Federated Farmers supports banks in their campaign to retain unusually low capital levels. But banks are withdrawing support for farmers who are under-capitalised

Federated Farmers supports banks in their campaign to retain unusually low capital levels. But banks are withdrawing support for farmers who are under-capitalised

In a sector that is used to having to deal with its fair share of risk it is not surprising that Federated Farmers has put in a formal submission to the Reserve Bank questioning the sense of the need for banks to increase their financial reserve funds. They took three main requests to the Reserve Bank asking it to:

- Rethink its one-in-200 years risk tolerance and take a less risk-averse approach, which will reduce the increase in capital required the additional costs on banks and their customers.

- Undertake a robust and independent cost-benefit analysis, including on sectors like agriculture.

- Adopt a longer transitional period allowing for a more measured, gradual pace of any change.

The Feds view is of course to protect farmers from ‘unnecessary’ higher interest rates.

The unfortunate fact is if farmers didn’t insist on sailing so close to the wind, they would be able to absorb this increase, even if they don’t like it.

Interest rates are at an all-time low, however, the numbers show that dairy farms in particular are not in any position to absorb more costs.

The Reserve Bank has identified that 35% of dairy farms have debt servicing costs of $35 per kgMS or greater. These farms are estimated to be barely breaking even at the current 2018/19 price forecasts with 2% in serious financial trouble. This is considerably less to the 2011/12 season when 4.5% were in trouble but with the uncertainty in budgeting what dairy farmers incomes are likely to be, still reason for concern especially as these struggling farms have doubled since 2015.

Agriculture makes up over 14% of the total private debt in New Zealand and over two thirds of this is held by the dairy industry.

Farmers banking survey

Back to the Fed Farmers, they have released their annual banking satisfaction survey. Completed by 1,300 farmer members, it shows a decline in satisfaction dropping from 74% last year to 71% this time.

The survey shows that there has been a 4% increase in farm businesses with mortgages which lifts the total with mortgages to 81%. Interestingly since November the only increase has come from dairy farms. As these are new mortgages the increase has presumably come from new farm purchases rather than an increase in debt, which may also be occurring.

Pressure from banks has also been perceived to have increased. Of the farmers surveyed 16% have said they are feeling under increased pressure, up 5% since November last year.

Farmers don't see the irony that through the Federated Farmers submission, they are supporting the banks to have an unusually low capital base, but banks won't support them - in fact will move against them - if they are similarly undercapitalised.

The arable and dairy sectors have identified this pressure the most with 20% of dairy farmers identifying extra strain. Perhaps sheep and beef farms are not showing with the sales that are occurring going into forestry rather than livestock. Given that dairy debt has increased despite a modest upturn in prices it appears that banks may be starting to lose patience waiting for dairy debt in particular to get to safer levels.

With the Reserve Bank’s plan to make banks increase their capital, it will decrease their ability to lend, at least until reserves are built up, and as agriculture is seen as more risky this sector may be where a reduction in lending occurs. Reinforcing this view was the news this week that SBS Bank is looking to restrict lending to farmers, particularly in the North Island and more specifically dairy farming which it sees as more risky.

Auction results

Even though the milking season is over for most dairy farmers the latest Global Dairy Trade took place this week. The good news was whole milk powder (WMP) had the least change. Unfortunately, everything else dropped apart from rennet casein and lactose. Overall the drop was a 3.4% drop with WMP losing 1.5%. The biggest fall came from cheddar cheese which dropped by 14%. Given the reduction in global production for the last couple of months the fall of the GDT should be seen as concerning.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Guy - just a small tweak, should read35% of dairy farmers have debt levels of $35 or more per kg ms - not debt servicing costs of $35 or more!!
Still very VERY high imho. I would struggle to stay positive under that sort of financial pressure.
The increased financial pressure reported by FF will likely be due to the banks finally acknowledging the RBNZ concerns and are now demanding principal repayments. Although apparently quite a common practice with other bank lending it will be a new experience for a number of dairy farmers.

The sad reality is that farmers are playing the same game as residential property speculators and wind up paying more than the prudent earning capacity that the farm will support. They are in fact farming inflation as much as the land. Those that get caught playing this game deserve to go broke. The banks part in all this is just about as bad; it is a pity that they cannot be made to suffer along with their hapless victims.

"Hapless Victims" - I dont think so - no one forces them to take on loans (except maybe the National party with their talk of doubling agriculture by 2025).
The "farming inflation" you mention is however exactly right. The game plan of every farmer I ever met was to get more land.
The mentality passed down through the farming generations has always been "they're not making any more land - eh" and as Robbos back forty becomes available after his passing it is eagerly swallowed up by the neighbours.

Yes it is exactly the same as residential speculators. Both require capital gain for the numbers to make sense and when the music stops its going to be bad for both groups.

Boys, your forgetting there are always two parties to a loan, the borrower and the lender. The banks are as responsible for the "hype" in the market as they are the ones that allow the realise of their capital that is leant to the farmer. Without the Capital the banks cant lend anything to the farmer. The more Capital the banks have to lend then the more likely farmers are to borrow it and buy farms. Its simple supply and demand. To sit behind a screen and blame the farmer for been greedy and chasing Capital Gain is a rather basic view of looking at how the game actually works - the banks are as greedy as the farmers but the banks are in a more informed position than the average farmer (they are highly educated v's us dum country folk that didnt get School C) so they should take some responsibility for their actions, which is what Adrian Orr is doing!

Fed Farmers don't do irony.
The key indicator of the banks attitude to customers is their insistence that if the RBNZ brings this in they will force customers to front up with capital the shareholders need.

The banks won't be able to.

Very interesting sentiments. My sister and her hubby were recently declined bank funding to buy the inlaws small family dairy farm despite a reasonably large amount of equity. I would have thought the deal a shoo in given the way banks have thrown money at similar farming operations in recent years...

It's not the amount of equity that matters the most, it is the amount needed to be borrowed. With banks now working on serviceability at an interest rate of around 7% plus principal repayments over a maximum of 25 years you need at least a 9% return on the debt level required to make the purchase. In an industry that has traditionally provided a return on total assets of between 3 and 7% that's not so easy anymore.

"Farming inflation" requires low interest rates. So the Feds are not happy with the prospect of them rising. They would gain more agreement if they did not act only in their self interest.
Reality is the Banks must more capitalisation to protect New Zealand. Simple that. Maybe resulting in reduced bank profit. Interest rates might not rise at all.

Why do people have to find a scapegoat when something doesn't go to plan? Farmers took a RISK borrowing money to buy more land in the HOPE of a capital gain based on buoyant milk prices at the time. Banks lent the money on the basis that that hope was reasonable and there was collateral to mitigate the risk. All fair up to this point.
Neither farmers nor banks know the future, and when the milk price subsequently slumped a couple of years later the risk didn't pay off. Risks aren't guaranteed to work in your favour, which is why there should be a high financial reward if they do. The farmers who went too hard chasing the biggest profits lose their farm and someone else gets it for a better price. This is how capitalism should work and is pretty much the reason for the high standard of living we enjoy today.

Guy - your indebted farmers number is incorrect. It comes from the RBNZ Financial Stability Report and it should read "23% of dairy farms have more than $35 of debt per kgMS and this accounts for 35% of all dairy debt".