Private finance ploughs into Brazilian agriculture

“Not many years ago, when a farmer faced a problem, he could sell his pick-up truck and that would solve his problem. But, as the money that’s involved in production has gone through the roof, if there’s a cash flow shortfall, the sale of a pick-up isn’t going to bridge the financing gap. It could be R$2 million, R$10 million – R$20 million.”

Itaú BBA's director of agribusiness, Pedro Fernandes, makes a reasonable point about increased scale in Brazil’s booming farming industry. Where once a pick-up truck was a large nominal expenditure for a farmer, today a cotton harvester costs around R$6.9 million ($1.3 million). Genetically-modified seeds cost huge multiples of those that were planted a decade ago – offering much higher and more resilient yields but adding to the jump in costs which have risen along with revenues.

“That’s where the opportunity is for financial institutions to help producers build financial capabilities and risk management,” says Fernandes.

The growth of Brazil’s agribusiness segment in recent years has been remarkable – so much so that the agricultural economy has decoupled from the national economy. Since 2010 the GDP of the country’s agribusiness has grown by 34%, compared with total GDP growth of 7.4%. The agro industry now accounts for 8.1% of the total economy.

This is having a radical impact on the country’s economy, financial institutions and even its politics. The agricultural lobby is the biggest and most well-organized interest group in congress – providing protection for tax and regulation that governs the industry – but perhaps blocking reform that will prevent international restrictions on exportation.

And that’s to say nothing of changing precipitation patterns caused by deforestation, which could be behind recent droughts in some areas of previously productive farmland.

Increasingly there are tradeoffs. Brazil’s cattle industry continues to grow – exports in 2021 were worth $7.97 billion up from $4.48 billion a decade earlier. However, involvement with lucrative commodity producers often pose risks to otherwise hard-won environmental, social and governance (ESG) reputations.

There has been a rapid increase in the price of all Brazil’s soft commodities. At the same time higher nominal yields require higher nominal finance – Itaú’s Fernandes estimates that this year’s crop will require financing of around R$750 billion.

Until recently the public-sector banks were responsible for a large majority of this business. Private-sector banks have now entered the segment looking for new loan growth that is largely collateralized and uncorrelated to other sectors of the economy. Loans from public-sector banks to agricultural producers are falling in relative terms as the overall financing continues to grow.

In a statement to Euromoney, Banco do Brasil says it expects to lend R$200 billion to the 2022/2023 harvests. The bank has an in-built advantage in agricultural lending. Recursos controlados are those financial flows that are obligated to go to the sector by law – capital placed in agriculturally aligned poupanças (or savings accounts) and which must be to be lent to agricultural companies at below-market rates. Banco do Brasil has the biggest share of such savings.

Private bankers argue this has meant that the public banks have built up lending relationships in the industry by offering cheap debt with very little focus on return on investment. Meanwhile, the private banks’ poupanças generate cheap lending for real estate clients. They could direct 10% to agricultural lending, but in practice the rules are so onerous and prescriptive that they keep 100% targeted to real estate.

Banco do Brasil’s $200 billion cut-price lending portfolio is certainly big, but given the size of the total required it leaves plenty of room for the private banks. Itaú’s Fernandez estimates that all recursos controlados for the agricultural sector from public and private banks total around R$300 billion – less than half of the required annual capital spend.

“A huge transformation has happened in the past 10 years,” says Fernandes. “The market has gone from being mainly financed by subsidized credit to being based on market rates.”

Bankers extrapolate these trends into the future and expect that in a decade the Brazilian agriculture industry could resemble that of Australia or the US where commercial banks are the dominant funding providers. It is therefore no surprise that the country’s private banks are rushing to lend.

Santander Brasil was one of the first entrants to this space in 2015 and remains one of the most aggressive, having built a R$35 billion agricultural exposure. Carlos Aguiar, director of agribusiness at Santander Brasil, says the bank is growing at a 30% compound annual growth rate and “has appetite for R$100 billion.”

Today Itaú has around $25 billion in credit provided to agricultural producers and a total of R$75 billion including all segments of the industry such as processors, transporters and service providers. The $75 billion is still only around 6% of the bank’s total loans and it intends “to keep growth fast” and Fernandes says that every year they’re doubling the number of farming clients.

The liquidity from the private sector is much needed. In recent years the supply bottlenecks created by the pandemic and now the war in Ukraine has meant that producers have been enjoying record prices and, with a relatively low exchange rate, revenues have soared. According to Bank of America, the recent softening in commodity prices – soybean and corn prices fell between 11% and 16% in early October and wheat and cotton fell 22% – is likely to be the 12-month floor rather than the beginning of a bear market and the sell-off should be short lived.

Revenues are expected to stay high but so too are input costs. And the greater nominal values and volatility impacting producers’ balance sheets mean that risk management isn’t just for the most sophisticated producers, it has to be incorporated throughout the sector. With working capital loans largely collateralized on farming land, failure to manage exposures could be lethal.

StoneX, a supplier of market intelligence and risk management services to the agribusiness industry in Brazil, has seen a rapid increase in demand for its services. The company began operating in Brazil in 2005 and now has 1,300 clients using its intelligence and risk management services.

