Memorandum submitted by Barclays Plc
IMPLEMENTATION OF CAP REFORM IN THE UK
INTRODUCTION
Barclays Agricultural Banking is the largest
single lending brand in UK agriculture, with lending exposure
of over £2 billion and a team of over 100 specialist managers
dedicated to the farming industry. Barclays have organised a series
of confidential workshops with key stakeholders within the associated
industries in order to explore and identify key implications.
The learning points from these workshops, as well as over 20 years
experience in the agricultural sector and agricultural banking,
have been drawn on in this paper.
This submission is prepared in response to a
series of seven questions supplied by the committee, regarding
aspects of the implementation of the CAP reform in the UK pertinent
to the capital and financial markets. Some of these questions
are based on assumptions regarding the impact of implementation,
which are addressed in answer 8.2.
1. IMPACT ON
ASSET VALUES
AND SECURITY
FOR BORROWINGS
From a security perspective the relevant assets
are land/property, off farm investments, quota and trading stock,
with land representing by far the majority of security. However
the importance of trading stock and quota values is considerably
higher for the tenanted sector, where land is not typically available
for security purposes.
It is also important to acknowledge that lending
decisions are made on the basis of profit generation and ability
to repay debt, and then subsequently under written by security.
Therefore where cash generation is not reduced, a fall in security
value will not of itself normally bring a loan into default. So
it is the impact on cash generation which would be of primary
concern.
1.1 LAND VALUES
For the last 30 years, there has been little
discernible link between land values and agricultural income for
the UK as a whole. Values are significantly influenced by many
factors such as development potential, fiscal policy, proximity
to conurbations, amenity attraction and agricultural productivity.
However, in some more remote areas, or those with low amenity
and no developmental potential, then agricultural productivity
and appeal are the main determinants of land value. Therefore
in these areas, values would be expected to reflect reductions
in farm income. There could then be a gradient in scale of value
reduction proportionate to distance from the urban areas, reducing
the influence on land value of non-agricultural aspects. However
local conditions will always dominate.
The current period of uncertainty has seen a
significant reduction in both land area being offered on the market
and on the number of agricultural buyers. Where agricultural transactions
have been undertaken, this has often been accompanied by attempts
to include the future entitlements through side letters and contracts.
However the volume of farms sold to non-farming purchasers has
remained level, where it is believed that amenity factors such
as location and residence quality are more important. This situation
is expected to be transitional, with trading returning to more
normal levels once the uncertainty around the implementation of
the MTR proposals is removed.
Since the MacSharry reforms, the arable sector
has seen some evidence of capitalisation of existing IACS payments
eligibility into land values, with higher values being seen for
eligible land compared to similar quality land without eligibility.
In the future, this value could vary according to the likelihood
of the Single Farm Payment (SFP) entitlements being separated
from land or retained in association via Regional Average Payments
or an equivalent hybrid (see answer 5 below).
The livestock sector has not seen such capitalisation
into land, possibly due to the requirement for quotas and the
value of subsidy receipts being directly linked to individual
farming systems. Some capitalisation would be a logical consequence
if the entitlement becomes directly associated with land, potentially
increasing values by around £2-300/acre (see answer 7.2).
Overall, the banking perspective, having allowed
a prudent discount in valuations assumed, and considering security
at a portfolio level (rather than specific farm level), suggests
land value changes are unlikely to cause significant security
issues. However, significant specific issues may emerge in cases
where land values have been significantly reduced. The impact
would cause re-adjustment, after which the use of land as security
is unlikely to be tarnished.
1.2 OFF FARM
INVESTMENTS
Clearly these are unlikely to be affected by
any agricultural trends.
1.3 QUOTA
The value of both livestock and especially milk
quotas tends to be highly volatile, relating to agricultural profitability
and supply and demand. From both perspectives the value of milk
quota would be highly vulnerable and we would expect it to reduce
in value after the de-coupling of the dairy sector. However the
value of livestock quotas would be negated immediately post de-coupling.
Due to the relative ease with which quotas can
be traded they have rarely been considered a major item of security,
though charges would often be taken when borrowed funds were used
for their purchase. The value of livestock and milk quotas are
more relevant in the tenanted sector, where they often represent
a significant proportion of the balance sheet value.
Of greater concern would be the residual debt
used to purchase such assets which have lost their relevance and
productive value (see also question 2).
1.4 TRADING STOCK
These values will fluctuate directly in proportion
to their associated profit potential. Therefore where they are
covered as security under an Agricultural Charge, and they represent
a major proportion of the overall security value, the security
position will be weakened assuming the expectation of profit per
item is reduced. This is most relevant in the tenanted sector
where the balance sheet will not be insulated by the relative
stability of land values and often little other security will
be available.
