Is the end nigh for Interest-only loans?
There has been a lot of media coverage lately around pressure being brought to bear on some of the main lenders in the New Zealand banking sector.
These pressures are coming from the Reserve Bank of New Zealand, the Australian banking regulators and the banks own internal analysis around their sector exposures.
One area specifically referred to by a number of media commentators is the over-exposure to the agricultural sector, be it dairy, horticulture, sheep and beef or some other form of rural lending.
So, what does this potentially mean for the sector and what are we already experiencing at the coal face?
Budgets – more emphasis is being placed upon accurate and updated budgets by lenders. It is vitally important to have an idea of how your lending requirements might pan out over a particular season. It is equally crucial to regularly update your budget as things can often change day to day in the agriculture sector, meaning bank lending limits may need to be moved at relatively short notice.
Banking covenants – again more attention is being paid to the terms and conditions attached to lending and whether your business is meeting those requirements. A common condition is having sufficient income to cover the interest being paid to a certain level. There has not been as much emphasis on this measure in the past, as the focus was very much on the net equity of the business.
It is now an expectation that the ability to service the loan is equally as important as the overall net equity position.
Potentially the most significant looming change for the agricultural sector is the reluctance of lenders to continue to rollover interest only loans. Why you might ask, when your facility has been interest only for 10 or more years? The answer is twofold.
It is now expected that a business should be sustainable to a point where it can pay back both principal and interest. The reliance on increasing capital values is no longer enough to guarantee an interest only facility.
As mentioned earlier, there is a general push by the lenders to reduce their sector exposure by changing the loan repayment terms to principal and interest. this means with each payment made, the overall loan balance is reduced.
So, this leads into the following things you should be asking yourself:
• What loans do I have on interest only terms and what is the expiry date?
• Am I able to take on a loan that requires principal and interest repayments?
• What term or mix of terms should I spread my repayments over; and
• What amounts should be fixed or floating? How does this effect my annual budget and cash flow?
If any of these questions leave you in some doubt as to the answer, then you should seek independent advice.