The key players involved in Nedbank’s agricultural finance solution discuss the merits of the deal structure in assisting commercial farmers secure financing.
- Bernhard Coetzer, CEO, RSA Agri Holdings and Free State Maize farmer
- Zhann Meyer, Africa head, global commodity finance, Nedbank Capital
- Sekete Mokgehle, head, global commodity finance, Nedbank Capital
- Hanelie Schutte, Acua Makelaars
- Adriaan Snyman, CEO, Free State Maize
- Jaco van Dyk, Free State Maize farmer
- Wallie Weeks, financial director, Free State Maize
- Shannon Manders, editor, GTR (chair)
GTR: How easy is it for companies like FSM to access input finance?
Snyman: We have been in this business since 2001. About three banks offer this type of input finance in South Africa. The important thing is that, with Nedbank, we are not competing with their retail branches. We are the contract manager rolling this product out as a wholesale product on behalf of Nedbank. That is the scope within which this fits and we see it as a partnership going forward.
GTR: What model do banks generally use when it comes to input finance?
Snyman: Most banks will keep it in-house and run it through their own retail branches, but it is a rather expensive way of running it as it requires the bank to own the infrastructure and carry the overheads. That is why we do it this way, on a contract management basis.
Mokgehle: One way to answer the question is to look at our case and to ask why we did not do it before 2012. The reason is that there are risks involved which a lot of institutions are often afraid of. You also need a skills base. In our case, we were worried about the risks and we did not have the skills base. But once you have a deeper look into and understand the risks involved, those risks can be mitigated. They can be passed to an insurer, largely. Other risks can be mitigated in the conventional way. We also now have the skills base. We were fortunate enough to have Mr Meyer join us last February, who brought with him a few other individuals who are helping us with the operating model and the operational risks involved in it.
Meyer: With regard to the structure, you do not necessarily rely on the contract manager’s balance sheet. The quantum of the facility is based upon the hectares contracted with the farmers. The premise is that you manage your price risk and insure your cultivation risk externally, and you look at your contract manager for operational ability and administrative systems. It is definitely doable on that basis, provided that the insurers have appetite for the risk, and that you can discover and hedge price risk. In other words, it is a scalable product not necessarily based on the balance sheet of the obligor.
Schutte: From the insurance side, we have seen a lot of banks trying to implement this type of facility. The thing is, however, that you have to have the footprint on the farms. Using a portfolio manager makes that much easier for a bank to get connected to the farmer in the field. Otherwise, they are not involved in or focused on that type of insurance or on that type of business. When you use a portfolio manager such as FSM, it is easier, because they are more focused on that type of facility and on that type of work. They have people on the ground who, together with the insurance people, can better infiltrate the farmers and obtain real-time information.
Meyer: Insurance does not cover bad farming practice, which is why we need agronomists and soil scientists on the ground to make sure that the farmers adhere to best farming practice and grow the crop to the best of their ability, using the soil and other resources correctly and controlling all the technical aspects that goes along with that.
Coetzer: Multi-peril insurance gave us the opportunity to expand. 10 or 20 years ago, you had to give your farm as security; now, you can use insurance. That is the advantage for us as farmers. The rest of the process around input finance is using the technologies available. That is the way to go.
Snyman: If I can add to what Bernhard said, multi-peril insurance also helps in the traditional credit process, whereby the farmer had to give his land as security and could farm only in terms of what the value of his land was. With multi-peril, you can take, for example, a 3,000-hectare farmer, who still gives some tangible security, but can now grow to 4,000 or 5,000 hectares; the additional hectares covered by insurance as collateral for the loan.
Schutte: The multi-peril policy was developed to provide an off-balancesheet facility. That was the main focus when we started input cost insurance many years ago. However, I think we need to be really strict in the future around the specific mitigation of the risk and granting of cover.
Meyer: Climate change is playing a role. It is definitely a risk factor in the market for the insurers.
Schutte: In the past, we worked only on the long-term average yield that the farmer declared to us. According to that, we gave him a percentage guarantee for the coming season. We are, however, now at the point where we have to better select our farmers and where the financiers as well as the insurance people have to be more involved and on the ground from the application for the credit facility until the end of harvesting.
