RBNZ warns dairy debt now more dangerous than before 2008; says 64% of debt in farms that would be losing money with payout at NZ$5kg

The Reserve Bank of New Zealand has highlighted a worsening of the indebtedness of some of New Zealand's biggest dairy farms, pointing out more than a third of the debt was held by dairy farms that were unprofitable at current dairy milk payout levels.

Dairy debt rose from NZ$11 billion to NZ$24 billion between 2003 and 2008 as a rise in expected milk payouts and a surge in farm values encouraged double digit lending growth by New Zealand's big four Australian owned banks.

The Reserve Bank said in a special section of its half yearly Financial Stability report almost half of this debt was held by the most indebted 10% of farmers, many of whom had invested heavily in buying out neighbours and converting sheep and beef farms to dairy farms.

The special section concluded by saying: "The dairy sector appears more vulnerable to a sharp decline in the payout than at the time of the peak in dairy prices."

"Aggregate debt is higher now than it was in 2007/2008, and a slightly greater proportion of this debt is now held by the most indebted portion of farmers."

"Declining farm land prices have eroded the equity buffers of indebted farmers, implying that banks would consider foreclosing on a larger proportion of farms if the payout fell sharply and was expected to remain weak."

The central bank said overall debt levels relative to production had declined since then 2008, but the stress for the most indebted farmers had become more intense.

"These aggregate debt numbers may disguise a change in the debt position of the most leveraged farmers," the bank said, pointing to an analysis it had conducted of DairyNZ's annual DairyNZ Economic survey.

The analysis showed a marked increase in the loan to value ratios of farms because of a 20% fall in dairy farm prices between the 2007/08 season and the 2010/11 season.

"The proportion of debt in high LVR buckets has increased significantly, which is likely to make banks less comfortable forbearing on troubled operations," it said.

The distribution of dairy farm debt in the 80% plus LVR 'bucket' had risen from around 7% in 2007/07 to almost 30% in 2010/11, the bank said.

Some farms were actually more vulnerable to a drop in dairy payouts than they were in 2007/08.

The bank estimated 36% of dairy sector debt was held by farms with negative cash flow at the current Fonterra payout forecast of around NZ$5.70/kg.

"This would increase to 64% of debt if the payout fell sharply to NZ$5/kg."

If the payout fell to NZ$5/kg, about 22% if dairy debt would be held by farms operating at a loss and with LVRs of above 80%. That compared with 4.4% in the 2007/08 season when the payout slumped.

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No shit , sherlock.
Do something about it - regulate these borrowers and their obviously stupid lenders out of the equation so OBR is not an issue. I don't want to fall with these inexplicably inept debtors. Fix it now, not after the fact. Unsecured depositors demand that you attend to your duty in this matter.

down boy! The payout hasn't dropped that far, banks aren't reposessing farms, but if a farmer is forced to walk off his land and hand the keys back to the bank, the bank can probably turn a tidy profit on-selling the farm to the Chinese.

No need to panic just yet


No need to panic just yet
Yeah Right!
We can take OBR off the table if the regulatory body, in this case the RBNZ, is executing it's duty in a proper and expected manner. Shouting "Fire" is not a solution.

Given this analysis - would it not have a significant bearing on these considerations?
Or are the RBNZ purposefully designing for an OBR event?  I'm confused.

hehe... no need to panic yet. can see the cliff, know its deep, looks like possibly moving towards it... lets panic when falling halfway down eh SGV?
"the bank can probably turn a tidy profit on-selling the farm to the Chinese."
Yes, lets just sell off the 10% of farms that are bankrupt just to keep the price of land up so banks and councils are happy. Maybe the next asset we should sell is the government... Oh wait, they're already bought.

I dont think the councils will care frankly, I mean in rates terms why would they?  They get their money what ever the farm value....the banks, yes.....sure...insolvent....
64% at < $5 is frighteningly huge....I'd be worried at 20%  whats that in $s per kg?  $5.50?

I can't quite see how this indebtedness on farms fits with the ungodly rush to secure Fonterra bonds.

