Asset-based lending is climbing to the top of the UK government’s economic recovery agenda. Despite political moves to encourage (some might say ‘coerce’) the banks to lend more – e.g. George Osborne’s recent meeting with bank heads regarding the new mortgage plans – there are swathes of small businesses which fail to meet banks’ lending criteria and must look elsewhere for finance, especially when less familiar plans and purchases need to be financed.
Additionally many overlook the fact that that Bank “capital adequacy” requirements are often significantly higher for lending to small businesses compared to residential mortgages etc., which may go some way to explain why Royal Bank of Scotland and HSBC have between them made almost 100,000 redundant and exited almost 100 non-core businesses in just the past couple of years and ING has left the UK entirely, which was previously a significant lender in the agri space.
The agricultural sector is a case in point. To state the position bluntly, farmers need tractors and combine harvesters. These cost money – a typical tractor cost is some £65k and a combine may run to three times that. Farmers are also trying improve their businesses by increasingly getting into the energy space by undertaking power generation on site (wind turbines, anaerobic digesters, solar panels and so on) and these are equally pricey with, for example, a small wind turbine coming in at £60k and few banks will provide finance despite attractive long term, index linked government backed “feed in” tariffs.
Even though any loan or lease arranged to support the purchase of these and many other key agricultural items, is secured on the value of that item, as well as on the farm business and is in some cases supported by personal guarantees, there’s an undersupply of finance and, unsurprisingly, an oversupply of demand.
This funding imbalance is allowing non-bank finance houses jointly to offer valuable lines of finance to the agricultural sector and, at the same time, via a fund structure, to achieve equally valuable, secured returns to private and institutional investors at a time when yields from traditional investments are low to non-existent.
What sort of returns can investors in funds offered by asset-based lenders in this sector expect to receive? Well, if past history is anything to go by, something like 6%-8% net per year is a reasonable target although these numbers will vary, not only with the state of the farming industry but also with the type of loan offered and therefore the amount of risk the manager (and by extension, the investor) is prepared to take.
In broad terms, it’s possible to divide the loan book into three cohorts divided by the planned use of the loan, by time horizon and, partially, by the security backing the loan. These three will command different rates of interest (higher at the long-end).
For example, if the purpose of the loan is to buy a main machine integral to the success of the business – a tractor for example – a one to three year duration is normal yielding a gross target return of 7.5% – 9%. However, funding longer-term such as for land purchases, may have a duration of four to seven years and command a concomitantly higher interest rate.
In my experience, the average lending period is four to five years and the average loan to asset value is between 70% and 80% with an average loan value of £75k but of course other managers may be working with different numbers.
This is a good and, dare I say it, valuable business to be in and there are relatively few threats to investment returns given the whole is underpinned by the fact that 75% of the UK’s surface area is managed by farmers (who provide some 60% of the UK’s food requirements) and so are integral to the structure of the country.
Yes, there are occasional defaults and arrears but these must be expected in any lending operation and are almost inevitably covered by the value fo the asset and by separate security underpinning any loan.
Competition from other finance houses (or indeed from renascent banks) should not pose problems even into the next decade. There’s room for all particularly as the UK economy seems to be staggering back into the black prompting increased demand for cash to support business development.
The growing uncertainty re the UK’s membership of the European Union with its notorious Common Agricultural Policy (CAP), seems unlikely to have major repercussions given successive British governments’ enthusiasm to increase national food security; moreover, farming will always be a key industry as the global population increases.
The great US entrepreneur, Paul Getty, is resonant here: “Money is like manure, you have to spread it around or it smells.”
