Friday, March 29, 2024

Stress pockets in agricultural lending

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Agriculture has fared relatively well during the covid-19 pandemic but vulnerabilities in the sector remain, the Reserve Bank says.
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In its Financial Stability Report for May it said lending to the agricultural sector is a key concentration of risk for the banking system, accounting for about 13% of loans, of which around two-thirds is to dairy farming. 

“The industry is vulnerable to income shocks given its dependence on global commodity prices and pockets of dairy lending have yet to recover from the 2015 downturn.

“Low serviceability metrics indicate the agricultural sector has entered this crisis with a limited ability to take on more debt to absorb temporary falls in income.” 

Northland, Auckland, north Waikato and Hawke’s Bay have also faced persistent drought since December, creating further stresses. 

“Some highly indebted dairy farms could face solvency and liquidity pressures were milk prices to fall materially.”

In a published chart of balance sheet and debt-servicing vulnerabilities, the dairy farming industry has the lowest interest coverage ratio, about 2%, and a low equity-to-assets ratio, about 35%.

The interest coverage ratio is calculated as the total income less total expenses divided by the interest, using industry aggregate values.

Before the covid-19 outbreak became a pandemic commodity prices for the agricultural sector were stable, allowing it to avoid much of the initial economic impacts. 

Businesses in the primary sector were also generally able to operate under alert levels three and four, unlike many sectors of the economy.

“However, the outlook has worsened somewhat,” the Reserve Bank said. 

Dairy prices in New Zealand dollar terms have fallen by about 8% since January while milk price futures for the 2021 season have fallen to about $6/kg milksolids. 

That is still above the low prices of the 2015 dairy downturn when the payout including dividend for farmers fell below $5/kg.

“However, there remains a tail of highly indebted dairy farmers from that downturn who generally require payouts above $6 to break even and these could face significant stress if commodity prices continue to fall.”

Non-performing loans in the agriculture sector were 2% in March, a small increase on their numbers in March 2018 but below the 3% levels of 2010 and 2012.

The dairy industry contains most of them, many of which became highly stressed during the downturn in 2015 and 2016 and whose long-term viability remains uncertain without substantial restructuring of their balance sheets.

Forestry and some other pockets of the primary sector are also vulnerable given the trade disruptions that have happened and possible export price falls, ANZ senior economist Liz Kendall said.

The financial system is sound and resilient to all but the most severe scenarios, Reserve Bank governor Adrian Orr said.

“Banks have good capital and liquidity buffers and need to use these to support customers and contribute to the economic recovery.”

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