Why farmers pay higher interest on loans

Specialist farm lending can be very profitable. Competition does not seem to wipe out the premium farmers tend to pay compared to other mortgage lending. It has puzzled economists from time to time.

Andrew Little’s stupid threats reported on Stuff this week remind me why good farmers pay too much for their mortgages. I suspect he has just helped ensure more years of super-profits for farm lenders.

I’ve seen no recent study, but the farm sector interest margin was estimated to average over half a percent over many years when I was a lawyer for various farm financing institutions and a director of Wrightson and its finance company arm.

Stock and station agencies were able to profit in that market, despite higher costs of funds and lower prospects of ‘back office’ economies of scale, because of information synergies. They could draw on the knowledge of their agents and branch staff to appraise risk, and to know early when to pull the plug. They were rarely caught having to enforce their securities with formal mortgagee sales. But other lenders too had low loss experiences most of the time, certainly low enough in the main study I recall to justify a narrowing of the gap between farm lending interest rates and the rates charged on other mortgages with similar security.

We concluded that farmers were paying hundreds of millions extra in interest mainly because of a unique sector risk specifically created by farmer politicians, and farmer activist groups. In no other sector will the borrowers as a class gang up to prevent enforcement. Selling up a farmer was often difficult, emotionally draining, expensive in legal costs and very slow. Farmer blockades, threats to bidders at mortgagee sales, and the risk of political intervention created a profile that added a precautionary extra risk premium smeared across the whole sector.

It affected even the best borrowers, because of the theoretical possibility that political intervention could put even their mortgages into a compulsory forgiveness regime, as was done in the 1930s, or enable unilateral deferment of payments, or prevent practical enforcement.

I recall discussing it with Federated Farmer board members. They pointed out that it had been many years since anyone in their leadership had been calling for farmers to use force or threats collectively to over-ride contractual obligations. They agreed that those sold up were usually in a hopeless position, and often much better off emotionally after it was all over than when they were trying to fend off the inevitable. Sometimes even the activists would admit privately that the person they were trying to “protect” was actually a dud farmer, and would never make it work.

But they still felt good damning the banks and organising collective action. They were much less interested in the actual consequence.

It was not fair, but all farmers paid (and still pay) the price. The sector is landed with a premium because of the long history of anti-mortgagee sale campaigns from groups like the breakaway Northlanders. More recently, those campaigning to make banks liable for letting farmers enter currency risk deals, or otherwise lending “imprudently,” have queered the pitch for the upcoming generation of entrepreneurial farmers.

David Farrar summarises well the stupidity in Andrew Little’s attack on the lenders. There may be reasons to worry about Aussie bank domination. But they are protected in it partly because of knee jerk regulatory responses to the GFC finance company collapses. The Reserve Bank supervision regime (and costs like AML/CFT) now protect the big banks from what should be the understory of new finance companies coming through in business lending to challenge them.

Even more worryingly, the Labour leader wastes his business credibility pandering to people who won’t make an electoral difference for him. How many less competent or stretched farm borrowers are there? Little should let David Parker handle the finance portfolio and stay well away from it. I’ve heard Andrew speak to business people. He would have been better not to show his inability to understand them, or the economy.

In the meantime Mr Little has just reinforced the profitability of mortgage lending to farmers. His calls will not change anything tangible, because most farmers and their advisers know it could be disastrous long term. But in the meantime Labour has handed banks a justification for their premium, just as Mr Little’s colleagues ensured super-profits for those of us who invested in the electricity generation share offers. Their stupid nationalisation threats added risk to the floats, and therefore rewarded those who were willing to accept that risk.

PS For another puzzled and expert reaction, try Croaking Cassandra here.

Stephen Franks is principal of Wellington commercial and public law firm Franks and Ogilvie.

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