Saturday, December 2, 2023

Reserve Bank cautions on dairy debt levels

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Prudent steps to cut borrowings in recent years give some bulwark against rising rates.
ANC says there are elevated levels of milk powder stocks in China, adding to the challenges from that market.
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Rising interest rates and weakening commodity prices have put dairy debt back on the Reserve Bank’s radar.

A prolonged period of debt repayment has kept the sector out of the central bank’s bad books in its twice-yearly stock-takes of the financial system in recent times.

But it was right back in the naughty corner along with commercial property landlords and heavily indebted Auckland homeowners with the publication of the Reserve Bank’s latest Financial Stability Report yesterday.

“Agriculture and commercial property stand out as business sectors where rising interest rates could lead to financial stress, given these sectors’ reliance on debt-financed physical assets such as property,” the report says.

“While the dairy sector has made substantial progress in reducing leverage following the 2015/16 industry downturn, farmers profits are being squeezed by rising inputs, a decline in the expected payout for the current season, and higher debt-servicing costs.”  

In its November Financial Stability report, the central bank noted the possibility of more pain for farmers as interest rates continued to rise.

At the time, Fonterra’s payout projection above $9 per kilogramme of milksolids gave it comfort that most farmers were still profitable and debt stresses within the sector remained contained.

However, prices on international markets have since fallen.

“Falling dairy prices over the past six months alongside increasing farm input costs, such as those of fuel, fertilisers and labour, are putting pressure on profit margins,” the reports says.

“Fonterra is now projecting a reduced midpoint price of $8.30 per kg ms this season driven by slowing global demand, particularly from China.”

The report said debt-servicing costs have increased sharply.

“At an aggregate level, average interest costs per unit of production increased to $1.20 per kg ms from 50 cents per kg ms in mid 2021.

“Narrowing margins from rising costs and falling international dairy prices have led to more requests for working capital and overdrafts to meet short-term cashflow needs,” the report says.

Indeed, monthly lending figures show agricultural debt began to increase again from October last year after 31 consecutive monthly falls dating back to April 2020. However, agricultural credit growth at 1.3% in March 2023 remains comparatively constrained relative to housing and personal consumer credit growth (3.5% annual growth) and other businesses (4.9%).

Speaking to media, the Reserve Bank’s manager of financial systems analysis, Chris McDonald, said while there are signs of increasing stress for agricultural borrowers, they remain at low levels historically.

“The environment generally is tightening for them and that is quite likely to have some impacts.

“But in saying that, when you think about the dairy sector we have seen them reduce their debt and strengthen their resilience over a number of years so that when times like this happen they are in a better position for it.”

Agricultural loans classified as non-performing – defined by the Reserve Bank as impaired or in default of their loan terms for 90 days or more – had increased to 1.1% at the end of March.

That’s up from 0.9% a year ago but below the 1.5% of loans deemed to be non-performing during a period of weak commodity prices in 2016 and well below the historic high of 4.4% during the 2011 dairy slump.

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