Sometime in 2016, shareholders in our big four banks will get something of a shock from New Zealand when they are forced to make more disclosure about the exposure to that country’s indebted dairy sector.
The big four may have to put aside more money than they have so far allocated to cover bad debts in the sector.
Our big four banks dominate the Kiwi economy, like they do in Australia – in fact they account for around 80% of the NZ bank sector, and have the lion’s share of the $NZ37 billion in loans to the sector.
The Reserve Bank of Australia has already put the banks on notice by mentioning their rising level of Kiwi dairy debt in this year’s Financial Stability Reviews.
Now the Reserve Bank of New Zealand revealed this week that it is closely monitoring the dairy loan position of the country’s major banks.
In a report which examined that financial health of the dairy sector (NZ’s biggest and most import export sector and a major area of domestic growth), the RBNZ said it “has also requested that the five largest dairy lenders undertake stress tests of their dairy portfolios, and is in discussions with banks to ensure that they are setting aside realistic provisions to reflect the expected rise in problem loans. The stress tests will provide a view of potential losses under similar scenarios and will be reported on in due course,” the RBNZ said in the report.
"Dairy sector debt increased from $11.3 billion to $29 billion between 2003 and 2009, due to rapid increases in land prices, a flurry of dairy conversions and significant on-farm investment. This rise in debt left highly leveraged farmers exposed when milk and land prices fell sharply in 2009.
"A swift recovery in global milk prices subsequently helped to limit the degree of financial stress, although non-performing loans increased to a peak of around 4 percent of sectoral debt.
"This experience has resulted in increased caution among dairy farmers and a slower rate of debt accumulation. However, debt levels remain at elevated levels of more than 300 percent of trend milk income. As at June 2015, dairy debt reached $37.9 billion, representing around 10 percent of total bank lending,” the central bank said.
One outcome from the stress tests could be the big banks, including our four, are forced to put aside more money to cover impaired or possible bad debts. NZ is a major profit centre for all four banks.
The RBNZ report reveals that New Zealand’s dairy herd has shrunk for the first time in a decade as the end of the dairy export boom has ended – herd numbers are down 300,000 to 6.4 million in June of this year – a direct reaction to the slide in global prices which seems to have ended in recent months, leaving them down more than 50% since the peak.
The previous boom ended in 2009 when milk prices fell, dragging down land values and triggering a surge in bad debts which reached 4% of total sector debt of $NZ29 billion.
The latest boom has seen debt rise further to more than $NZ37 million (over $A30 billion), or 10% of total bank loans in the system.
The RBNZ forecasts that “Most farmers are estimated to make cash losses in the current season, compounding cash flow pressures experienced in the later part of the 2014-15 season.
"Despite some farms with high debts facing considerable difficulties, most farms are expected to remain viable over the medium term. Losses for the banking system as a whole are estimated to be manageable even under a severe stress scenario for the dairy sector,” the RBNZ said.
The New Zealand ministry for primary industries said this week that it expected milk production to fall 7% in 2015-16. But it forecasts that prices will rebound in late next year and into early 2017 as demand rebounds.
