How banks value a farm: what borrowers should know before applying for finance

 

The central message should be that a bank does not lend merely because a farm is worth several million dollars. It usually considers two separate questions:

Is the farm and other security sufficient to protect the bank?

Can the farming operation generate enough cash to service the debt?

Both must generally be satisfactory. ANZ has described repayment capacity as the central consideration in primary-production lending, while also taking account of the borrower’s farming capability, projected cash flows, security and industry conditions.

How the farm is valued

A rural valuation is more complex than valuing a suburban house. The valuer may consider:

• Recent sales of comparable farms.
• Productive hectares rather than total hectares.
• Soil type, rainfall and water security.
• Irrigation licences and infrastructure.
• Carrying capacity or expected crop yields.
• Fencing, sheds, yards, housing and machinery improvements.
• Road access and proximity to processors or markets.
• Land condition, weeds, erosion and contamination.
• Restrictions, easements and environmental obligations.
• How readily the property could be sold.

APRA requires bank collateral valuations to reflect fair value and prevailing market conditions, including the likely time required to sell or realise the security.

That last point is important. A neighbouring farm may have sold for an exceptional price, but the bank’s valuation may be more conservative if the property would appeal to only a small group of buyers.

Value is not borrowing capacity

A farm valued at $5 million does not automatically support a $4 million loan.

The bank will calculate a loan-to-valuation ratio, but it will also test whether the borrower can meet interest and principal repayments. The land provides collateral; it does not itself make the repayments. APRA describes the LVR as a measure of the extent to which a loan is supported by collateral, rather than a substitute for assessing whether the debt can be serviced.

Banks may therefore lend less than a borrower expects, even where substantial equity exists.

Income and productive capacity

The bank will normally examine several years of accounts, tax returns, livestock schedules, crop records and cash-flow forecasts.

It may assess:

• Average farm income over several seasons.
• Commodity price volatility.
• Seasonal production risks.
• Existing loans and equipment finance.
• Family drawings and living costs.
• Interest-rate increases.
• Drought, flood, disease and input-cost risks.
• The borrower’s experience and management record.
• Whether income is diversified.

A single exceptional year may not carry much weight. The lender is more likely to consider sustainable earnings across both favourable and difficult seasons.

This is why banks offer seasonal facilities and working-capital products in addition to long-term land loans. Agricultural income does not arrive evenly each month, and farm finance must often accommodate the production cycle.

What counts as collateral

The farm is usually the principal security, but it may not be the only asset considered.

Additional collateral could include:

• Another rural property.
• A residential property.
• Water entitlements.
• Livestock.
• Plant and machinery.
• Cash deposits.
• Guarantees from related parties.

However, not every asset will be accepted at its estimated sale value. Banks may discount livestock, machinery and other assets because prices can fluctuate and selling costs can be substantial.

The lender may also distinguish between fully secured, partly secured and unsecured exposure according to how the loan compares with the bank’s assessed value of the available security.

What applicants should prepare

The practical service element of the article should explain that borrowers can improve the quality of an application by arriving with:

• Three years of financial statements and tax returns.
• Current livestock, crop and asset schedules.
• A realistic cash-flow forecast.
• Details of existing liabilities.
• Production history.
• Water licences and lease agreements.
• A business plan explaining how the loan will increase income or efficiency.
• Evidence that the operation can withstand lower prices, poor seasons and higher interest costs.

The borrower should also understand that the purchase price and the bank valuation may differ. When the bank valuation is lower, the purchaser may need to contribute more equity.

The Rural Times View

A farm may be valuable property, but to a lender it is also a business exposed to weather, commodity markets, operating costs and management decisions.

Land value gives the bank security. Farm income gives the borrower the capacity to repay. Additional collateral may strengthen the application, but it cannot permanently compensate for an operation that does not generate sufficient cash.

Prospective borrowers should therefore ask two questions before approaching a lender: What is the farm conservatively worth, and what level of debt can its normal earnings safely support?

The strongest farm-finance applications answer both.