Through accepting TAF Fonterra ceases to be a true cooperative in the sense of maximising value and return of supplying shareholders milk. Farm gate milk price to be defined by Milk Price Manual, therefore defined limits on value of farmgate milk. To realise added value through a dividend and capital appreciation(depreciation) no need to be a supplying shareholder/farmer (is a Queen St syndicate investor a farmer?), can just by units in fund. This model satisfies the governments and economists understanding and knowledge of economic principles and behavior. Apparently we can expect to see a more vibrant and progressive dairy industry develop, generating more income for NZ. I don't know where farmers be they rural or Queen St and their debt levels fit into this vision.

Stephen H - Unsecured depositors can't fight the RBNZ or the banks. They have no option but to position themselves differently.

but is that a bad thing?  If you know there is a problem and you have some exit options and trigger points a depositor can move all of it overnight, they are highly liquid.

Steven - I have entry and exit strategies in place for everything financial. It is my responsibility to look after my assets and income. I am not actually so worried about myself and my investments. I am however concerned with how other people may end up as I know many people don't have any strategy to implement. If enough people get bitten then there could be effects via Government that could affect me if I'm not on the ball.
Having too much money sitting in a bank is always a concern. You have to do something with it and all this instability and irrationality is a problem as right now everyone needs a clear direction and certain other factors must be met to provide stability to the wider community.

So vote with your feet, leave the banks and tell them why. 
"unsecured" dont forget.
and if this is right its the big 4...so TSB? kiwi? coop are safer?
suspect a domino effect though...

Very stern facial expression, almost serious. But just like residential property the RBNZ academics well sit in their ivory tower analyse data to death, philosophies about all sorts of strategies and do very little, while collecting their big fat tax paid salaries.

I think returns to dairy farmers have to fall - as they will now have shareholders they have to pay profits to under new capital structure

Updated with video of Bernard in there now

Guess that's what happens when you extend and pretend and try to paper over a debt problem with more debt. Forget the OBR. Even if implemented it will never be enforced. All the banks here are too big to fail, way bigger in proportion to our economy than the US titans. Firsty major sign of trouble and banks will scream armageddon and the government will implement guarantee again. Will it be rural or residential debt that cracks first and will one take down the other.

wtf - I think you might have misinterpreted the intent and application of the OBR.  It allows the tbtf banks a convenient avenue of failure at the expense of the unsecured creditors - which includes deposit holders.  It's a way around the tbtf problem which ensures they (the banks) remain in business.
And to my understanding an OBR "event" is not "enforced" in terms of the regulatory environment - rather it is applied on a triggering event occuring.  The banks, I would imagine, have welcomed the legislation.  It prevents them from being nationalised in the event their lax lending practices catch up with them.

Except it removes their intrinsic backstop the Govn? Hence making them riskier for investors? 
Would they care if they are nationalised or not? either way surely the CEO and directors would be toast anyway....not having an OBR keeps the bonuses rolling in a little longer....

Of course they would care if nationalised - and no, I'd be prepared to bet if an OBR event occurs the CEO and directors will remain largely intact - it's not the shareholders taking the haircut after all!!!!!

The OBR already exists in a number of different policies. The name just brings them all together under one document with a few tweaks. Effectively all it is, is an orderly liquidation of that banks assets but maintaining the payment system and allowing depositors access to a proportion of their money within a couple of days (hence the requirement for all the banks to align their computer systems with the RB). Depending on the state of the bank this could be anywhere from 50-80%. The management and board would be removed. The RB would be in charge as statuatory managers. The shareholders would probably be wiped out. Covered bonds complicate the issue.

Ah, no I see the difference or mean there is or can be a difference between what the entity that is the bank and its shareholders want and the CEO and his/her bonus and tenure. Yes they'd care but in different ways.  I wouldnt bet on a CEO staying....at least logically that person would be toast...of course things dont always work out that way.  If Im wrong in my work we'd lose $s and reputation and I'd be out on my ear of that I have no doubt....maybe even sued out of my house...
CEO's seems to get golden parachutes no matter how bad and look what happened to the heads of the UK banks.

