Reserve Bank warns indebted NZ dairy sector still vulnerable

The Reserve Bank has once again highlighted dairy farm debt in its latest Financial Stability report. Photo / Supplied.

New Zealand's dairy sector remains financially vulnerable, despite higher milk prices, the Reserve Bank said in its latest financial stability report.

The central bank, in noting Fonterra's record 2018/19 loss and the lack of a dividend that year, also raised questions about the co-op's ability to pay dividends in future.

The Government has proposed tougher regulations for farmers to improve water quality and to reduce greenhouse gas emissions at the farm level by 2025.

"Additionally, Fonterra made a record loss after writing down some assets by $826 million and announced that it will not pay a dividend for the 2019 financial year," it said.

"This announcement raises concerns surrounding its ability to pay dividends in the coming years," it said.

Despite above-average dairy commodity prices and reasonable profitability for the dairy sector as a whole, a "significant share" of the dairy sector remained financially vulnerable.

It said progress has been made by some borrowers in reducing debt and restoring balance sheet sustainability.

"However, the most indebted farms have struggled to achieve profitability and repay debt," the bank said.

"A significant share of dairy loans are still being closely monitored by banks, and the share of loans that are non-performing has increased," it said.

"The sector faces longer-term cost challenges in reducing its environmental impacts and many farms have little resilience to weather another period of low commodity prices."

The Reserve Bank said the agriculture sector represented the second most significant credit exposure of the banking sector.

Dairy debt, in particular, was high and concentrated.

The agriculture sector accounts for around 14 per cent of financial system lending, with two-thirds of that to dairy.

"The sector has a high debt-to-income ratio at 350 per cent, and debt in the dairy sector is concentrated, with 30 per cent of debt held by highly indebted farms."

Some dairy farms were financially vulnerable, as reflected in the rise in dairy non-performing loan ratios over the past five years.

The Reserve Bank has raised questions about Fonterra's ability to pay dividends. Photo / File

Dairy sector debt fell by 0.9 per cent in the year to September, reflecting banks' reduced appetite to lend to the sector and a decline in demand for new loans.

Banks expect to tighten credit availability further over the next six months.

"Meanwhile, reasonable dairy prices have reduced the need for some farms to borrow to cover operating costs and banks are actively working with farmers to amortise existing debt," it said.

Low interest rates should help many farmers to pay down debt by reducing interest costs, it said.

"However, a number of banks are seeking to increase their margins by imposing fees for the provision of various facilities to farmers and through repricing higher-risk borrowers," the Reserve Bank said.

"This means that the most financially vulnerable farms are unlikely to see significant relief in their financing costs."

Options to address excessive debt were limited as farm sales are at historically low levels, it said.

Farm price inflation is low and tighter restrictions on foreign investment may reduce demand for dairy farms.

"Farmers cannot therefore easily sell dairy farmland to repay debt," it said.

In May, the Reserve Bank estimated break-even point for highly indebted dairy farms to be $6.20 a kg of milk solids.

Fonterra has forecast the milk price to be in a $6.55 to $7.55 per kg range for 2019/20.
Some economists have predicted the milk price could hit $7.50/kg.

Separately, Federated Farmers said its members' satisfaction with their banks had continued to erode and the number who felt under pressure from banks has risen to 23 per cent from 16 per cent.

According to its latest banking survey, most farmers remained "satisfied' or "very satisfied" with their banks, but the number giving those ratings slipped from 71 per cent in May this year to 68 per cent in the November survey - the lowest point since the surveys began in 2015.

"This is disappointing but not at all surprising given what we have been hearing over the past several months of banks getting tougher and changing conditions as they seek to contain or even reduce their exposure to agriculture, and also as they respond - prematurely - to the Reserve Bank's proposals on bank capital," Feds economics and commerce spokesperson Andrew Hoggard said.

The Reserve Bank is due to announce changes to the amount banks need to hold in order to back their capital adequacy on December 5.