The move by the Reserve Bank of NZ to cut its key interest rate to an all time low of 2.25% yesterday can be understood by what Fonterra, the giant Kiwi diary company and the world’s largest exporter, said and did this week.
The company cut its milk price forecast for the 2015-16 season to a nine-year low of NZ$3.90 a kilo, from NZ$4.15 a kilo – the driver the continuing global supply glut which is still pressing down on world dairy products prices.
That is sharply down from Fonterra’s all time high payout of $NZ8.50 a kilo in 2013-14 (that included a 10 cents a share to shareholder farmers as well).
The global auction on March 1, when prices rose 1.4%, was the first rise in 2016. Before then prices had dropped 13.2% from the start of the year, continuing the decline since 2014. Global dairy prices are in fact down 62% in US dollar terms from February 2014 to March 1 this year.
And that is negative news for Australia’s big banks – as Moody’s pointed out in a report late yesterday.
"The decline is credit negative for New Zealand banks because a lower payout reduces the income that farmers receive, thereby threatening the asset quality of banks exposed to the dairy sector," said Daniel Yu, vice-president senior analyst at Moody’s, in a written statement.
The ratings agency said that ANZ, ASB (Commonwealth) and BNZ (NAB) were the most exposed to the country’s agricultural sector.
The latest cut would mean dairy farmers would earn about $NZ400 million less than previously expected for their milk in the 2015-16 season.
The company said the new forecast price of $US3.90 a kilo was “unsustainably low”, and Fonterra was assuming the situation would not improve before Christmas.
NZ dairy industry and farmer groups are now warning that the cut and the weak prices will put more pressure on dairy farmers and their finances – many have over capitalised in the boom and owe tens of billions of dollars to the banks.
The big four Aussie banks have an estimated (from the Reserve Bank) $A30 billion of exposure to the Kiwi dairy industry, and tens of billions of dollars in housing finance as well.
The RBNZ has already ordered the five big NZ dairy lenders (including the ANZ, NAB, Westpac and Commonwealth) to stress test their loan portfolios and to make sure they have set aside enough funds to cover a sharp rise in problem loans.
That and the Fonterra announcement helps explain the singling out of the strains on the dairy industry by the RBNZ in its post decision statement yesterday.
"The main domestic risks relate to weakness in the dairy sector, the decline in inflation expectations, the possibility of continued high net immigration, and pressures in the housing market.
"Domestically, the dairy sector faces difficult challenges, but domestic growth is expected to be supported by strong inward migration, tourism, a pipeline of construction activity and accommodative monetary policy,” the RBNZ said.
And NZ analysts now accept there will be a further rate cut, perhaps mid year, to 2%.
The cut is big deal for the big four Australian banks which dominate NZ banking with around 80% of the market. The ANZ last night showed its hand by keeping 0.15% of the 0.25 cut in announcing an 0.10% drop in mortgage rates.
That is a move the ANZ and the others did in Australia with our two rate cuts in 2015. They did it to improve their profits and net interest margins (and lifted rates for both investors (twice) and owner-occupiers (once). The other Australians banks are tipped to follow suit.
In a sign of the spreading impact of the price cuts, Fonterra has confirmed about 3600 to 4000 businesses that provide services to Fonterra are having to wait up to three months to be paid.
“Let’s be clear here, Fonterra is absolutely sound – a very sound business,” chief financial officer Lukas Paravicini said, according to a story in Fairfax media’s NZ papers.
Fonterra invested heavily last year to increase the volume of milk it could process in New Zealand and had since committed to not increasing its debt levels, he said.
Chairman John Wilson said the lower forecast price would come on top of an expected 4% drop in milk production. “Clearly these prices are unsustainably low for our farmers in New Zealand and more widely,” he was quoted as saying.
In its second Financial Stability review of 2015, the RBA pointed out that, "Australian-owned banks’ largest international exposure is to New Zealand, where all four major banks have sizeable banking operations. As is the case in their Australian businesses, housing lending represents a substantial share (a little under half ) of the major banks’ credit exposures in New Zealand.
"The major banks also have substantial exposures to the agriculture sector in New Zealand, reflecting the economic importance of the dairy industry there. Specifically, the major banks’ exposures to the agriculture sector are around 13 per cent of their credit exposures in New Zealand, around two-thirds of which (roughly $30 billion) are to the dairy industry.
"Although a much smaller share of assets than housing lending, dairy exposures are riskier in terms of both their probability of default and likely losses in that event, and the risk of loss is currently higher than usual given the low level of global milk prices. There is also a risk that stress in the dairy sector might exacerbate the rural property price cycle,” the RBA said.
