NZ dairy farms expected to be in profit this season, says Reserve Bank

The Reserve Bank says farms have been supported through the recent dairy price downturn, which has helped to limit loan defaults. Photo / Wanganui Chronicle

The Reserve Bank said most New Zealand dairy farms are expected to be profitable in the 2017-18 season but they remain more indebted than other farm sectors.

Commercial banks' non-performing loans to the dairy sector have declined, the central bank said in its financial stability report.

Global dairy prices have declined in recent months, but remain well above their mid-2016 levels, the bank noted.

Banks have supported farms through the recent dairy price downturn, which has helped to limit loan defaults, it said.

"It is appropriate for banks to continue working with the sector to use improved cash flow positions to reduce debt levels in the sector over time," it said.

Fonterra has a milk price forecast of $6.75/kg for the current season, up from $6.12/kg in 2016/7.

Private sector economists expect to see a revision down to around $6.25 to $6.50/kg when the co-operative reviews its milk price forecast next month.

At those levels, farmers would still be ahead of Dairy NZ's latest estimate of break-even of around $5.20 to $5.25/kg.

Farm debt ballooned when prices slumped to $3.90/kg in 2014/15 and to $4.40 kg in 2015/16.

The Reserve Bank said that although dairy prices have eased recently, the price of whole milk powder is still around 35 per cent higher than in mid-2016 and butter prices have almost doubled.

Combined, these two products account for 60 percent of the value of New Zealand's dairy exports.

Banks are reporting fewer loans that need to be closely monitored and have started to reduce their provisions against losses on their dairy loans, the report said.

Non-performing loans (NPLs) have fallen by $100 million since May and the share of banks' dairy loans that are non-performing is now 1.6 percent, down from 1.9 percent at the end of 2016.

The recent peak in NPLs is much lower than the peak that followed the sharp decline in dairy prices in 2008.

During the recent downturn, bank lending to the dairy sector increased by $5 billion or 15 per cent, mainly for working capital purposes.

Farms also borrowed almost $400 million through Fonterra's soft loan scheme.

"With leverage in the dairy sector already high, this growth in debt has left the sector more vulnerable to another period of low dairy prices or an increase in interest rates," it said.

"Within banks' agriculture portfolios, lending to the dairy sector poses the greatest risk to financial stability as it accounts for 10 percent of total bank lending," it said.

The next largest agriculture sector, sheep and beef, accounts for just 3 percent of total lending.

The dairy sector is also more indebted, relative to its income and assets, than other agriculture sectors.

Debt in the dairy sector is estimated to be more than three times income, compared to a debt-to-income ratio of around two for the sheep and beef sector.

Lending to the dairy sector also tends to be at higher loan to value ratios, meaning banks and farms would be at greater risk if farm prices fell, it said.

Banks are diversifying their agricultural lending into other sectors. Lending to non-dairy agriculture increased by 8 percent over the year to September, reflecting strong growth in lending to the sheep, beef and horticulture sectors, it said.

"Diversification may improve the overall risk profile of banks' agriculture lending portfolios," the report said.