GTR: Are you seeing much demand for this type of insurance in South Africa at the moment?
Schutte: Already 40% of our market is input-cost insurance. If we do not do it the right way or get the right mindset in the next few years, we will lose this facility.
GTR: Is it up the insurers to regulate?
Schutte: They tried to regulate it with underwriting rules, but we have to combine with the banks and portfolio managers. That is the most important thing in the next year or two.
Mokgehle: I am curious as to whether we have a lot of insurance companies and underwriters in this product?
Schutte: All major insurance companies now offer the facility, to a greater or lesser extent. Some have a greater appetite for it, and others less. The big banks and insurance companies take more risk and then reinsure it; the smaller ones accept less risk on the multi-peril side. Between 30 and 40% of the value of the South African insurance market is embedded in the multi-peril product.
Meyer: From a farmer’s perspective, I am interested to learn: if you have a facility like this, should it be enough to supply you with enough funding to procure all the necessary inputs? If you are a farmer financed on a conventional structure, where they have to mortgage land as security, would you necessarily find some of those farmers skimping on production inputs and taking the risk of sub-optimal yield, purely because they have access to less funding? Does this facility allow you to farm more productively as you have the required levels of funding at your disposal?
Coetzer: They will reduce their planted hectares in order to apply optimal inputs. They will not however have the ability to expand.
Schutte: Two things have driven the facility: one is the SAFEX price for that commodity, and the other is the long-term yield. If your price is under pressure and if your long-term yield is not adequate, you will not have enough money. If the price is high – like it is now – and if you multiply that by 60 to 65% of the long-term yield of four or five tonnes, that will be enough. But as soon as the price drops and if the long-term yield is not high enough, you will not have enough money, and farmers will then have to reduce their fertilisers or chemical application programmes.
Coetzer: If you go to the east of the country, your loan amount will normally be enough; if you go to the west, however, with traditionally lower yields, it might become a problem.
Meyer: Another important factor of the facility is that farmers benefit from a hedged price. A farmer does not necessarily have an open chequebook that SAFEX would require if the price moves against him. He will need to maintain that position with mark-to-market payments, and a farmer does not necessarily have those funds available. This facility allows the farmer to benefit from the use of a derivative instrument on SAFEX, which they would not normally have access to.
Snyman: That is a very important benefit. Can you imagine a farmer who puts up his farm as security and is unhedged in the market? With this product, you do not necessarily put up your land as security; you have multi-peril insurance plus a hedged position, which, in most cases, is a minimum price. You can, then, still participate in any upswing in the market, albeit at a cost. You know that you can participate in a rising market. If the price goes up, I can afford to buy more inputs to have a prudent production process.
GTR: Does FSM have a fixed number of farmers who you provide input to as part of this scheme? Are there specific criteria that farmers have to meet in order to gain access to this financing?
Snyman: FSM has a group of about 80 farmers currently on our books. As Sekete indicated earlier, we would like to grow the book to about 120 farmers in the next season. In terms of how we support farmers, first of all the farmer need not come to us for credit. We have relationship managers all over South Africa, except in the Western Cape. We go to the farmer on their farm. Applying for credit is quite an admin-intensive process: you need the trust deed, for example, if it is a trust; you need copies of IDs, etc. We arrive at the farm with a laptop and a scanner so that we can scan all of those documents while we are in the farmer’s home. That is the first process in terms of how we support the farmer.
Second, we make all payments on behalf of the farmer. The farmer can go and buy inputs where they wish to. They can negotiate their own discounts and we will guarantee that payment, as long as it is within the farmer’s budget, as allocated by us. As and when the invoice comes in and we get the proof of delivery signed by the farmer, we will make payment against that on the farmer’s behalf. It stays the farmer’s, and the farmer can still claim the VAT – we are not involved in VAT administration at all.
