Increased dairy cash-flow pressures tipped to emerge this season

Fonterra's farmgate milk price forecast for 2015/16 sits at $4.60 a kg of milksolids, well below the average breakeven point of $5.40 a kg.

The dairy sector faces cash flow difficulties in the year ahead but most farms are expected to remain viable over the medium term, say the Reserve Bank and DairyNZ.

Fonterra's farmgate milk price forecast for 2015/16 sits at $4.60 a kg of milksolids, well below the average breakeven point of $5.40 a kg.

The joint article said that with dairy farm debt representing around 10 per cent of total bank lending, there were implications for the New Zealand financial system if prices remained low.

Most farmers are estimated to make cash losses in the current season, compounding cash flow pressures experienced in the latter part of the 2014-15 season but losses for the banking system as a whole are estimated to be manageable, even under a "severe stress scenario", it said.

Dairy sector debt increased from $11.3 billion to $29 billion between 2003 and 2009, due to rapid increases in land prices, a flurry of dairy conversions and significant on-farm investment. The rise in debt left highly leveraged farmers exposed when milk and land prices fell sharply in 2009.

A swift recovery in global milk prices subsequently helped to limit the degree of financial stress, although non-performing loans increased to a peak of around 4 per cent of sectoral debt.

Between February 2014 and August this year, global dairy prices fell by more than 65 per cent in US dollar terms due to increased global supply, sanctions on Russian imports, and reduced Chinese demand following a build-up of inventories during the 2013-14 season.

The worst cash-flow pressures are expected to emerge in the current season, compounded by low retrospective payments from the 2014-15 season, the article said.

Despite the significant cash-flow pressures facing the sector, dairy farm land values have been supported by low interest rates and a largely positive long-term outlook for the payout.

The Real Estate Institute of NZ's dairy price index continued to grow at about 10 per cent per annum throughout the summer of 2014-15. However, land values have recently shown signs of weakening, on limited sales volumes. Banks have supported the sector by expanding lending by more than 10 per cent over the past year, on the basis that most farms are expected to be profitable over the medium-term, the article said.

However, there is an increased risk of a rise in non-performing loans.

"Highly indebted farms are particularly vulnerable, as they tend to have less equity and lower profitability."

It was estimated that 49 per cent of the sector had negative cash flow in the 2014-15 season. These cash flow pressures are expected to increase, with around 80 per cent of farmers - representing almost 90 per cent of sectoral debt - expected to have negative cash flow in the 2015-16 season.

"The worst case scenario features a slow recovery in the payout and a sharp decline in land values, resulting in non-performing loans increasing to around 44 per cent," the article said. "While this scenario presents a highly challenging environment for the dairy sector, our results suggest that losses for the banking system as a whole would be manageable."

According to a Federated Farmers survey, banks are still standing by their farmer customers.