“Commodity prices need to remain high, given the debt that’s gone into the sector,” Orr told Parliament’s finance and expenditure committee.
In the Reserve Bank’s latest financial stability report published last week, it said although most dairy farms have been profitable for the past three seasons, the sector’s debt-to-income ratio is 350%.
And 30% of dairy debt is held by highly indebted farms which have borrowed $35 for every kilogram of milk solids they produce.
Fonterra’s milk payout for the season just gone was $6.35/kg MS and it is forecasting a payout of $6.55-to-$7.55/kg MS for the current season.
The Reserve Bank’s manager of financial systems analysis, Chris Bloor, told the committee there are still some farmers that are only marginally profitable, despite high dairy prices, and banks have been encouraging them to start repaying principal as well as paying interest.
That has led to an improvement in some problem loans, Bloor said.
However, “some of the worst loans are not improving at all” because those farmers are still struggling to achieve profitability even with higher milk prices.
The increase in non-performing loans also signifies that banks are recognising some dairy loans won’t be repaid in full. “It’s not that bad debts have risen, but that they’ve reassessed them.”
Labour Party MP Kiri Allan asked whether it was a case of the banks being eager to lend while the sun was shining that’s responsible for some farmers’ current predicament, noting she has been hearing that banks are now aggressively turning away farmers.
Orr said the short answer is “yes,” and that “without doubt” the sector had been subject to “white gold-type fever” when dairy prices peaked in 2013.
A lot of the work the RBNZ has been doing with banks about their conduct and culture has been looking at such situations, he said.
Changes banks are making won’t prevent the next economic downturn but requiring them to hold more capital “is one way of ensuring banks are incentivised” to make prudent lending decisions because more of their own money will be at risk.
The Reserve Bank has proposed a near doubling of minimum bank equity and will announce its final decisions on exactly how much additional equity banks will have to carry tomorrow.
Orr said that the banking sector is very competitive and, while some banks may decide to cut back on dairy lending, others will decide to increase their dairy lending.
“We’re not in the consumer protection business” but the RBNZ is working very hard with the banks to encourage prudent lending. “No bank wants to be the first one to blink” because they recognise they contributed to the current situation.
Deputy governor Geoff Bascand told the committee that banks take their obligations seriously and “at their very best” are working hard to bring their affected customers through current difficulties, but it’s often a very slow process.
Orr noted that while lending to dairy farmers has been shrinking, overall lending to agriculture has risen 2.5% in the last year and lending to horticulture is up about 15%.
He acknowledged banks are now charging riskier customers more. “The banks are being very sharp with their pencils” and have been passing on the benefits of falling interest rates this year to their better, less indebted customers.
National Party MP Nathan Guy asked how concerned the RBNZ is about the impact on New Zealand’s economy of those very indebted farmers, who are also facing greater regulatory imposts, particularly environmental ones.
Bloor said the problem currently is limited to a few hundred loans and a few thousand may be vulnerable to an economic downturn.
Orr said any impact on the financial system and the economy would be “at the margin” while Bascand said it may be “very difficult” for some individual farmers but “from a system perspective,” it isn’t a significant problem.