In terms of how the farmer is assisted by FSM and the insurers, a prudent soil analysis is done, so we know the nitrogen, phosphorus, potassium and pH levels, the ratio between calcium and magnesium in the soil, and we know whether or not they need to be addressed. We know whether there is aluminium toxicity in the soil. We also test the carbon content of the soil, which translates to the capacity of the soil to hold moisture against gravity.
Schutte: The type of soil is very important, which is why we have to start at the beginning. The basis of production is the soil. You have to start with the combination of the organic material available in the soil and the levels of acidity, calcium and magnesium. The third aspect is the farmer’s ability to produce. A good farmer with less than excellent soil can produce an average yield of four tonnes. On the other hand, there may be excellent soil but not a good farmer. That combination of the soil and its physical and chemical composition, and the farmer’s ability and experience, is very important. Weather conditions during the production season will play a big role on the outcome of the planted crop.
Meyer: The inverse is also true, in that you might have an excellent farmer in a bad area with a poor soil type and profile. He will not succeed and is unlikely to get multi-peril insurance, because the perceived risk will be too high. You can spend as much money as you like to get the chemical composition of the soil right, but a poor soil type and profile will stump you season after season. The long-term average yield is thus the start of the conversation with the farmer.
Schutte: If the price is under pressure, you have to increase your yield; otherwise, there is not enough funds available to farm optimally. You cannot really change your long-term yield. It is fixed. It is the result of production over five or 10 years, and the more the better. That is the important factor that we must not lose sight of.
Meyer: You talked about farmers being able to grow. What is the benefit of larger-scale mechanisation using bigger implements on increased hectares? Can we quantify that? Commercial farmers are growing bigger and the smaller guys are falling by the wayside. Has the break-even point shifted?
Coetzer: It is about economies of scale. 15 years ago, you could farm 300 hectares and survive; today, you have to farm at least 1,000 to 1,200 hectares just to survive. It is a growing threat. Jaco will pay R400 to R500 per hectare less for his seed than the average farmer.
Meyer: Because he can negotiate his price as a bulk buyer.
GTR: How important is timing when it comes to providing finance?
Coetzer: This is a critical issue. We have already started with the new season. It is only July but we are already busy preparing the fields for next year. For the banks, the facilities have to be in place from July. The west is still busy with the harvesting process, but we have finished in the east and we are preparing our fields.
Schutte: From the insurance side, one of the big problems is that farmers are getting the finance too late. If we do not give the money in October, it is too late. Most of the problems in insurance are related to late finance and late planting. In certain months, you have to do certain things, and you have to keep to that.
Meyer: The policy is very strict in terms of the planting window. If you move outside of that window, the policy will not pay out. The risk associated with frost late in the season is just too high. There is a trend in terms of the use of technology in commercial farming. Jaco, I know you make extensive use of precision farming techniques. How important is that for sustainable farming in the future? What is the value that you see as a precision farmer in embracing that kind of technology? Could there be a short and long-term benefit in terms of insurance premium savings? How do you assess that risk against a long-term crop model?
van Dyk: Precision farming is the way to go these days – it is about a long-term objective. It is not about doing it today and enjoying the benefits tomorrow. After nine years, we are beginning to see the progress that we have made in terms of taking out the land that has not done well. That is the way to go in order to lower input costs and to increase yields.
Schutte: The definition of precision farming must be very clear. A very small percentage of farmers in South Africa can afford precision farming at the moment, because you need the right equipment to do it. It costs a lot per hectare. But it does result in a sustainable and higher average long-term yield over time. Every year, you want to be producing the maximum number of tonnes. If you then have a drought, the insurance is there to pay out, but you cannot insure more than your real average yield. This is what is hammering the insurance business at the moment.
Meyer: You apply fertiliser and seed according to the soil potential, on a differentiated basis. It is a detailed approach focusing on specific areas within the land. It is GPS-linked, so your soil map will tell your planter where you are on the land and apply more fertiliser and seed as you go over soil with more potential. It will equally reduce seeding and fertilisation on areas with low yield potential.
GTR: If more farmers adopted these precision farming techniques, would they more easily be able to access the financing that they need?
