RBNZ concerned about too much lending to farming, commercial property

The Reserve Bank has warned in its May Financial Stability Report (FSR) (pages 22/23, 28/29) that banks should be careful about lending too much to the farming and commercial property sectors, which are particularly vulnerable to lower commodity prices, falling property prices and a long recession in New Zealand. The bank was particularly concerned about heavy new lending to dairy farmers, particularly new entrants who have converted large properties to dairying. It said there was a risk of a significant fall in land prices and it was concerned that banks now had 15% of their lending in farms, up from 10% earlier in the decade. It was also concerned about a 20% increase in lending to commercial property owners and developers in the last year, which appeared to have been at least partially driven by banks having to step in to fund the completion of property developments that developers had defaulted on with finance companies. Here's the comments below from the FSR verbatim.

On Commercial Property Commercial property exposures account for slightly more than 10 percent of the New Zealand banks' total domestic lending, and have continued to grow rapidly despite the challenging economic environment. In the year to February 2009, for example, total bank lending to the commercial property sector increased by nearly 20 percent, which is substantially faster than other business lending. Most of this lending is secured against physical assets, but with commercial property prices expected to fall in the period ahead (see Chapter 3), there is a risk that banks could incur rising credit losses in this sector, particularly if "˜forced selling' by distressed property investors weighs heavily on property valuations Within the commercial property sector, one particular area of concern is property development. As discussed in previous Reports, ongoing strains in the non-bank sector have substantially reduced developers' access to mezzanine financing. This increases the risk that some projects will remain unfinished, exposing banks to increased credit risk. Moreover, with demand for new commercial and residential property currently very subdued, arranging the sale of a part-completed development at a "˜market' price is extremely difficult. Depending on the circumstances, there may be instances where it is preferable for a bank to provide the additional financing required to complete a project rather than risk its cancellation "“ a dynamic that could explain some of the recent strong growth in lending to the commercial property sector. On Rural Lending Credit exposures are also significant in the agricultural sector, particularly given the recent rapid growth in rural lending and the sharp decline in farm incomes during the 2008/9 season compared with a year earlier. Some more highly leveraged farms, notably in the dairy sector, are having difficulty in servicing debt, despite recent declines in interest rates, and there is evidence of increased use of overdraft facilities earlier in the year than is typically the case. Rural land prices are also likely to come under increasing pressure through the remainder of 2009, with the market for farm sales currently very thin. Default rates on agricultural lending remain relatively low at present, and the major banks have indicated that they intend to assist rural borrowers through a period of weaker returns. Despite some more positive trends in dairy prices recently, it appears unlikely that commodity prices will return to the elevated levels of 2007/8 in the foreseeable future, and banks should be prepared for a situation in which farm incomes remain relatively low for an extended period. Prompt action to carefully manage exposures to financially stressed farms is likely to be necessary. Lower payouts are affecting farmers' cash flows and some farms have been forced to rely more heavily on credit lines and overdraft facilities earlier in the season than usual. Some farmers have ample headroom to increase debt if required, while others should be able to cut operating costs to reduce borrowing needs. As a general rule, "˜family farms' are better placed to cut costs than larger corporate farms with more rigid wage structures. In aggregate, however, the agricultural sector's vulnerability to a further tightening in the availability of credit or renewed weakness in returns appears to have increased. Leverage in New Zealand's agricultural sector remains high following rapid growth in borrowing in recent years as commodity prices increased sharply, pushing up rural land prices. Bank lending to the sector more than doubled in dollar value between 2003 and 2008, and continues to grow more strongly than lending to other parts of the economy, although growth rates have eased in recent months. Loans to agriculture currently account for 15 percent of total bank lending in New Zealand, up from around 10 percent earlier this decade. Rising agricultural debt has been accompanied by a trend increase in farmers' debt-to-earnings and debt-servicing ratios. As noted in the May 2008 Report, the distribution of agricultural debt is highly skewed across the sector, with indebtedness generally greatest among dairy farms, especially new entrants to the industry and farms that have expanded through leveraged land purchases in recent years. Fluctuations in rural incomes, which influence land prices and lending growth with varying lags, are a key source of risk to both borrowers and lenders in the sector. These risks have become more pronounced recently as lower commodity prices and weakness in the world economy have reduced export receipts. Rural land prices appear to have eased after a period of significant increase, with a considerable drop in sales volumes potentially reflecting a widening gap between buyers and sellers. This may foreshadow a significant fall in land prices.