Banks may increasingly lose patience with farms with very high cost structures and very high debt burdens, warns Chris Bloor, financial systems analyst at the Reserve Bank of New Zealand.
The bank is reviewing the capital commercial banks must hold as sufficient provision for the dairy industry’s debt.
And it is concerned about housing market vulnerability and bank funding pressures.
Auction prices for whole milk powder have increased 69% since July and Fonterra has raised the farmgate forecast to $6/kgMS, which is likely to return the average dairy farm to profitability, says Reserve Bank governor Graeme Wheeler in his six monthly financial stability report.
“Nevertheless, parts of the dairy sector remain under significant pressure,” he adds.
“In aggregate, dairy farms have reduced costs, but there is significant variation in cost structures across farms. Even with the improvement in dairy payouts, some farms may struggle to achieve profitability, especially given that 20% of farms account for about 50% of overall dairy debt.”
Debt levels have been stretched further as dairy farms have borrowed working capital to absorb operating losses over the past two seasons. High debt levels leave the sector vulnerable to any weakness in dairy prices.
With recent price improvements, credit losses are likely to be lower than suggested by the more severe scenarios in stress tests of banks’ dairy exposures last year, Wheeler says. Nevertheless, problem loans are likely to increase further, as losses take time to materialise.
Therefore, he says, banks should ensure provisions and other buffers are appropriate for expected losses.