TDB Advisory director Geoff Taylor says that’s likely to be one of the big negatives about the NZX Milk Price Futures contracts.
“The closer some farmers get to the detail of how the contracts work and develop an understanding that they may have to pass over a material amount of cash at the beginning of the futures contract, when they currently have access to very little cash, the harder it will be to get those farmers over the line,” Taylor said.
He warned it was too simplistic to take a view that additional deposits to a margin account held a low credit risk for banks just because, at the close of the hedge, any losses on the futures trade were counteracted by gains in the physical market.
“Margin lending does very much have a genuine credit risk attached.
“What if, at the end of the season, even with a gain in the sale proceeds from milk onfarm, the farmer still wasn’t making a profit? There may have been a drought or some other effects on the farm business’s profitability.
“The banks are still the creditor so even though there were increases in milk revenue that should otherwise have compensated for the losses in the hedging contract, it may be, in the worst case scenario, banks have lent more money and will not recover it.”
If the farmer was already laden with debt, additional margin funding could be problematic.
But director of financial markets at brokerage firm OMF Nigel Brunel said while it was fair to say there was still an amount of credit risk for the banks in margin funding, the bank’s client would have faced the effects on profitability of drought or other onfarm risk regardless of whether they were hedged or not.
“Let’s not be too chicken little with this,” he said.
If farmers had to deposit large sums into margin accounts it would be because the money they were earning for their milk was going up significantly too.
Margin call requirements could mean futures weren’t a tool some farmers should use because of their particular situation but for others a bank would see a major benefit in their clients having greater certainty around milk price income, he said.
“Banks may be nervous following the problems some of them had with interest rate SWAPS but we’ve all had food poisoning and that doesn’t mean we stop eating.”
Bankers spoken to by Dairy Exporter all said their larger clients were the most interested in the product with many of those clients former users of Fonterra’s GMP.
They were more likely to have boards and defined price risk management strategies and could more readily develop a hedging policy.
All noted that every farm would have a different attitude to risk and each client’s situation would be different so they needed to be worked with on an individual basis if they were interested in using hedging or options tools.
They were generally positive about the new market but all warned farmers needed to be fully aware of what they involved and how they worked.
“We’ll be looking at their (clients’) businesses to make sure they could manage a margin call but if there is one then that’s going to be because the price they’re receiving for their milk is trending up and that’s got to be good news,” ANZ agribusiness general manager Ross Verry said.
Farmers needed to identify financial advisers well-qualified to work with them on evaluating their options so they had a high level of understanding around the products, Verry said.
BNZ head of agribusiness John Janssen believed it would take time for the market to develop, which was a good thing.
“We’re for it – anything that gives farmers more tools to manage their business is good but the caveat is be careful, and for the average farmer I’d say don’t jump in boots and all. Take a wait-and-see approach.”
If there was enough demand the bank would investigate developing a product that packaged the price risk management tool to create a product that was simpler for farmers to use.
“We’d take a look at that but we’ll wait and see how it all develops,” Janssen said.
Westpac’s head of agribusiness Mark Steed also said developing an over-the-counter product on the back of the futures market was always a possibility but at this stage there didn’t appear to be any advantage in doing that.
ASB had no plans to produce a price risk management tool backed by the futures market either.
ASB rural general manager Mark Heer said in terms of margin accounts the idea of having costs associated with managing risk wasn’t new but in this case there was also the opportunity cost of having that money sitting in an account over the duration of the contract period.
If a farmer took out a futures contract in May, cash would sit in the margin account until October the next year.
But, like any risk management tool, the bank would work with individual customers to evaluate their situation.
More: https://www.farmersweekly.co.nz/milk-price-derivatives/