1.5 OVERALL COMMENT
The impact on security values will be most significant
for the tenanted sector, where they could be reduced very substantially
or even completely in the case of livestock quotas. Conversely
owner-occupiers are likely to see less significant reductions
due to lower proportionate impact on land value, combined with
the lower gearing associated with land ownership, which is a reflection
of the lower return on capital in land.
2. THE IMPACT
OF REGIONAL
AVERAGING ON
TENANT BORROWINGS
INCURRED FOR
LIVESTOCK QUOTA
PURCHASE
It is widely assumed that the use of Regional
averaging would restrict the occupier's ability to trade SFP,
to selling it to the subsequent occupier at the point of transfer
in land occupation, with no other potential purchasers (see question
5 below). Negotiating from such a position of weakness suggests
there would be little value attached to entitlements in this situation.
Therefore tenants who purchased livestock quotas in the past,
would see their value lost, rather than transferred into the new
entitlements. They would of course retain any debt outstanding
from original quota purchase and subject to the comments in 1.1
above, this would increase the financial pressure they might face.
Combined with a reduction in trading stock values
post MTR (see 1.4), it is possible that some tenants will face
negative equity positions, reducing their ability to exit if faced
with a non-viable business after the impact of the MTR.
3. THE RISK
OF LARGE
SCALE BANKRUPTCY
UNDER THE
REFORMED CAP
There is no expectation of large-scale bankruptcy
as a result of UK implementation of the CAP reform measures.
It is not possible to quantify whether any bankruptcies
will result due to the ongoing uncertainty around various aspects
of implementation. However it is not expected to be high, though
some sectors and business types may be more vulnerable than others.
Higher risk sectors will be those where income is reduced, as
well as asset values, since the latter will reduce their options
in subsequent restructuring, whilst it is the reduced income which
drives the need to restructure.
Initially there will be little income reduction,
more a change in the way the subsidy income is achieved, though
over time the SFP is widely expected to reduce, due to National
Envelope, modulation, financial discipline and mounting financial
pressure associated with EU enlargement. It is widely hoped that
such reductions would be accompanied by increasing business efficiency
and ability to source other income streams, to the extent that
this reduces or even prevents a net impact on business profitability
and this balance is critical to all assumptions around future
asset values. However, in the Dairy sector, the proposals also
include a significant reduction in the intervention support of
prices, potentially reducing incomes significantly. When combined
with reduced milk quota values (see 1.3) and dependant on the
value attached to the entitlement (see 5), this will represent
a significant increase in financial stress, to the point where
some business failures are likely. This is especially true in
the tenanted sector where balance sheet reserves are typically
lower than that of owner-occupiers and may also be reduced by
a greater proportion. It is important to remember that for the
Dairy sector, these payments are meant to provide partial compensation
for these expected price reductions and in this aspect the sector
is different to others.
The land owning sector may face similar income
issues, but are more likely to be able to restructure through
sale of lower productivity assets, to reduce debt or invest in
higher return assets.
4. CASHFLOW ISSUES
ASSOCIATED WITH
LATER PAYMENT
OF THE
SINGLE FARM
PAYMENT
Where individual businesses appreciate and plan
for the delay in payment, it is unlikely that a timely request
for increased overdraft facilities pending subsequent receipt,
would cause any problems from a bank's perspective. However any
extra borrowing would incur finance charges and so represent an
extra cost for the farmer.
Problems may occur from the bank's perspective
where there is uncertainty regarding the customer's eligibility
for the payment, as the bank is unlikely to be able to assess
whether all conditions of payment, e.g. cross compliance, have
been met. This could become a problem in marginal cases, if business
viability would be significantly compromised in the event of non-receipt.
5. OPPORTUNITY
TO TRADE
ENTITLEMENTS UNDER
DIFFERENT SINGLE
FARM PAYMENT
OPTIONS
To allow trade, the market requires a willing
vendor, a willing purchaser and a mechanism to achieve the trade.
To establish a market value, there would ideally be more than
one potential purchaser.
The different SFP options will impact on the
number of potential purchasers, since to purchase entitlement
for subsequent claim, a purchaser would need land in their control
that is currently without entitlements. Conceptually they might
have entitlements of a lower value such that they would be willing
to discard the lower value in order to purchase and claim the
higher value payments.
The Individual Historic Entitlements (IHE) option
would result in a small but significant area of UK farmland not
having entitlements associated with it (the "naked acres").
The result is a greater supply of land than entitlements, which
would allow a market to develop due to the increase in potential
purchasers.
