Keith Woodford discusses trends in on-farm dairy debt and the challenges it creates

Keith Woodford discusses trends in on-farm dairy debt and the challenges it creates

By Keith Woodford*

The latest statistic for on-farm dairy debt held by banks was $40.9 billion at October 2017. This equates to $22 per kg milksolids. 

Despite the major upturn in dairy prices of more than 50 percent that occurred between July and December 2016, and with those improved prices then holding through much of 2017, there were lags for the increase to flow through into farm incomes. Debt therefore continued to climb through to July 2017 reaching $41.2 billion. It then declined by $285 million in the three months through to October 2017. Looking back ten years, the dairy debt remains more than double the 2007 figure of $18.8 billion.

 The recent decline in debt is surely a positive sign, but in the greater scheme of things the recent decline is modest. Key questions remain as to the long term financial stability of the dairy industry.

The big picture would seem to be that farmers have used most of the increased income to finance deferred maintenance, plus some machinery replacement, plus some fertiliser catch-up.  They will also have been repaying some of their Fonterra loans, which do not show within bank debt, through milk cheque deductions. Farmers have also had to spend-up on supplementary feed to counter what has been a terrible winter and spring across much of the North Island.

On many farms, it has been PKE that has come to the rescue. Despite the bad press which PKE so often receives, for many it has been the saviour in terms of cow welfare, land protection and spring milk production.  And so, 2017 will be a record year for PKE imports, with associated cost for farmers.

There have also been pockets of ongoing development. These relate to an ongoing move to off -paddock winter feeding of various types, ongoing effluent management investments, and in Canterbury, to completing the conversion of inefficient surface irrigation systems to the much more water-efficient pivots.

Assuming that any drop in current dairy prices is modest and the summer is kind in terms of weather, then many farmers, having made the catch-up from two years of low milk prices, will now be able to increasingly nibble away at their debt over the coming year. But there is a big assumption in all of this, and it relates to future dairy prices. Also, North Island farmers are facing this coming summer with minimal silage in the stack. That will mean more expenditure on PKE.

Trying to predict dairy prices is a fools’ game, but the current outlook is indeed cloudy. European farmers are now well into expansion mode again and current production is at record highs. It is likely to increase further. American production also continues to expand, with cows producing more each year, and herd growth in the big farms outweighing the decline in the small farms.  Australian, South American and even New Zealand production are also up on last year.

On the demand side, consumption of fresh milk continues to reduce across the developed world, but this is counteracted by increasing cheese consumption.  Indeed, cheese is considerably more important than fresh milk in the developed world.  Dairy fats have been the stand out performer over the last 12 months but are now coming off those highs.

In developing countries, it has been China and Algeria that have been the saviours over this same period for dairy commodities, particularly the milk powders. However, in China it has been value-add products (infant formula and UHT cream) that have been growing the fastest. Infant formula imports, largely from Europe, are now approaching three times the value of WMP (whole milk powder), which comes almost exclusively from New Zealand.

So, on the supply side there are some big clouds, whereas on the demand side the sun is only shining weakly.  This means that ‘caution’ is indeed the key word for both the short and medium term.

Changes are also occurring in the banking sector and this has major implications for those who are highly indebted. To understand the changes that are occurring, we have to look across the Tasman, not only to the head offices of he ‘big four’ New Zealand banks, but also to APRA (the Australian Prudential Regulatory Authority) and the Reserve Bank of Australia.  Yes, the behaviour of New Zealand’s banks is indeed strongly influenced from Australia, as well as by our own Reserve Bank!

Perhaps we also need to look at Holland, with Rabobank now close to $10 billion of loans to New Zealand agribusiness.

There is no doubt that the big four Australian banks, and ANZ in particular, have been reviewing their dairy lending. The reason that ANZ is particularly important is that it is the bank with the largest market share, and it would like to reduce its exposure.  

All banks remain open to new lending where the risk is assessed as low, but all banks are moving towards bigger risk margins in the rates they charge those who are highly indebted. In addition, any new lending has to stack up in terms of being able to repay the capital over a 20 year period, and being resilient to base lending rates of seven percent and a milk payment of $5.70 per kg milksolids. Banks now require five-year business plans for new projects on this basis. The days of ongoing interest-only loans are over.

There is an irony in relation to the increased risk margins. It means that once a farmer is assessed as high risk, then the interest rate increases, and therefore the risk of financial non-performance further escalates. 

The key problem right now is that a number of farmers have debts of well over $25 per kg milksolids, and some have debts over $30 per kg milksolids. It is these farms in particular that lack resilience to any dairy downturn. It is unclear as to how many farmers are in this category, but it is enough to be a worry.

There is another group of farmers who have prospects for being cash flow positive in the short to medium term but lack the headroom to make investments needed for long term environmental and financial sustainability. 

In this current environment, it is likely that the price of dairy farms will drop. There is anecdotal evidence this is already occurring. This drop could become substantial. Predicting the extent of the drop, just like trying to predict dairy prices, is a fools’ game.

What we do know is that there is an increasing number of farmers who would like to sell-up, and a marked absence of new buyers who have buying enthusiasm combined with the necessary equity to balance new debt. The exception for this supply and demand imbalance is a few ‘A grade’ farms with top quality infrastructure and a low cost of production, and those small farms that are immediately adjacent to a larger farm with leverage capacity.

