Fran O'Sullivan: White gold rush turns deep shade of red

Agriculture Minister David Carter appears to be in a state of denial regarding the gathering debt snowball that threatens to engulf exposed parts of the dairy sector.

Carter had the rural lending principals from the major banks at his Beehive office on Monday to, as he put it, "chew the fat around the issues out there in rural New Zealand with regards to banking, indebtedness, land values and cash flows".

From his account - as reported in the Herald yesterday - the minister emerged from the bankers' briefing convinced the dairy sector remained "resilient" in the face of falling incomes. ANZ National, Westpac, ASB, BNZ and Rabobank had indicated farmers were looking at cost structures and actively managing them.

Carter blew off suggestions - including from this columnist - that the situation was far more difficult than either the banks, Government or industry leaders were publicly conceding. Pressure was simply at the "minority end" of the sector, where farmers who had bought land at a high price for dairy conversions were obviously facing strain.

What he was hearing "wouldn't be consistent with some of the more extreme comments that have been in the media recently".

It's not clear exactly what factual information the bankers put before Carter and Finance Minister Bill English, who also sat in on the meeting. Carter's press person indicated (in response to my questions) that the minister simply wanted to get a sense of what the banks were finding to see if it matched up with what he had been picking up around the rural traps.

According to the press spokesperson, no written data was put in front of the meeting. Neither, according to English's office, had the Treasury been asked to take a hard look at the implications of the dairy commodity-price collapse. That had all been left in Reserve Bank Governor Alan Bollard's basket.

This "trust us" approach seems a tad injudicious given the growing amount of independent data that suggests bank lending at the height of the "white gold rush" was New Zealand's own version of sub-prime lending.

The widely respected Agriculture Production Economics report points to three issues which have arisen out of what it calls "farming for asset gains".

1. Debt is a problem throughout NZ agriculture, but at the farm level it is still highly concentrated.

2. Where that farm debt is highly concentrated - eg, at least 20 per cent of New Zealand's dairy farm production - it is such that farms cannot, and will not ever, meet their debt servicing commitments even under the most promising payout and interest rate scenarios. This is New Zealand's equivalent to US sub-prime lending: reliant on continuing asset gains as income was never going to meet debt-servicing commitments.

3. The issue is building as its destructiveness compounds along with the debt. The real questions are as to the detonator, the timing and how well the consequences are handled.

It is that second issue - the claim that at least 20 per cent of New Zealand's dairy farm production will not be able to meet debt-servicing commitments - that should be flashing red signals at the Beehive.

Particularly given the fact that Bollard has been beating the drum on rural indebtedness for some months now. In its recent financial stability report, the central bank noted that default rates on agricultural lending were relatively low for now, with the major banks having indicated they intended to help rural borrowers through a period of weaker returns.

But New Zealand's banks were facing an increasingly challenging operating environment with bank asset quality deteriorating markedly in recent quarters as the effects of economic slowdown became clearer.

The banks are not turning a deaf ear to farmers. Short-term overdraft borrowing rates have fallen an average of 2.68 percentage points since December, according to a Federated Farmers survey. But that was almost 1.5 percentage points less than the fall in the official cash rate over the surveyed period.

The Feds make the point that with rural debt now hitting $45 billion (with dairy responsible for 61.5 per cent of the total) every 1 percentage point off interest rates results in $450 million being transferred from the banks' pockets to that of the overall agriculture sector.

But has the Government got in behind Federated Farmers on this score? Carter's press person seemed to think not.

Meanwhile, commodity prices for dairy stay well below Fonterra's comfort zone, and the exchange rate remains uncomfortably high.

Asia Pacific's Roger J. Kerr yesterday added more fuel to the debate by pointing out that if international whole-milk powder prices continue to weaken over coming months and the New Zealand dollar exchange rate holds above US60c, Fonterra will be forced to drop its 2009/2010 milk-solids payout forecast to below $4 from the current $4.55.

"Such a change, if it was to happen, would be a very negative signal for the New Zealand economy as incomes in the largest export industry would be below cost levels.

"The economic consequences would be dire and force the NZD lower as international investors and currency traders re-rated the NZ economy downwards," said Kerr.

More of the "extreme" comments the Agriculture Minister would rather not hear?

What is of even further concern are reports which suggest most major banks' economists had predicted the NZ/US dollar cross rate would be in the US43c to US52c level for the second quarter of 2009. (Apart from the BNZ which had forecast US63c).

Given that the cross rate has been bouncing along at over US60c for some weeks now - well above the US59c rate on which Fonterra based its recent forecast - this outcome surely would have been raising another red alert in the Beehive. Particularly as the banks may well have factored their own farm lending on similarly rosy assumptions.

Here's Kerr again: "It is very apparent from various media reports that a number of major exporting companies failed to hedge their currency risks forward to sufficient levels when the NZD/USD rate was in the low 0.5000's several months ago.

"The main reason for this failure to protect export receipts was that at the time leading economists in NZ were boldly predicting the NZD to go to 0.4000 to the USD and they convinced a few boards of directors to overrule their own hedging policies and take a big punt."

All this points to the need for ministers to instruct Treasury to do some real due diligence on the dairy sector's exposures and do some scenario building.

Or is that too "extreme" to expect?