Farmers in Australia and New Zealand have traditionally relied almost exclusively on a handful of banks to meet their debt financing needs. However, as the agriculture sector continues to expand and banks are unable to meet the demand for finance due to regulatory constraints, opportunities are arising for private market investors to offer agriculture credit solutions.
Adrian Redlich, CIO at Merricks Capital, James Murfett, agriculture portfolio manager, Dan O’Donoghue, head of private credit, and Geoff Davis, head of portfolio management explain more about the opportunities.
Q What are the key features of the agricultural finance landscape in Australia and New Zealand?
Adrian Redlich: The agricultural credit market in Australia is highly concentrated and dominated by the commercial banks, with 93 percent of credit coming from five Australian banks and their New Zealand subsidiaries, plus one or two international players. The commercial banks have been facing ever increasing restrictions in the space over the past decade. Tighter prudential regulations following the global financial crisis have increased the requirement to hold capital and led to a reduction in risk taking. This has created an opportunity for non-bank lenders, such as private credit fund managers. In other sectors, such as commercial real estate or asset-backed securities, we’ve seen increasing allocation of capital in Australia and around the world coming from private credit. But in agriculture, there’s been little new provision of capital outside the banking system. Demand for agricultural credit is growing by just under 8 percent, but the supply of credit from the banking system is only growing by around 4 percent. So, in a market that’s approximately $135 billion, there’s a gap of $5 billion-$6 billion a year in capital that can’t be provided by the banking system. As an investor, you can spend your life looking at the macro and trying to predict what’s going to happen, but if you can identify where there’s a scarcity of capital, you should find good investment opportunities. The agriculture sector provides just such an opportunity, and Merricks Capital is well positioned to capture it.
Q How should agriculture credit investors deal with climate volatility?
Geoff Davis: The foundation of our agriculture investment strategy is to build a resilient, well-diversified portfolio that can withstand the inevitable disruptions of the sector. Having navigated floods, cyclones, avian influenza and abrupt trade embargoes, we understand the importance of only underwriting sectors we know deeply and diversifying across borrowers, regions, commodities and production systems. Because credit carries capped upside, minimizing downside risk is critical. We structure loans to mitigate unexpected events, including climate risk, and work closely with borrowers when issues arise. An experienced team is essential: when necessary, we exercise commercial judgment and reassess credit through our defined investment process to manage investments through seasonal challenges, ensuring our credit decisions align with both portfolio performance and each borrower’s longterm viability. A recent example is our financing of apple orchards in Hawke’s Bay, New Zealand, severely impacted by Cyclone Gabrielle in February 2023. Through proactive engagement – including site visits and co-ordination with other creditors – we ensured the borrower could trade through the aftermath. By restructuring the loan to allow a 12-month extension, the properties transacted as planned at a 30-40 percent premium to immediate post-cyclone levels and matched the 2021-22 peaks for New Zealand horticulture.
Q How can managers decide when the time is right to deploy capital into agriculture credit?
AR: It’s important in a highly cyclical industry like agriculture that when you lend with a two-to-three-year lens that you have a view on where your borrower is going to be in two- or three-years’ time, not just today. We did have some concerns about global growth a year or so ago, particularly with China slowing, and the potential impact on commodity prices. But that has stabilized. From a top-down perspective, one thing that’s very important to focus on with Australian and New Zealand credit is the export parity. We’re now at a point in the cycle where currencies are weak relative to the US dollar, the cost positioning of the sector looks good and the revenue outlook looks stable. There’s also a shortage of supply in commodities like beef, so we can expect robust pricing. In the agriculture credit space, we’re lending against farmland. Farm values have proven to have extremely low volatility, compared to commercial real estate or housing, so our underlying collateral remains extremely stable.
However, the revenue line is important in terms of the quality of the underlying borrowers. The uptick in the export parity, in terms of Australia’s and New Zealand’s competitiveness, means the outlook has improved. We can afford to adopt a more aggressive approach.
“One of the overarching benefits of agriculture credit is that it’s performed well in an inflationary environment” ADRIAN REDLICH
Q Which subsectors are currently attractive?
James Murfett: The horticulture sector is providing a lot of opportunity. It has not attracted a great deal of capital over the last couple of years due to challenging seasons and relatively modest returns due to softer commodity prices. But we believe there are relatively strong tailwinds to support borrowers and fill that gap in the short term. With almonds, for example, 80 percent or more of global production is out of California, but the planted area there is shrinking. That’s creating opportunities for other growing regions, such as Australia, where we are well positioned to provide support to the growers. We also see opportunities in Australian beef. It’s a sector we’ve watched closely for years – cattle prices went through the roof in 2021/22 due to favorable weather conditions and the national herd rebuild, and our investments did well through that period. Then there came a point where the commodity price got too high, and we didn’t write any new credit in that sector for 18-24 months. We didn’t think there was much upside left in it, which turned out to be accurate. But the current herd rebuild in the US is going to tighten supply and potentially provide some strong new tailwinds for pricing here in Australia.
Q How can agriculture credit funds compete with banks?
AR: A key difference is that we tend to charge higher interest rates than the banks. This is because we’re funding borrowers that are generally in a growth and transition phase. When they achieve a more stable operating environment they tend to go back to traditional banking. Or, they’ll have achieved their growth targets and they’ll be in a position to sell to bigger institutional players. That’s been a significant theme in Australia in particular. Domestic and foreign pension funds have been the most active buyers of large-scale farming assets, typically from individual corporations that are backed by individuals and families that have created value through aggregation and development. It’s a major theme of the exits of our borrowers. We are aware of more than 50 institutional equity players investing in Australian agriculture.
“Farmland is a scarce resource and land values are less correlated to macroeconomic events than commercial real estate” DAN O’DONOGHUE
Q How does agriculture credit compare to credit strategies in other asset classes?
Dan O’Donoghue: The volatility of asset prices is probably the main differentiator from, say, commercial real estate. Farmland is a scarce resource and land values are less correlated to macroeconomic events than commercial real estate, which means that farmland is seen as a store of value. My grandfather used to remind me that they don’t make farmland anymore. And, as cities expand in different parts of the world, and in Asia in particular, there’s less farmland than there was 25 years ago. So, we certainly see it as a safer and more robust valuation asset class. Our competition in raising money in agriculture comes from other fund managers looking to deploy into the sector, in particular the more than 50 agricultural equity funds. In agriculture credit, we effectively have a fixed income product. Returns are compressed, but because of the competitive environment that we find ourselves in today, we’re still able to achieve the same returns as we are in other asset classes, with considerably less volatility in asset values. We effectively have contracts with the borrower to pay us a fixed amount over a fixed period, so our returns are not correlated to commodity price or asset value, which is the key differentiator in a credit strategy.
AR: One of the overarching benefits of agriculture credit is that it’s performed well in an inflationary environment. That is because the revenue of most farms tends to be linked to inflation. So, it’s offered, for many investors, a rewarding portfolio diversification. Whereas higher inflation, which has meant higher interest rates, has proven to reduce valuations in other real estate equity or real estate credit strategies. In agriculture, valuations have been more resilient because the higher revenue offsets any implications from higher interest rates.