Snyman: It is not only the financing but also the insurance. If you can show the insurance provider that you know what kind of soil you have, what to do on that type of soil – whether or not to plant, whether to plant sunflowers or maize – and what the fertility status and the capability to hold moisture is of your soil, the insurer will look differently in granting multi-peril insurance. Likewise, it will be either easier or more difficult to access finance.
Coetzer: Insurers offer lower premiums for precision farmers so there is a cost advantage.
Schutte: There are a few things that we work on. We work on the type of cultivar you plant. Soybean is a very high-risk crop; maize carries a lower risk. Normally, farmers in the east will plant soybean and maize; to the west, they plant more maize and sunflower in some areas. Depending on the combination of the summer crops, we will determine the risk and calculate the premium rate. The second point is the long-term yield and how it has fluctuated over the last five or 10 years. We look at all of those aspects and do individual underwriting per farmer to calculate their premium on their multi-peril policy.
GTR: Is there a high rate of defaults?
Schutte: In the current season, there are minimal claims in the east, but in the west there are a lot; mainly due to the drought. It is not the amount of rain you get, but when you get it. Drought is the single biggest multi-peril risk.
Others perils are heatwaves, wind, excessive rain, frost, insects, etc. There are a number of perils. There are two policies: the hail policy and the multi-peril policy. There are a number of risks that we cover under the multi-peril policy, but the single biggest one is drought.
GTR: How do initiatives such as this aid in food security?
Meyer: It is important to stress that farmers are now enabled to use economies of scale on land not necessarily within their ownership structure. Farmers can now go and cultivate land that they do not own. In terms of food security, first, you increase production by increasing the amount of hectares planted by a proven commercial farmer; second, you keep the farmer in business, because they do not go into liquidation in a season where drought was prevalent. The insurance pays out and keeps them on the farm. Thirdly we advance sufficient funds for the farmer to produce optimally. In terms of optimal production, it is important to mention at this point that the facility does not, at this stage, cater for small-scale farming. This is a commercial offering on a wholesale basis with a single obligor, being the contract manager.
The specific use of this product in Africa is premised on two things: first, the insurance available; and second, a price that is discoverable and a mechanism that can be used to mitigate price risk. In South Africa, that is fairly easy, because we have a well-developed commercial structure and exchange that is transparent and liquid. That is where the rest of Africa still has a long way to go.
GTR: Is South Africa seen as the model for the rest of the continent?
Meyer: Yes, provided that we can access insurance and mitigate price risk. At an agricultural level, the rest of Africa normally relies on small-scale farming. Small-scale and subsistence farmers, as you can imagine, largely grow crops for their own consumption. This model would not work there because, as a bank, we take our comfort in the fact that the crop acts as the collateral for the loan. A structure like this is not feasible if my client eats my collateral, so it is not a model that is sustainable in the rest of Africa at this stage, unless there are commercial offerings in the countries that can be financed in the same way. The model needs development to enable it to cater for a typical small-scale environment.
Snyman: I would not call it a trend but something that is now awakening is on land that, under the government’s redistribution programme, was bought by the government or given back to the previously dispossessed communities. With a product like this and multi-peril insurance, a commercial farmer can now go and lease that land. Although it belongs to the government, you can create enough security to farm that land and put it back into production, while, at the same time, employing people from the local community. You can maybe even think of giving them ownership in the operational company.
Mokgehle: The statistics say that just under two thirds of the world’s arable land lies on the African continent. After a few years of track record, and I think our team is almost ready to hold hands with entities like FSM that can see opportunities north of the Limpopo and to say that we now might expand into the rest of the continent. It is always good to start at home, however.
Snyman: It will not happen now but, in three or five years down the line, it is definitely something that we can look at. I agree with Sekete: first build your base at home. There is a lot of redistributed land in South Africa that will now come back into production. Benefit your own people at home, and then move north of the Limpopo.
GTR: What markets would you move into?
