Credit growth in the agriculture sector has surged from zero in January to an annual rate of 4.5%.
Much of it is dairy sector debt and the 20% drop in dairy farm prices between the 2007/08 and 2010/11 seasons has pushed dairy farmers into higher loan-to-value ratio brackets.
Reserve Bank governor Graeme Wheeler was questioned about his concerns when he appeared before Parliament’s finance and expenditure committee to discuss the bank’s latest financial stability report (FSR). He said dairy-sector debt represented about 10% of total bank and non-bank lending and half the debt was held by the 10% of most-indebted farmers, which was something the banks needed to think about.
The ministry expressed its concerns in the latest farm monitoring report on dairying (see story page 17), which said 20% of the dairy farms with high debt were vulnerable to a drop in payout. Federated Farmers Dairy chair Willy Leferink said there had been a beautiful period, particularly last year, for farmers to shore up their balance sheets but people ignored it.
Asked whether farmers might sell the economic rights of their Fonterra shares to help run down their debts, he said this could help raise cash but the debt was in the billions and $500 million wouldn’t make much impact.
Because banks held security over assets they would probably have to be consulted.
However, investment analyst Brian Gaynor said farming debt had been used wisely and was making a positive contribution to the economy.
Reserve Bank figures show dairy sector debt grew rapidly from $11b in 2003 to $30b in 2009, where it appears to have stabilised. The latest FSR includes an update of an earlier Reserve Bank analysis of dairy sector indebtedness, in light of forecasts that dairy payouts could drop below $6/kg milksolids again for the 2012/13 season. The analysts concluded the dairy sector appeared more vulnerable to a sharp decline in the payout than at the time of the peak in dairy prices five years ago. Aggregate debt is higher now than it was in 2007/08 and a slightly greater proportion of this debt is held by the most-indebted portion of farmers.
“Declining farmland prices have eroded the equity buffers of indebted farmers, implying that banks would consider foreclosing on a larger proportion of farms if the payout fell sharply and was expected to remain weak,” the FSR said.
The report also said dairy debt accounted for about 10% of aggregate bank and non-bank lending and 63% of lending to the agriculture sector. Almost half this debt was held by the most-indebted 10% of farmers, who were exposed when milk prices fell sharply in the wake of the global financial crisis.
The decline in milk prices over the 2008/09 season had been short-lived, the FSR said, but it illustrated that dairying returns could be volatile. This had led to greater caution in the sector in recent years.
But it was not clear that the overall debt position of the sector had materially improved.
Borrowing had increased sharply in the immediate aftermath of the decline in milk prices, as farmers drew down on credit lines for working capital. Debt levels had subsequently declined as a share of MS production, but it remained higher than in the 2007/08 season.
Its farm monitoring report said while most farmers would be able to survive a tough, year, two or three years of payouts under $6/kg MS would be another story. A key aspect of survivability was the amount of debt farmers carried.
Farmers had paid off a significant amount of debt over the past two years, but few would do so in 2012/13 because of the tight financial situation.
And at an aggregate level total agricultural debt had diminished little, because as some farmers paid off debt others borrowed more. Within the monitored farm population, 7% of farms had a total debt greater than $30/kg MS and another 12% had a total debt of about $25-$30/kg MS.
“This indicates that 19% of dairy farms are in the ‘danger zone’ with respect to debt levels.”
Dennis Wood, head of Act Three Rural Insolvency and Investigations, predicted rural receivership numbers would keep pace with rising rural bank debt. His data showed there had been at least 50 rural receiverships since early 2011 and about 200 receivership appointments since the beginning of the global financial crisis, excluding rural businesses that had voluntarily been wound up, liquidated and/or were the subject of mortgagee sales.
Wood, who works with the rural, banking, legal and commercial sectors to help resolve insolvency, taxation, shareholding and financial issues, said many business owners left key financial decisions until it was too late. Some in receivership were extreme examples of financial delinquents, who failed to heed warning signs or listen to financial advisors or bankers. Often they were “cowboys”, sometimes entrepreneurial, who were poor listeners and managers and didn’t know the meaning of a forecast cashflow.
