Vigilance around fixed rate mortgages

This is leading many rural borrowers to consider if now is the time to be looking at fixing rates. Head of Corporate Agribusiness at Crowe Horwath, Hayden Dillon, cautions that with markets still showing volatility, making hedging decisions simply by following economists’ advice can be fraught with danger.

“Even with another cut appearing to be imminent, the market appears to have little appetite for more, and inevitably talk will begin around when they may start to go up,” says Dillon.

“Many rural borrowers are now looking at an interest rate curve that is still relatively flat, and thinking now could be the time to take some cover. But there are variables that you need to be aware of before you start to consider your options.”

The commercial and rural industry is experiencing a new era of banking and as such banks are being set higher hurdles by regulators to maintain their stability. As a result in some cases they have added in additional clauses into lending agreements. Dillon points out that it is important to ask the right questions and fully understand all the relevant clauses before being seduced by the bankers’ fixed rate offers.

“It is important to understand exactly what your agreement with your lender is for the fixed rate before signing up to anything,” Dillon says.

“Since the global financial crisis lenders have adjusted clauses in fixed term rates to provide themselves with more flexibility to exit the loan if they are not comfortable with the credit conditions. In the event your credit position deteriorates, some contracts will allow the bank to exit the fixed loan, and any costs are borne by the client. This is why you need a full understanding of exactly what your agreement with your lender actually means.”

The global financial crisis also brought in new central bank regulations from the government for banks to comply with. While these changes have created legitimate additional costs, they should not be used as an opportunity for banks to obtain a few extra points at the borrower’s expense. Dillion explains, “You need to ensure there is transparency in your pricing. Whatever your credit position, you want to ensure you are getting the best possible outcome for your business.”

There are various ways to do this and Dillon points out the best way will depend on the business’ credit position and the type of lending facilities being used.

Dillon notes, “Each bank has its own yield curve, this means that even though you may have the same credit margin as your neighbour, each bank has a different cost of funds for the lending so your ‘all up rate’ will be different.”

Dillon cautions that event risks such as Brexit continue to linger as potential dangers to the markets, and their effects are very hard to predict and with this in mind, as well as taking into consideration the new challenges post the global financial crisis, farmers should work on establishing their own hedging strategy that takes into account their risks and ability to manage them.

Dillon advises, “Once you go through a process of asking yourself ‘what if’ questions to assist in establishing a hedging framework. You will find it easier to act proactively, rather than being reactive to the market commentary.”

While markets and banks operate quite differently now, it does not change the need for a good hedging policy to help manage business risk, nor does it mean that you cannot implement one with the current yield curve. However, it does mean that you need to do your homework before entering into any decisions and of course the larger the debt, the more is at stake so ensuring you have quality independent advice in this environment is a good investment.