Over the past six months there have been many frightening headlines about Northern Rock, US sub-prime lending and feverish speculation about the impacts of a global credit crunch.
So, will these significant pressures in the financial sector be felt by UK farmers in 2008? Well, the good news is that to date there has been no change in the availability of credit. Sound farming businesses with sensible plans have been able to borrow money just as they have in the past.
Agriculture is seen as a secure industry with economic cycles that don’t follow those of the rest of the economy. I honestly believe that even for tenanted businesses without the collateral of the owner-occupier, lending policies will not change.
However, there is one impact that has received little attention so far but that will be having a material impact on some businesses.
Even though at HSBC, our current view is that during 2008 there will be four separate quarter percentage point rate cuts in the Bank of England base rate, this does not mean rates for every bank loan will automatically follow suit.
LIBOR based lending has, until recently, been relatively rare in UK farming with farmers and the “big four” banks preferring to link interest rates to the Bank of England Base Rate.
But over the past couple of years LIBOR-based facilities have been offered by a number of banks. LIBOR is the London Inter Bank Offer Rate and is the rate at which banks borrow from each other on an overnight or short-term basis. Historically the LIBOR rate has followed Bank of England base rate quite closely but with upheavals in the financial markets this link has been broken (at least on a temporary basis).
It is a “market rate” determined by supply and demand and because the banks have had less confidence in each other and the ability to repay, a restriction in supply has driven up the price.
Bank of England base rate
When the Bank of England cut its base rate in December to 5.5%, LIBOR rates barely moved and a differential appeared which immediately impacted on those with LIBOR linked loans.
At the end of December 2007 Bank of England base rate was 5.5% and LIBOR was 6.35% costing those on LIBOR loans an extra 0.85% on their borrowing. For someone borrowing £250,000 this would equate to an additional annual cost of £2125 – if the balance and the differential remained in place for a full year.
The challenge for those with LIBOR-linked loans is to decide will this differential remain in place for an extended period and if yes what can they do to minimise the impact?
The answer to the second question is perhaps easier than the first. In most cases it should not be difficult to switch from LIBOR-based rate borrowing to a Bank of England Base Rate.
If your bank is heavily dependant upon the LIBOR market for raising funds this may be more of a challenge but as I said at the start sound farming businesses with sensible plans should not have a problem with raising finance across a range of banks.
More difficult is to decide whether the extra cost is a short or a long-term issue. This requires a view on future events and predictions are always difficult. In uncertain and volatile times they become even more difficult!
The HSBC Global Economics team also suggests that LIBOR will reduce during 2008, although it is not expected to return to its traditional level of closeness to base rate until nearer the end of the year (see table)
Source: HSBC Global Economics Q1 2008
Much is likely to depend on the level of confidence in financial markets and whether the credit crunch becomes a reality.
At the very least those with LIBOR-based loans should be keeping a close eye on the financial markets and track the differential cost. It would also be wise to understand fully what actions would be required to switch across to Bank of England base rates and what costs might be incurred in doing so.
In the end the decision will rest with the individual farmer and in these uncertain times understanding and managing risk is going to be a significant part of successful farm management.