“We have a programme that takes producers through risk management strategies for the entire commodity chain,” says Fabio Solferini, chief executive of StoneX Brasil. “We teach clients how to address the volatility of both the commodities and the FX.”

The company runs its own derivatives book, hedging Brazilian producers via over-the-counter contracts and balancing any residual exposures through commodity exchanges. The company made post-tax profits of $48 million on revenues of $96 million last year, with almost all the profits generated from its risk business. StoneX continues to add risk products, recently adding fertilizer hedging to its portfolio.

Meanwhile, insurance is almost non-existent as an option. Following a couple of years of drought, insurers – which Fernandes reckons had built up exposures worth around 12% of an annual harvest – suffered losses and have all but exited the business. This has increased the demand for derivatives strategies; and added a little to delinquency rates and therefore to the market-based cost of funds for farmers.

However, despite the very high margins on offer for risk products, not all bankers think that derivatives products make sense in this space.

“We did research into this area and we don’t think it’s a suitable product for farmers,” says Aguiar. He also believes that the concept is widely misunderstood. “Farmers tend to see hedging as a positive or negative result; and if it’s negative they think they’re losing money – they suffer with that. They don’t appreciate that they’re locking in a price,” he says.

Aguiar says that while Santander Brasil helps larger exporters with FX hedging, he believes that most producers should simply fix prices through contracts with an off-taker.

Aguiar is building up his direct lending to the industry, focusing on collateralized lending based on land. The bank has segmented the market: the largest 600 farmers have more than 10,000 hectares and are targeted by all banks. Aguiar says the bank competes for this business, but adds that the “juice” for the bank is the second tier, those with between 100 hectares and 10,000 hectares.

Santander Brasil – in line with the other private banks – tries to take a holistic approach to financing these farms. The private banks are all developing their own specific approaches and segment the industry in different ways. Itaú uses revenues rather than hectares as its framework, arguing that low-grade cattle farms of 2,000 hectares generate the same $1 million in revenues as two hectares of high value crops such as carrots.

However, they all emphasize the cultural aspects of their strategy – making visits to potential clients rather than expecting them to travel to branches. They also provide special training for bankers who serve the sector exclusively, often recruiting from farming families or individuals with a working knowledge of the families that they are trying to approach.

It’s becoming a big banking endeavour. Santander now has 300 relationship bankers covering farms and that team more than doubles if product specialists are included in the count. Itaú says its agriculture team is close to 800. Bradesco is another big private-sector provider of credit and services to the industry.

These headcount numbers don’t include fintech ventures. Many of the private-sector banks are also investing in agritech companies to reach segments of the market that their main strategy doesn’t cover. For example, Santander Brasil has bought 80% of a startup called Gira that provides small producers with loans that are collateralized by production rather than land – either because the land values aren’t sufficient or, more often, because the farmer doesn’t own the land on which he is producing commodities.

“It’s a more risky proposition because it is based on the personal capacity of the farmer rather than the land – we’re taking the production as collateral,” says Aguiar. “We did R$400 million of lending in the first year and this season we expect to grow that to R$500 million to R$600 million.”

Meanwhile, Itaú has bought a minority interest in Agritech Orbia, which finances seeds and plants for farms, as well as helping producers sell commodities. And there are other opportunities too. For example, Itaú has created a joint venture with Syngenta, a global agricultural company, called Reverte, which is an initiative to help farmers develop degraded unfertile land into productive farmland.

The rush to finance Brazil’s agricultural sector is not without risk, however.

“It was only natural that all these banks decided to step into the market all of a sudden – which is fair,” says Fabiana Alves, executive director and head of Rabobank’s corporate bank in Brazil. “What is not necessarily fair is that they try to appropriate the title of being the agribusiness bank, because they’re not. We’ve been financing this industry for more than 120 years so this is in our DNA – it’s not jargon for us.”

Rabobank adopts a different strategy in the sector and has been offering dollar lending to exporters for years.

“Our model in Brazil is to differentiate ourselves on our knowledge of the global trade finance chain but also on our capability to launch financial products that were not available for Brazilian agribusiness companies,” says Alves. With the public banks focused on local currency lending and the private banks yet to enter the space, Rabobank had a large market to itself.

The bank now has a large client list. Alves claims as clients 45% of companies in the sugar cane industry, 35% of orange juice producers and 21% of soybean farmers, as well as 80% of cotton and 60% of pulp and paper producers. This means a total loan portfolio of around $10 billion, which is growing above the 6% average rate of the industry as a whole.

Alves is an agronomic engineer by background, with expert knowledge of the global agricultural industry. She sees rapid growth opportunities for agrifinance in Brazil given that the industry is looking at structural transformation.

“The infrastructure for transporting commodities to export markets is improving, but it’s still a bottleneck,” she explains. “There’s still a lot of room for investment there. And when you look at our competitiveness in the global market, it’s amazing that we are being competitive despite the fact that our logistics are expensive.”

Alves says the sheer scale of Brazilian agriculture and the opportunity to finance it – as well as the plethora of infrastructure and related investments it will generate in the coming years – mean that all the private-sector banks will be able to grow teams and loan portfolios without competing head-on too much.

“When we host American farmers here – and we show them the logistical issues we have and show them the chaos we face at harvest – they are very impressed that we are still able to be competitive,” she says. “If we scale these issues… then US agribusiness is going to be in trouble.”