September 15, 2016

New Zealand Ag Lenders Likely to Weather the Dairy Storm

 |  By: Fran Howard

Following several years of low milk prices that led to extremely thin margins for dairy producers, New Zealand milk prices are projected to improve just enough and in time to head off a major banking disaster caused by record-high on-farm debt in the one of the world’s largest dairy exporting countries.

Dairy farm debt in New Zealand hit a record $40.1 billion (NZ) in June 2016, the equivalent of nearly $30 billion (US), according to data released last week by the Reserve Bank of New Zealand. From June 2003 through December 2009, Agriculture credit in the dairy sector grew by double-digit annual gains of between 10% and 29% from $11.3 billion to $29 billion (NZ).

“Agriculture lending slowed dramatically between 2010 and 2011, with increases of less than 3% annually, most likely due to favorable milk prices,” notes Mary Ledman, dairy economist with the Daily Dairy Report and president of Keough Ledman Associates Inc., Libertyville, Ill. “By 2014, the pace of dairy farm debt picked up once again, growing by 6%.” Those gains were followed by a 9% increase in 2015 and a 6% gain in 2016, when total debt reached $40.1billion, its highest level ever.

“The importance of the dairy sector to New Zealand’s agricultural economy and national economy should not be overlooked,” says Ledman. “Dairy farm debt accounted for 61% of New Zealand’s total farm debt in 2003, and it grew to 69% in 2016. Dairy products are New Zealand’s largest export.”

The Reserve Bank of New Zealand indicated in March 2016 that New Zealand’s banking system was robust enough to weather a severe dairy stress test after conducting a stress test on the country’s five largest dairy lenders in late 2015.

“Under scenario one, the average milk price recovered to $5.25/kgms by the 2017-18 season and dairy land prices dropped by 20%. In the second more dire scenario, the average milk price assumption was for prices in the 2015-16 season to fall to $3/kilograms of milk solids (kgms) and remain below $5/kgms until 2019-20 and for land prices to plunge 40%,” notes Ledman.

The five banks, on average, reported losses under the two scenarios that ranged between 3% and 8% of their total dairy exposure, according to the Federal Reserve Bank of New Zealand.

“The test results also suggested that in the short term, banks would increase their dairy lending to help existing clients manage through negative cash flow before acknowledging a longer-term rise in loan losses from a prolonged downturn in the dairy sector,” Ledman says.

New Zealand debt per cow has risen right along with total dairy farm debt. “Debt per cow rose dramatically from $3,000 in 2003 to $8,000 in 2016,” she notes. “Debt per cow retreated in only two of the last 13 years, 2010 and 2011, both years with higher milk prices.” New Zealand pay prices reached $7.89/kgms in 2010 and $6.40/kgms in 2011.

“In stark contrast, New Zealand milk prices for the 2014-15 season averaged $4.69/kgms, and estimated milk prices for the 2015-16 season are closer to $4/kgms,” notes Ledman. “Clearly, exceptionally low farm-gate milk prices during the past three seasons, coupled with more expensive land and cattle, have contributed to total rising debt in the dairy sector and debt per cow.”         

The outlook for New Zealand milk prices in the 2016-17 season has improved from the 2015-16 season. Fonterra’s latest estimate calls for milk prices plus earnings to average between $5.25 and $5.35/kgms.

“Fonterra’s estimate is near the Federal Reserve Bank of New Zealand’s scenario-one stress test assumptions, which may be just enough of an improvement for banks to support their existing client base through another tough season,” she adds.