ARE YOU GETTING THE BEST DEAL FROM YOUR BANK?

The right finance and working capital is necessary for your farm or agribusiness to grow. While the Reserve Bank sets the base rate, knowing how your bank calculates your customer margin will help you pay as little as possible in bank fees and interest.

Well-managed businesses with solid foundations pay lower interest rates than poorly managed ones. So, showing the bank that your business is well-managed will help you pay less. You can consider it a reward for doing business well.

The banks do this by adding a customer margin to your interest rate. This figure is based on your individual situation. So, while you can’t negotiate on government mortgage fees, you can negotiate with the bank on their fees and the customer margin. If you can show the bank you’re in a strong position, you can negotiate this which helps to reduce costs.

This might sound too hard. But remember, banks expect you to negotiate to get the best deal. They’re doing the same, so don’t miss out on what you’re entitled to.

In this blog, I’ll explain how the bank calculates your rates and your customer margin. Understanding this, and the impact on fixed rates, will help you get a better deal.

A recap of interest rates

Banks borrow money at wholesale rates, which they can then lend to borrowers at a higher retail rate. Each week, banks must advertise their base rate, which includes covering the cost of borrowing funds, operating costs and shareholder dividends.

The RBA cash rate decisions, the state of economy and demand for money all affect the base rate.

Read my blog from July for a more detailed explanation – How Banks Set Their Interest Rates

Different loans also have different base rates. An overdraft (which goes up and down) generally has a higher base rate than a term loan.

Customer margin and the 5 Cs

The interest rate on your mortgage or loan is a combination of your base rate plus or minus your customer margin. Every bank has their own method for calculating the margin. Some start with a higher base rate and deduct the margin, while others start with a lower base rate and add the margin. It’s one reason you can’t compare customer margins from bank to bank.

How much customer margin the bank adds to your loan reflects how much risk the bank thinks there is in lending to you. If they think the risk (of losing money) from the loan is high, they’ll add a higher customer margin.

How do they determine the ‘risk’? By looking at the 5 Cs:

• Capacity (also referred to as cash flow)
• Character
• Capital
• Conditions
• Collateral

I’ll explain each of these below. By understanding each of these factors, you’ll be in a better position to improve your customer margin and reduce your loan costs.

Capacity

We sometimes refer capacity to as cash flow. Cash will always be king, so you need to show you can make enough cash to make all payments, including interest.

To do this, work out your revenue using reasonable and achievable assumptions about future yields, commodity prices and costs. Records and historical averages are a good place to start, but remember to take any variations into account.

Do the same for your expenses. Use historical information as a starting point but review and adjust to reflect changes in business operations, increases in prices and allow for the unexpected.

Character

Character looks at your management expertise, your honesty and integrity. The bank wants to know what you’ve been like to deal with in the past, and what you’ll be like in the future.

If your credit history is poor, the bank will see you as a higher risk. But if you can show that you’ve handled difficult times and made the most of the opportunities in the past, the bank will see you as a lower risk.

One of the best ways to show this is with good profit results and a stronger equity position each year.

Capital

We could also describe your capital as your financial position and that of your business.

• How much do you own?
  • How much is your net worth?
  • How much debt do you have?
  • What is your debt-to-equity ratio?

From the bank’s perspective, the more equity you have, the less risk you present because you have cash or assets you can use to pay back your loan.

Conditions

The bank will also take the general economic conditions into account. They’ll want to understand what is happening in your industry, both here and overseas. Are the markets strong? Is your commodity in demand or is there an oversupply?

While you can’t change these external factors, the bank wants to know how you manage interest and exchange rates, climate variations and changes to global prices. Different banks may have different perspectives on industries, which can sometimes depend on how much debt the bank has tied up in that industry.

For example, many South Australian wine regions have an oversupply of wine because exports are down. This may affect the perceived risk for growers or winemakers looking to borrow.

Collateral

What assets can you provide to secure your loan? Are they good quality and are they adequate? A good quality asset is one that would be attractive for potential purchasers to pay a good price. If it’s an asset no-one will want to buy, the bank will see it as lower quality.

Banks look at adequacy as a loan to value ratio (LVR). The lower the LVR, the lower the risk.

Calculating your customer margin

While character, cash flow, capital and conditions are considered collectively (and usually result in a score between 1-10), collateral is considered separately. If your business fails in all other areas, the only way the bank can cover its losses is to sell your assets to cover your debt.

So if you have a low LVR (say less than 30%) and a very high customer rating, you mightn’t have any additional rate added to the base margin.

But if you have a very high LVR (say over 70%) and a lower customer rating, you may have extra added to the base rate. Sometimes, the bank may even decide that your LVR is too high and refuse to lend to you.

Understanding the impact of your customer margin on fixed rates

Knowing how the decisions you make in your business affect your customer margin is important, especially if you’re thinking about fixing your interest rates.

Once you fix your interest rate, you’re effectively fixing your customer margin, which is the one part of the interest rate mix you can control.

You know how variable agriculture can be and how often the 5 Cs change. Over time, your position may improve, but if you’ve fixed your rate, your bank won’t be re-grading your risk and reducing your customer margin. And even if you request a review, there’s no guarantee the bank will change your margin.

Be upfront and honest with your bank. Tell them about additional collateral, negotiate hard (or get your broker to) and be upfront about shopping around.

Understanding your current and historical financials can also make an enormous difference. Develop well-grounded predictions and make time to research current market conditions. Remove unnecessary risks, be super clear on your costs and price projections and always have a medium-term plan. The bank will be more confident lending to you if they can see you’ve done your homework. If you’re unsure or don’t feel comfortable negotiating on your own, use a trusted consultant or broker.

Client case study

My clients asked their bank for a better variable rate and requested a quote for fixed rates. The bank declined to improve their customer margin and quoted fixed rates based on their current customer margin.

My clients were unhappy with this and engaged me to conduct a tender to other banks plus their current bank. The results below show the difference in securing a low customer margin before fixing rates.

TENDER RESULTS
Current Bank (before tender)
Variable	7.61%
Fixed – 2 years	8.2%
Fixed – 5 years	9.26%
Current Bank (after tender)
Variable	6.45% (a reduction of 1.16% on their customer margin)
Fixed – 2 years	7.04%
Fixed – 5 years	8.10%
Alternative bank
Variable	5.9%
Fixed – 2 years	6.55%
Fixed – 5 years	7.45%

To understand the impact of these rates on the amount of interest my client paid, let’s say they fixed $1 million for two years and another $1 million for five years.

	Current Bank (before tender)	Current Bank	Alternative Bank
2 years	$164,000	$140,800	$131,000
5 years	$463,000	$405,000	$372,500
Total interest paid	$741,150	$642,550	$592,000

By engaging me and putting their loan out to tender before fixing rates, they saved $149,150 in interest payments.

Review before fixing

With rising interest rates, locking in a fixed rate and having certainty about your repayments might have seemed tempting. But before you commit, it’s worth taking the time to have a professional look at your situation. As long as your record keeping is up to date, putting your loan out to tender should be straightforward. When you consider how much it will save you, you’d have to agree that it’s worth it.

Over to you  

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