No the opposite Kate. The banks are resisting it. I spoke to Don Brash and banking academic David Tripe about it last year and neither think it will work. One bank failing will bring down the others without an instant government guarantee, OBR or no OBR. Everyone, especially overseas creditors will try to run for the exits at once and ask questions later.
It relies also on everyone picking up a copy of the banks disclosure document, reading and understanding it, having faith in its accuracy and acting accordingly. You are an educated person. Would you pick up a large document from 4-5 banks, read and evaluate their contents and feel like you have made an informed decision?
Even that champion of the free market Don Brash has altered his purist views. “I was very keen not to acknowledge, even to myself, that any institution was too big to fail, but try as I might I could not escape the conclusion that the closure of any one of the four would have unthinkably grave consequences for the New Zealand economy as a whole, and would not, indeed should not, be tolerated by any New Zealand government” and goes on to say “I have some sympathy with the view of Nassim Taleb, the author of Black Swan, who early in 2009 wrote ‘Nothing should ever become too big to fail…Whatever may need to be bailed out should be nationalised; whatever does not need a bailout should be free, small and risk bearing.’” As one of the architects of the original deregulation, this is a big admission.

WTF - thanks for that post. Another way around the "too bog to fail" is to split banking services up and prevent them from getting too big to fail. That way they do not have to be nationalised and the tax payer wouldn't need to be involved in a bailout.
Banks should have to guarantee the unsecured depositors. Banking could be opened up so there is more competition. Telecom had to unbundle its infrastructure, so unbundle the banking sector.

 Yep breaking them up would be the low cost option for the taxpayer.
the other option is one I mentioned other day. Banks would still be allowed to lend money but at 100% reserve of clearly designated interest earning savings/investment accounts (which would not be government guaranteed), as opposed to non interest earning current accounts (which would be government guaranteed and not part of a bank’s balance sheet). The payment system would be separated from the banks other services. If a bank failed, its customer’s current accounts and the payments system would be isolated from the liquidation of its other assets and remove the Armageddon threat bank executives use to get bailouts. Low risk-low interest mortgage products, med risk-med interest rural products, high risk-high interest business products etc. Your choice and transparent where the money is going. http://www.jamesrobertson.com/book/creatingnewmoney.pdf  p23-30

The commercial banks would oppose your excellent suggestion of providing zero, or close to zero, interest bearing guaranteed current accounts, it would be all too hard for them, and anyway, could they be trusted to keep the funds segregated?
Why not rejig your idea slightly, and have the government directly offer the accounts, for those that wish to partake?  KiwiBank is already established, under government ownership, and has the infrastructure in place.
The commercial banks then don't have to do anything different from what they are doing at present, they can carry on, but competing for the business of those who are willing to accept a lower, or even zero return, in exchange for a 'bank' that can function like a safety deposit box.

Grian Gaynor may have been a little adrift of reality yesterday with his article:

Agriculture debt an economic winner:
But then he was working off information from the MPI.

Silly to expect the RB to do anything when the banks command the credit stuffed economy.

You mean the RBNZ is the master franchisor Wolly? Well I never!

Captain Wheedler barks from the Wheelhouse." Ahem, attention dairy farmer person, it has come to my attention you may be oversubscribed to  your freindly banker due to the expansion of your enterprise.....uh , now we bring this to your attention as unforseen events , such as our neutral policy on currency overvaluation,  or our non interference policy on Bank mortgage lending may indeed have a marked impact on your ability to continue in your present venture.
In the unlikelyhood we will be directing, imposing, or even suggesting any regulartory extensions to your freindly banker, we feel it only fair to warn you of the extreme possiblity you may go udders up...ha..! just a little accounting humour there...(shuffles papers) 
 We are further aware you are no longer enjoying the hedge practices your collective Parent Fonterra were enjoying in previous years, but feel obliged to inform you we have neither explanation nor corrective policy for that either.   
Having observed the direction the local banking industry has taken on unparalleled lending over these past years, we feel it unlikely the Banks themselves will come to any distressed levels of concern as there is plenty of potential for private home forclosures while increased demand for housing exists.  
 It will be more likely they ( the Banks) will look to foreclose on offending loans and  should the need arise, mop up any shortfalls from unsecured depositors.....so, no harm done then. 
 We appreciate this announcement may fall a little short by way of any solutions by which you might benifit, but would add we are in the the business of  financial economic observation and statisics gathering to prove historical observations.
As and when your precarious debt position becomes unsustainable, you will rest a little easier knowing we told you so...probably....even though just about everyone of those awful bloggers at interest .co had pointed all of this out without any of our supporting documentation at all, the cheeky sods.