The Regional Average Payment (RAP) option would
allocate entitlement to all farm land, so that future trade would
be almost entirely restricted to transfer between an outgoing
and incoming occupier of the same land or other land under simultaneous
transfer. It is conceivable in this situation that the market
would acknowledge that the land occupancy is the dominant factor,
so the value associated with the entitlement itself could be incorporated
into the cost to access land, either rental or purchase values,
with the Entitlement becoming effectively worthless.
Hybrid models are more difficult to comment
on due to the infinite number of such models. Fundamentally they
will provide the same scenario as one or other of the two options
above, depending on whether they involve entitlements being applied
to all land (as per RAP), or just that which was historically
subject to payments (as per IHE).
6. QUANTIFYING
THE AMOUNT
OF "NAKED
ACRES" THAT
WOULD FACILITATE
THE TRADE
IN ENTITLEMENT
This is not easy, due to uncertainty around
how many forage acres are not currently associated with existing
IACS declarations and so how such land might be registered in
the future (examples would be land used for dairy and lowland
sheep production). This data may be partially available to DEFRA
via annual census returns and IACS database, but we do not believe
it is in the public arena.
Land utilised for non supported cropping during
the reference period is all potential "naked acres",
subject to current cropping usage, and for example, it is known
that there has been a reduction in the area of land used for potato
production since the reference period of 2000-02.
Crude estimates might suggest as much as 1-2%
of UK land might be "naked", assuming no further shift
in cropping areas away from un-subsidised crops. Therefore it
seems likely that there is sufficient over supply of land relative
to entitlements to allow a market to be established under an IHE
type regime.
7. THE MECHANICS
OF THE
MARKET IN
ENTITLEMENTS AND
HOW PRICE
WOULD BE
SET
7.1 THE MECHANICS
OF A
MARKET
The UK is well supplied with independent brokers
who currently trade in both milk and livestock subsidy quotas,
so would be well placed to make a market in entitlements.
There will need to be a central administration
process, possibly undertaken by the Rural Payments Agency.
An important function of this body should be
to register third party interest in these entitlements, to ensure
transfers are made with the agreement of all such parties. Third
parties might include lending institutions who have financed the
purchase of the entitlements could also be interested parties.
Such a process would give lenders comfort to provide further support
to the ongoing restructuring of the sector through lending to
individuals who are expanding, to purchase extra entitlements.
This might be an important criteria for lenders in marginal cases,
especially those with a weak balance sheet where a registered
charge on the purchased entitlement may be the only available
security. Further examples of third parties would be other partners
in a business and in the future, newly established landlords who
have provided entitlements to new tenants.
7.2 HOW MARKET
PRICE WOULD
BE SET
Quota trading market precedents suggest that
supply and demand, purchaser confidence, plus expectation of associated
income will be the largest determinants in future entitlement
values for trading.
However, in trying to establish a logical value,
a Discounted cashflow technique would suggest the entire income
stream might represent a Net Present Value of around £450/acre
for the cereals sector and a dairy sector payment value of around
9p/litre. This includes the entire value of national envelope
funds, assumes a medium but increasing level of modulation and
10% discount rate. Depending on confidence regarding the longevity
and the likelihood reduction of the payments, this might give
a market value of around half of those total values, so £225/acre
and 4.5p/litre. This assumes a willing purchaser would only pay
a price that allowed them to achieve significant return on his
investment over and above the purchase price.
But it is worth noting that the market sophistication
is not such that a discounted cashflow technique is likely to
always be adopted and values significantly higher than this are
being speculatively discussed by brokers.
8. OTHER AREAS
OF COMMENT
8.1 SPEED OF
DECISION
Whilst the implications of the payment regime
chosen are very significant for certain sectors, this has to be
balanced against cost of the current hiatus in business planning
and evolution in all sectors, meaning there is an imperative need
for a imminent decision. Once announced, the focus of the farm
businessperson should return to evolving their business to maximise
returns for the future either in or out of farming.
8.2 INCOME IMPACT
OF MTR
The questions submitted by the committee tend
to assume a level of reduction in income and hence asset values
for the agricultural sector. Whilst this is logical, it is important
to remember that off farm incomes have increased dramatically
over the last few years, making an important contribution to the
cash surpluses of such farms. This trend is likely to continue.
Another important factor is the increasing productivity,
cost control and cash focus of the sector which are all likely
to help mitigate the scale of impact which a simple projection
might indicate.
Therefore for most sectors, the balance between
loss of income due to reduced subsidy and improved income from
other sources is not easy to predict. This is more straightforward
in the dairy sector where the price reduction is likely to be
more distinct.
8.3 EXCHANGE
RATE
The impact of a further weakening of the pound
to euro exchange rate has the ability to increase the pound value
of the overall subsidy income to UK farmers, which would also
be accompanied by an improvement in the competitiveness of UK
products compared to the EU.
Barclays Plc
February 2004
| 