With hindsight, one can see that the current situation is the outcome of an exuberant historical lending policy by the banks extending back some ten years. It can indeed take many years before the chickens come home to roost.

This exuberant lending was combined with investment behaviours that were fuelled by the lure of tax-free capital gains – a situation that does not exist in most developed countries, including Australia, USA and Britain. It is a key reason why our land prices tend to be much higher than equivalent land overseas.

Some will see a likely industry restructuring within a context that economists call ‘creative destruction’. Within this philosophy, painful outcomes are necessary and need to be faced up to. However, any such restructuring takes time. A cautionary note is that many of the largely unrecognised environmental improvements that farmers have made, and will continue to need to make as the restructuring occurs, are less likely when farmers are financially stressed – just think ‘Crafar Farms’ as an extreme example. There are also profound questions to be answered as to where new buyers, with the necessary equity capital, are going to come from.

The current situation does not imply a crisis. But it does indicate there is reason for concern.

*Keith Woodford is an independent consultant who holds honorary positions as Professor of Agri-Food Systems at Lincoln University and Senior Research Fellow at the Contemporary China Research Centre at Victoria University.  His articles are archived at You can contact him directly here.

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These debt figures appear to be averages - what we should be looking at is the debt levels of only those farms with debt and analysing those to the next level.

Farms with no or very low levels of debt present no risk to anyone - let alone the banking system.

Farms with high levels of debt based on costs and revenues that didn't follow the forecast models are a risk to depositors, shareholders and possibly tax payers. Farms with no debt are a risk to banks. Bankers can't milk those farmers.

The real problem is that we don't have dairy farms any more. We have instead a whole lot of industrial factories scattered around the countryside... and yes it is "the outcome of an exuberant historical lending policy by the banks extending back some ten years." Thanks Sir Chon for your guidance here.

These over capitalised factories have infrastructure in place which is only good for one thing. And when it doesn't pay there is no alternative land use.
A nice dead end cul de sac.

Bob Jones once commented that farmers failed to analyse their investment as a business. Not sure of the exact reason but presumably the lifestyle influence gave them rose tinted spectacles. I suspect a bit of this still exists.
Then the banks are to blame for being too liberal with cash? Maybe, maybe not.

"The real problem is that we don't have dairy farms any more".

Over-generalisation here. There are plenty of quite traditional farms, running a few hundred milking cows, with little capitalisation, little debt, and input costs under $4/KgMS.

The reason they are not on the front pages is that they are actually doing very nicely at the moment.....

I tend to agree with the notion that there's a Pareto going on here: 20% of farms holding 80% of debt or something along those lines. Averages are terrible muddlers of real-life scenarios......

I take it you arent in Canterbury - not too many tradition dairy farms here.
But for sure there are still some out there.

Is the 80 - 20 principle at play here .

Dairy and farm debt generally is a perennial problem here in NZ , but given the low interest rate environment , the farmers with large debts should be using this window to pay down debt .

Instead we see Field Day purchases of all sorts of keep-up with the Jones's purchases with more hock

Excellent read, Keith - indeed it's a worry for all NZ - first time I've seen the issue framed in a debt to kgMS way. Regards this statement:

There is an irony in relation to the increased risk margins. It means that once a farmer is assessed as high risk, then the interest rate increases, and therefore the risk of financial non-performance further escalates.

The same irony applies of course for the 10% deposit Welcome Home loan first home buyers. Sad state of affairs.

I think it was the Muldoon government that subsidised/incentivised the increased production of lambs?
Perhaps in this 'new' world we find ourselves in, the government needs to consider some kind of financial support/assistance in the reverse - that being associated with de-intensification and hence a marked lowering of input costs for those heavily indebted farmers.

I just don't think that PKE is an appropriate way forward.

But the banks assign then own risk then put the interest on as they feel
I was with westpac liw debt dept and was threatened with asset recovery on a 70k debt on 600 acre farm

Money is required elsewhere before labour gets a look in. Example taken at random:

Two years experience
Direct junior staff
Run the shed

In return:
$51,240 per year - $6,240 rent (120 pw)
leaves $45,000 before tax. Advertising an average 55 hours per week leaves you making $15.73 an hour for a lot of responsibility.

NZ dairy land prices are diabolical when viewed with an investment hat - free cashflow is substandard & a >50% decrease is long overdue to make an ROI comparable to market opportunities. Investing for future capital gains at these prices (albeit CGT-free) is crazy, but common, in a largely generational-support-reliant industry post Fonterra.

There is one factor that has a 'Pareto-factor' bearing that has not been mentioned which, with some independent thought, does imply a crisis RIGHT NOW. Monetary policy in the west since 2007 has been set at CRISIS LEVELS - there has been no 'creative destruction'; just an artificial price of money, inflated asset prices & zombie companies. The deck chairs have been shuffled though...

The Fed has printed >$USD15T alone, on a P/E of 30 =~$450T in artificial rate suppression. That's before the main transmission mechanism - fractional reserve banking! The BOJ, BOE & ECB have done similar - no inflation... yet, largely because of the demographic position in the west & technological impact to global cost base.

The BRICS will have >15% of the vote on 01/01/18.... marking a paradigm change re the $USD being the reserve currency & with that much debt.... People are already voting with their feet - Bitcoin at $USD22K!