 is amended to require internal appraisals to be independent of loan origination, loan processing and loan decision processes, when should that amendment take effect?

• Should distressed agricultural loans be managed only by experienced agricultural bankers?
• Do asset management managers need more information (such as the cost to the lender of holding the loan) to make informed commercial decisions about management of distressed agricultural loans?
• Are there circumstances in which default interest should not be charged?
  • In particular, should default interest be charged to borrowers in drought declared areas?
  • If it should not, how, and where, is that policy to be expressed?
  • Should the policy apply to other natural disasters?
• In what circumstances may a lender appoint an external administrator (such as a receiver, receiver and manager or agent of the mortgagee in possession)? Is appointment of an external administrator to be the enforcement measure of last resort?
• Having regard to the answers given to the preceding questions:
  • Is any regulatory change necessary or desirable?
  • Is any change to the 2019 Code necessary or desirable?
• Should there be a national system for farm debt mediation?
  • If so, what model should be adopted?
• Should lenders be required to offer farm debt mediation as soon as an agricultural loan is impaired (in the sense of being more than 90 days past due)?