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Reserve Bank estimates NZ dairy sector may default on 2%-to-14% of loans

Tuesday 15th December 2015

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The Reserve Bank has estimated the cash-flow shortfall for the average dairy farmer is likely to be more than $1 per kilogram of milk solids this season and that banks could see defaults on between 2 and 14 percent of dairy sector loans.

In an updated assessment of dairy sector vulnerabilities, the central bank said low global milk prices are placing dairy farmers under significant cash flow pressures with most farmers expected to have cash losses in the current season, compounding weak returns from the previous season.

Despite some highly indebted farms facing “considerable difficulties”, the report said most farms are expected to remain viable over the medium term and losses for the banking system should be manageable even under the worst-case scenario.

Dairy sector debt hit $37.9 billion in June, up from just $11.3 billion in 2003, due to rapid increases in land prices, a flurry of dairy conversions, and significant on-farm investments when global dairy prices were high. Dairy sector debt represents 10 percent of total bank lending.

Between February 2014 and August 2015 global dairy prices fell by more than 65 percent in US dollar terms due to increased supply, sanctions on Russian imports, and reduced Chinese demand following a build up of inventory levels.

Farmers are facing consecutive sub-$5/kgMS payouts this season, while the average payout needed to break even has risen to $5.40/kgMS due to increased debt levels and a shift to more cost-intensive operating structures.

However there’s a wide variation in the breakeven payout across farms depending on debt levels. For example, the top 50 percent of farms had an average break even of $6.75/kgMS in 2014/15 compared to $4.79/kgMS for the other half.

The Reserve Bank said the cash-flow shortfall for the average dairy farmer is likely to be more than $1/kgMS based on DairyNZ forecasts of $4.15 for effective milk revenue, taking into account Fonterra Cooperative Group’s latest $4.60/kgMS forecast for the farmgate milk price.

It estimated 49 percent of the sector operated below breakeven in the 2014/15 season and this season 80 percent are likely to have negative cash flow, increasing markedly demand for working capital from the banks even with Fonterra’s interest-free loan support package until the end of the year.

So far, dairy farm land values have been supported by low interest rates and a largely positive long-term outlook for dairy payouts but more recently land values have started to weaken on limited sales.

“There is a risk that land values could fall if cash-flow pressures persist, especially if confidence in the longer-term milk price outlook deteriorates,” the report said.

The risk of non-performing loans in the dairy sector is also higher with those highly in debt most vulnerable.  For example, the 20 percent of debt with the highest debt per kgMS has an average loan-to-value ratio of around 68 percent and an estimated break even payout of $5.80/kgMS this season.

How many non-performing loans will eventually result in loan defaults is highly uncertain, the bank said. But assuming all non-performing loans do default, the results suggest losses are manageable for the banking sector as a whole with loss rates ranging from 2 percent of the dairy portfolio under the base scenario, rising to 14 percent under the most severe scenario.

These losses amount for between 2 and 18 percent of total before-tax profits of the five largest dairy lenders over a typical four-year period.

These lenders have been required to undertake stress tests of their dairy portfolios and have had discussions with the central bank to ensure they are making realistic provisions for the expected rise in problem loans. These stress tests will be reported on in due course.

A Federated Farmers banking survey out today shows a virtually unchanged level of farmer support for banks during the past three months of low dairy prices with 80 percent satisfied with banks regarding mortgages, the same as in August.

There was an increase though in the percentage of farmers feeling they had come under undue pressure from their bank, rising to 6.4 percent from 5.5 percent in August.

“We’re staring down the barrel of an El Nino summer and it seems there are more difficult months ahead for the dairy industry, so we need these high levels of support to continue," said Federated Farmers national president William Rolleston.

 

 

 

 

BusinessDesk.co.nz



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