Snyman: Our expertise lies in the grain market. It is something that we can hedge. We will not finance something that we cannot hedge. We will not even go to something that you can back off on a back-to-back basis with an off-take agreement. If prices rise and the farmer does not benefit, that is not ideal for the farmer. Second, a wheat farmer can do everything perfectly. They can say that they are going to harvest their wheat tomorrow, but tonight there might be a hailstorm. The insurance will pay out, and they will duly pay their loan back, but I have sold the wheat to the miller and I now have to buy it out. On a back-to-back contract, where there is no futures exchange, it is not ideal. That is why FSM will remain only in crops that one can hedge. The good news is that you can hedge Zambian maize on the local market.
GTR: What other neighbouring countries would you look at?
Snyman: If there is stability in Zimbabwe, we could probably look there. We could also look to Namibia, Botswana, Tanzania and Mozambique. You must keep in mind that, when you go to these countries, it is a whole new ball game, with different laws. Zambia, for instance, is landlocked. There is no export opportunity. There is a surplus being produced, but where do you go with the surplus? What is the infrastructure to move inputs in and to move the grain produced out? Are you allowed to trade in a currency like the US dollar? Can you repatriate your money to South Africa? One needs to take all of that into account.
Meyer: There are a lot of external factors that impact on the ability of Africa to grow its agricultural production base. One is logistics: the transportation of both inputs and of the harvested commodity, and the storage of it. Africa is losing a substantial percentage of its crop to a lack of storage, resulting in insect and moisture damage.
Snyman: As an example, in terms of supply-and-demand balance for Zimbabwe, we are all aware that, from September onwards, it will run out of white maize. To transport one tonne of white maize from Jaco’s farm to Harare costs R1,100 – that’s just the transport costs. You can buy that maize here for R2,000 per tonne, and you will add R1,100 just for the transport. It takes 72 hours to get across the border at Beitbridge – slack time for which the transporters will charge you. You need efficiency to get across the border. You need to get the rail lines up and running again. A block load of railcars can move 2,200 tonnes, whereas one Interlink truck carries only 34 tonnes.
We have a customer in Zimbabwe who wants to take 4,000 tonnes of maize per month from us. That is 1,000 per week or 200 tonnes per working day. At 34 tonnes, you would have to move six trucks. You come to something like 15 trucks that you need to have on the road to move 1,000 tonnes a week, which is totally inefficient. With a train with a block load, however, you need to load two trains per month. Logistics and infrastructure is the turnkey to unlocking the potential of Africa to produce food for the world.
GTR: Do you face challenges in terms of logistics and infrastructure within South Africa itself?
Snyman: It is still good but there are challenges to overcome. We do not export but some of the multinationals that do will tell you that they get orders to load a 40,000-tonne ship. They will call Transnet and say: ‘This slot is for 40,000.’ Transnet will say:
‘I will supply you with railcars.’ Then two weeks before they need to load the ship, Transnet will come back and say: ‘I can move 20,000 tonnes.’ You cannot move 40,000 tonnes by road in two weeks, so, all of a sudden, that company had to call us and say: ‘We are not going to take this maize off your hands. We can only move 20,000 tonnes and move that in two weeks’, which, in itself, is a monstrous type of operation.
The other thing is that our ports can take only 30,000-tonne ships, which is a big problem. In terms of the buyers in the Middle East and the Far East, imagine what you can do the moment you can put in 50,000-tonne ships or 80,000-tonne supermax ships. Currently, we have three ports to discharge in Durban, but each can take one boat of 30,000 tonnes, because of the draft, which is 9.6 metres at most.
If you changed that to a draft of 12 metres and put three 50,000-tonne boats in, or to a 15-metre draft and three 80,000-tonne supermax ships in, it would change the whole ball game. We are at a freight advantage from South Africa to the Middle East and Far East of anything between US$10 and US$15 a tonne versus South America and the US. Someone needs to put up the capital to buy one of these ports and increase the draft. East London’s port is idle, it is just standing there.