Leferink agreed many farmers had been imprudent and would find it hard to shore up their balance sheets now.
“Budget for the long term. See where you are going and see if there is light at the end of the tunnel.”
However, Gaynor emphasised that debt could be used for sound investment purposes and had been by most agriculture sector participants. He questioned the economic benefits flowing from $102.7b more of residential mortgage debt over the past 10 years.
It was clear from agriculture export and production figures that farming debt, which was modest compared with business and individual debt, had been used wisely and had made a positive contribution to the economy, he said. His data showed:
- $31.7b of additional agriculture debt generated $21.3b of extra dairy and meat export receipts over the 10-year period.
- $102.7b of new residential borrowings helped to create $50.7b of new housing and apartment consents over the same period.
Gaynor also said between now and 2050 NZ agriculture would require $210b of additional capital to generate growth and a further $130b to support the purchase of existing farms from ageing farmers.
“NZ agriculture needs to find innovative ways to attract domestic and foreign capital and Fonterra’s trading among farmers (TAF) scheme is a step in that direction,” he said.
“The obvious outcome is that more and more of our agriculture assets will be purchased by foreign interests, particularly Asian.”
Foreign investors might control and monopolise the supply chain to customers, which would reduce the price paid to NZ farmers, and overseas shareholders might move value-added operations out of NZ, meaning the tax base could be compromised when domestic companies and assets were owned by offshore interests.
Searching for answers on debt
One question niggling the Reserve Bank was whether aggregate debt numbers might disguise a change in the debt position of the most-leveraged farmers.
It looked for an answer and for signs of changes in the distribution of debt by analysing data from DairyNZ’s annual Economic Survey, which captures balance sheet and profit-and-loss information on a sample of about 200 dairy farms. The bank recognised some limitations with the data base: larger farms are underrepresented (the largest farm in the sample has a land area of 420ha) and the survey counts “soft” loans from family members as part of farm debt.
Also, the average market value of land seemed to lag behind available measures of farm price indices, so analysts adjusted market values to more closely reflect movements in the QV dairy price index).
- A marked increase in loan-to-value ratios (LVRs) over the past four years. This reflects the 20% decline in dairy farm prices between the 2007/08 and 2010/11 seasons.
- The proportion of debt in high LVR buckets has increased significantly, which is likely to make banks less comfortable forbearing on troubled operations.
The Reserve Bank analysts examined key profit-and-loss information for farms in the top quartile by LVR, compared with average farms. They found the high LVR farms had similar average farm working expenses (FWE) to other farms but had tended to invest significantly more than average, partially explaining their high debt.
Higher debt servicing costs in turn mean the average break-even payout is about 70c/kg MS higher for the high-debt farms.
“Despite the exceptional returns of the past few seasons and low interest rates, net debt levels (debt less current assets) remain elevated at $28/kg MS, $2.40/kg higher than in 2007/08.”
But debt accumulation among leveraged farmers had slowed sharply over the past four seasons because of a significant reduction in investment, the bank said. Indebted farms had also made some progress in rebuilding buffers of liquid assets that were drawn upon during the 2008/09 season.
About 36% of dairy-sector debt would be held by operations with negative cashflow if FWE remained unchanged under the current Fonterra payout forecast of $5.65-5.75/kg MS for the 2012/13 season. But this would increase to 64% of debt if the payout slumped to $5/kg MS.
FWE fell by 23c/kg between the 2007/08 and 2009/10 seasons, partly in response to lower payouts.
But compared with the 2007/08 season, the equity positions of the troubled farms spotlighted by the Reserve Bank analysis was weaker.
In a scenario where the payout fell to $5/kg MS, about 22% of dairy debt would be held by farms operating at a loss and with LVRs of above 80%, compared with only 4.4% in the 2007/08 season.
“Those numbers could be higher still if land prices declined, although the scope for price falls is now lower than in 2007/08, given current farm prices now appear more in line with fundamentals.”