Australia’s big four banks – ANZ, NAB, Westpac and the Commonwealth – are facing the potential of multi-billion dollar losses should the NZ dairy industry’s current crisis deepen and force farmers into financial restructuring, defaults, which in turn trigger sharp falls in the value of dairy farm land, leaving it unsaleable.
Low global milk prices – down more than 60% in two years – are generating significant financial pressure for NZ dairy farmers (and the sector giant, Fonterra), with around one half of the dairy sector currently experiencing a second consecutive season of operating losses, according to the RBNZ.
And, if the downturn proved to be deeper than expected, recovery of loaned funds would take longer, as well as the banks being forced to make big impairment losses – a move that could wipe out much of their earnings and see them need capital injections from their Australian parents.
A stress test conducted by the Reserve Bank of NZ on the five major lenders to the country’s struggling dairy sector, found that while the banks would survive, it would not be without some considerable pain.
The stress tests did not single out any of the five banks – it was applied to the group of five as a whole, but the RBNZ (and no doubt regulators in Australia such as APRA and the Reserve Bank) will be discussing the results with each of the five and the application of the findings to the dairy and total loan books, provisioning and finances.
Four of the five are owned by the big four Aussie banks – ASB is owned by the Commonwealth, Bank of NZ by the NAB, the ANZ (the old National) and Westpac.
A summary of the RBNZ test found, “The average bank reported writing off about 25% of initial dairy exposures during scenario 2, and 12% during the first scenario”.
“The variation in reported write-offs across banks was significantly lower than for loss rates, suggesting that the estimated loss to resolve stressed assets was a key driver of differing loss rates,”a summary of the test released yesterday, says.
In other words – the deeper of the two scenarios – lower milk prices for longer and a 40% fall in land prices, could see losses in the dairy sector of up 10% of total loans ($NZ38 billion), or nearly $NZ4 billion, compared to total profits in today’s terms of around $NZ5 billion for the sector.
The review found that the NZ banking system was “robust to a severe dairy stress test" the results of which ‘Summary of the dairy portfolio stress testing exercise’ were published yesterday by the Reserve Bank.
Five banks that are the largest dairy sector lenders participated in a stress test run by the RBNZ in late 2015.
The bank said two scenarios were tested, with scenario one assuming that the dairy payout recovers to $NZ5.25 per kilogram of milk solids by the 2017-18 season (currently $NZ3.90 a kg) and a fall in dairy land prices of 20%.
The second more severe scenario saw a dairy payout falling to $NZ3 in 2015-16 and remaining below $NZ5 until the 2019-20 season with land prices falling 40%.
“On average, banks reported losses under the two scenarios ranging between 3 to 8 percent of their total dairy sector exposures,” said Head of Macro Financial Bernard Hodgetts said in a statement yesterday.
“Bank lending to the dairy sector stands at around $38 billion, which is approximately 10% of the banking system’s total lending. We would expect losses of the order seen in the stress scenarios to be absorbed largely through lower bank earnings rather than through an erosion of bank capital,” Mr Hodgetts said.
“The test results suggested that in the shorter term, banks would increase their dairy lending in order to support existing borrowers facing negative cash flow, before facing a longer term rise in loan losses if there were a prolonged dairy sector downturn," the RBNZ said yesterday.
That would in turn mean that land prices (the main security for the loans) would remain lower for longer, and problem loans would be hard to resolve given the land took longer to sell.