While we can still move a lot of grain by road and there is definitely grain moving by rail, you need to open up the countryside railway lines. In any decent year, 1.5 million tonnes of maize is produced along the line between Bultfontein, Wesselsbron and Bothaville. About the same quantity of maize – 1 to 1.5 million tonnes – is produced in a decent year along the line from the Eastern Free State via Bethlehem down to Durban. If you got those lines functional again, you could move two to three million tonnes of maize to the export ports and earn currency for our country. That is definitely a big question that we need to start to address in South Africa.
Meyer: The condition of our roads in certain rural areas is another hindrance. Transporters are apparently now refusing to go and pick up maize from certain farms, purely because of the quality of the roads – their trucks get damaged.
van Dyk: Not only on the farms; at the Driefontein silo near us, if you want to offload your maize there, they refuse, saying that it is going to put their costs up. The roads are just too bad.
GTR: What is your outlook for the future of this facility and others like it?
Meyer: To reiterate, it is Nedbank’s vision and it fits into our strategy to grow this type of offering to very select clients. It is also our aim to work with our partners in Africa – and specifically Ecobank – to grow this product across the Limpopo and north into Africa in order to aid food security and to give life to our strategy in Africa. It is, however, important to stress that there are caveats around the facility, and the most important part is partnering with a contract manager that has the track record, history and capability to manage this facility on our behalf. FSM is that partner for us, so we are proud of the association.
Mokgehle: Touching on the issue about the need for availability of finance, from a banking point of view it is always tricky with new relationships. You have to take the relationship to other individuals who are the decision-makers. Once you get into a facility, continuation is easy.
van Dyk: As a farmer, FSM is taking a load off my shoulders, leaving me to put 100% into farming rather than going around looking for finance.
Coetzer: It is also a relationship, not just between the bank and FSM, but also between the farmer and FSM. Relationships are important in farming. Farmers are very loyal.
Schutte: For us as insurers or risk managers, it is about using technologies to mitigate risks for the bank and for FSM, and to form close relationships. Close relationships and mutual trust is the success of good, sustainable business.
Snyman: I would summarise by saying that this type of input finance is about relationships and focused synergies. Nedbank focuses on what it can do best: accessing and providing liquidity in the market, pricing it correctly and developing a product that it can pass on to a contract manager like FSM. We focus on credit and on hedging that risk. The farmer can now focus on production and increasing yields. The insurer can focus on mitigating risks through multi-peril and hail insurance.
Borrower: Free State Maize (FSM)
Amount: R275mn agricultural input finance and margin call facility
Tenor: 12 months, with a discretionary renewal option
Lender: Nedbank Capital
Law firm: Norton Rose Fulbright SA
Insurance broker: Acua Makelaars – using several insurers and underwriters
Transaction overview: This input finance facility for Free State Maize (FSM) is used by the borrower to provide risk management expertise as well as to fund inputs that farmers will use in the various phases of the grain production process, including seed, fertiliser, diesel and pesticides.
The facility also has a sub-limit of R75mn which funds the agricultural derivatives used to hedge the grains planted against any potential price and market risks. The hedges can either be agricultural derivatives offered on the South African Futures Exchange (SAFEX) or they may take the form of fixed price contracts from third parties.
Nedbank Capital’s Zhann Meyer comments on the structure of the transaction: “The finance offering consists of four pillars. The first is the farmers, so we need to be comfortable with the technical ability and experience of the farmers on the scheme. The second pillar is the contract manager, represented here by FSM. The contract manager is crucial to monitor farming activities and for mitigating operational risk. They are the bank’s obligor in the structure. The third pillar is insurance. Multi-peril insurance on the crop, to mitigate cultivation risk, is crucial for us. This, together with hail insurance, forms the basis upon which this product differentiates itself from conventional mortgage-based agricultural lending products. The fourth pillar is price hedging; in other words, protecting the bank against fluctuations in the maize price or whatever commodity is grown. We also use FSM for that.
It has a dedicated team managing price risk on our behalf, and we mostly use SAFEX to enter into either put options or short (selling) contracts for the contracted harvest.”
The deal was first signed at the end of 2012, but the bank intends for the facility to increase over time. “The Nedbank team is currently engaged with FSM for a bigger-sized facility for the season going forward,” says Sekete Mokgehle.