Is there a conspiracy here?
The TAF comes in and the milk fat price to farmers goes down. Now farmers have to sell their shares to stay afloat.
Hmmmm. i wonder

Conspiracy..? no Mike, just predictable Corporate freemarket behaviour...
 As I said last year ....Shift the power....dilute, or destabilise the entity... repackage it...onsell or public list it.
Consumption of the vulnerable..or the made vulnerable, rather than the predation upon the weak.
 Next step, Henry V..goes something like...We are all in this together...to which the somewhat enlightened collective responce is...the F*%k we are...get thee away from me you debt burdened leper...
 Oh righto then chaps and chapesses we'll have to reconfigure the sharetrading platform, here and there,...and there ...oooh and there...and just sign ....

You mean "The Trojan Horse"!!!!!

Yes Grumpy...the enemy within.

Yep - interesting times ahead if the dollar holds its strength and payout sits where it is. 

"more than a third of the debt was held by dairy farms that were unprofitable at current dairy milk payout levels".
Hmmm, my observation of dairy farmers is that they are totally allergic to paying any tax, & hence being unprofitable is their policy.  eg they buy more land for a run-off, borrow heavily, then at the end sell up for a nice tax-free capital gain.
Profit is the last thing they want.  But that may be just the ones I know. 


A nice  tax free gain is old school Philly. We are in different times now dude. These days its all about paying off some of that large debt. And you know what that means. Having to pay a whole lotta tax. The hole dug by those suckered into this bubble is 150% bigger than they ever bargained on. No one ever thought they would ever be paying tax. With capital gain off the table, the properties cant be sold, the debt must be paid. That means for every buck earnt, you have to earn at least another 50c to pay all the taxes. A tuff ask at the moment.

I assume Stangoodvibes is trying to  be funny when he says " The payout hasn't dropped that far, banks aren't reposessing farms, but if a farmer is forced to walk off his land and hand the keys back to the bank, the bank can probably turn a tidy profit on-selling the farm to the Chinese.
No need to panic just yet"
As I have said before 40 % of Dairy Farms need $6.00 - $6.25 to break even, and there is very little money to be made in selling land for profit as the banks well know. The northland region will have its first sale of a dairy farm by tender next week, the first since the payour drop  and it isn;t looking good.
Newsflash mate banks are selling up farms or inviting farmers to sell, I deal with farmers and banks all day and with the pending drought particularly up North things are looking seriously nasty.Most of the NOrthland farmers are still trying to mitigate the effects of the last drought.
Those farmers caught with Swaps are paying 9% plus interest and any profitability they did have is being swallowed with increased margins,
As for the OBR,. A real concern as covered bonds take precedence over local customers if default occurs, why are deposits and rural lending having to go into the portfolio are the LVRs for housing crazy as well, not enough meet the threshold?

Its drying out quick Janette. The winds are atrocious.

How relevant/right is the QV dairy price index. (of which the report states LVR is based)?
or any valuation......
"The proportion of debt in high LVR buckets has increased significantly, which is likely to make banks less comfortable forbearing on troubled operations," it said.
The distribution of dairy farm debt in the 80% plus LVR 'bucket' had risen from around 7% in 2007/07 to almost 30% in 2010/11, the bank said.
one in three is a substantial portion... but affirmed here:
Murphy said he was dismayed to hear figures suggesting 28 per cent of New Zealand's dairy farmers were financially at risk, based on their borrowing levels and their ability to repay loans.
It seemed banks had lent money recklessly to farmers who had made poor investment decisions based on "crazy" capital gains and unlikely returns.