I was posed the question. “How do you get a bank loan?” The answer is simple, but the action is much harder. That is, it is easier said than done.
First, you need to be able to demonstrate your business has historically been profitable. Five years of annual accounts supplied by your accountant will demonstrate your level of historical profitability. If you have been through a period of capital expansion or development, you will need to do some explaining. It will help immensely if you can fully explain what has been happening rather than “you had better ask my accountant”.
Secondly, you will need to convince the bank your business will continue to be profitable over the coming five years. This will require you to make some budgeting assumptions on production, income and costs. These assumptions will need to be backed by sound justification.
Using a budgeted lambing of 140% when your historical average is only 125% is going to take some justifying. If your personal drawings have historically averaged $120,000/year, don’t try to fool yourself and your banker by budgeting $80,000. They won’t believe you. In the same way, don’t budget $140/lamb, when the long-run average has been significantly less.
How profitable does your business need to be? Simplistically, you will need to demonstrate that you will be able to repay your debt from cashflow over a 20-year time frame.
Thirdly your business needs to be sustainable. Not only financially, but also environmentally and ethically. You will need to demonstrate you are good at what you do, you are financially literate, and you are fully aware of the many challenges that are coming at you. That is, you don’t have a head-in-the-sand or she’ll-be-right attitude.
Finally, you need to be able to supply the bank with adequate security for them to fall back on, just in case the budgeted assumptions don’t come to fruition. Essentially this is a reflection of the strength of your balance sheet.
As an absolute minimum you need to have 40% equity in your business. Ideally though, it should be greater than 50%. The more uncertainty there is around your historic and projected profitability and your own capabilities, the greater the level of equity you will need to have in your business.
Therefore, in very simplistic terms, there are four boxes you need to tick. If you can justifiably tick every one of those boxes, banks will still fight and compete for your business. In that regard, it is still a very competitive banking market.
The problem is though, in the current banking environment, if there is doubt in any of those boxes, banks will look for business elsewhere. Sadly, “elsewhere” may actually mean a completely different sector altogether.
The Reserve Bank of New Zealand (RBNZ) is of the view that the rural sector is over indebted, particularly dairy. So, banks are less inclined to take a risk on a “box” with a question mark.
Further compounding the situation from the banks’ point of view is they are now required to hold more capital on their balance sheet. It is too complex to explain in a 700-word column, but the guts of it is, the RBNZ announced in December 2019, banks need to reach a minimum capital ratio of 18% of risk-weighted assets over the next seven years.
Currently that sits at about 14%. In dollar terms, that equates to around an $18-$20 billion increase in capital. Just for clarity, the increase in capital doesn’t come from increasing deposits. It comes from bank shareholders. Why would shareholders agree to increase their level of capital invested? There is only one reason. Return on investment. Banks need to be profitable to attract and retain capital.
For banks to be profitable, they need to lend into areas that give them the best return on their capital. Therefore, banks will become increasingly discerning not only in which sector they lend into but also who, within that sector, they lend to.
Therefore, make sure your business and your management has a warrant of fitness. If it doesn’t, what are you going to do about it?
- Peter Flannery is an agribusiness advisory for Farm Plan, Invercargill.