A golden era for farm borrowing?

Farming is a capital intensive industry with money required to fund land, buildings, machinery and stock. More recently, many businesses will have also borrowed to invest in on farm renewables.

The latest statistics available from 2018 show that bank advances to Scottish agriculture totalled £2.34bn. To put this in context, the area of crops and grassland in Scotland, excluding rough grazing, amounts to c. 4,680k acres. Average debt therefore amounts to £500 per acre, although this will of course mask wide variations between businesses, with many operating with no bank debt.

In response to COVID-19, bank base rates were cut to a historic low of just 0.10% compared to 0.75% at the start of 2020, resulting in savings for those borrowing on variable interest rates. Currently the long term outlook for interest rates remains subdued and it is possible to borrow long term on very attractive fixed rates. For those old enough to remember it seems that we have come a long way from the dark days of the early 90s, when base rates approached 15% and finding the cash to pay the interest, never mind the capital repayments, was a very real concern.

In line with what happened in the financial crisis of 2008/09, agriculture seems set to retain its “safe haven” status, with banks remaining keen to lend to the sector. Hopefully this will continue, but as in life there are no guarantees.

For those business with significant debt now may be an opportune moment to review the structure of their borrowing. Is the balance between overdraft and long term loans correct? Should more of the debt be to moved onto fixed interest rates given the attractive rates currently available? Is the repayment profile appropriate for the cash generating ability of the business? These are all valid questions to ask and given the unique circumstances in which we find ourselves would it not be prudent to take stock?

It may also be worth considering the security on offer. Banks will typically look for a maximum loan to value ratio of 60-70%. If possible, there may be advantages in retaining a parcel of land unsecured so that if necessary, security can be granted to a secondary lender at a future date thereby maintaining added flexibility.

Low interest rates may also encourage some to borrow to invest or expand. This can of course make perfect sense provided the return generated from the new project exceeds the costs of borrowing. Taking on “unproductive” debt to fund losses or drawings however seldom ends well.

Although banks are willing to lend very long term to agriculture, at some point the debt will have to be repaid. Unless this is to be achieved from a future asset sale it is likely that any debt will have to be repaid from trading profits. Trading profits are of course subject to tax and with personal income tax rates in excess of 40% for higher rate taxpayers (and likely to rise) the level of funds available for debt repayment post tax may be less than expected. If borrowing significant amounts for new projects, consideration should be given to investing and borrowing through a corporate structure. Any profits earned in a company are currently subject to a flat rate of corporation tax of just 19%, thereby maximising the funds available for debt repayment. As always, specific advice should be sought on business structure, but if repayment of debt out of trading profits is a priority then a corporate structure can have significant advantages.

With interest rates at record lows borrowing has never been cheaper. Now is the ideal time to ensure that farm finances are correctly structured to ensure that businesses maximise their chances of success whatever the future may hold.

If you would like to discuss your circumstances or get our advice on your farm finances, please get in touch with our EQ Agriculture team via agriculture@eqaccountants.co.uk or call 01307 474274 / 01334 654044.