Banks in good position to withstand pressure from weaker dairy sector, Moody's says

New Zealand's banks are in a good position and should be able to withstand pressure on the agricultural sector from weaker dairy prices, according to ratings agency Moody's Investors Service.

The credit ratings agency is in the process of updating its New Zealand Banking System Outlook annual report, which will include a slight moderation in economic growth to reflect the weaker dairy sector. Global dairy prices have remained lower for longer amid increased supply from New Zealand, Australia, Europe and the US and lacklustre demand in China and an import ban in Russia.

Fonterra Cooperative Group [NZX: FCG] is expected to lower its forecast payout to farmers for this season following its board meeting next month. The dairy exporter currently forecasts a payout of $5.25 per kilogram of milksolids for the 2015/16 season, from $4.40/kgMS last season and a record $8.40/kgMS the previous season. Economists expect a payout of between $3.75/kgMS to $5/kgMS for this season, while Dairy NZ estimates $5.70/kgMS is the industry average breakeven point for most farmers.

The Reserve Bank has said a second year of low payouts would be a concern for the New Zealand economy, especially for some 25 percent of dairy farmers currently trading with negative cashflow.

"Given the weakness in the agricultural and the dairy sector, we do expect to see some pressure on banks' exposures to the dairy sector," said Daniel Yu, Moody's vice president, senior analyst, financial institutions. "At this stage, we are still comfortable. Our ratings have always reflected a certain element of volatility in the New Zealand economy and any weakening will be off a very strong base."

Yu said farmers are more cautious after having increased debt in 2008 to take advantage of higher prices, only to see prices drop sharply in 2009, which then put pressure on banks' asset quality.

Banks' asset quality has also improved quite significantly over the past few years, he said.

"Any weakening will be off a very strong base and at this stage we think it will be quite manageable for the banks," he said.

Yu said New Zealand bank ratings included a buffer to counter a certain amount of volatility from events such as adverse weather or natural disasters.

"The ratings have always incorporated a certain element of volatility," he said. "If you look at the key metrics for the New Zealand banks, whether it be profitability, capital, asset quality or funding, they have all improved over the past couple of years and we haven't actually moved the ratings despite this improvement, so the ratings do have a certain amount of buffer in them to withstand some weakening in their metrics.

"We continue to monitor the situation. If we do start to see metrics deteriorate beyond our expectations, that's obviously going to be negative for the ratings. At this stage we would expect the deterioration to be manageable within our current buffers."

A Federated Farmers survey published this month showed a net 25.7 percent of farmers expect their debt to increase over the next 12 months, compared with a net 6.7 percent in January. Debt expectations picked up across all farming sectors, led by the dairy industry where a net 48.9 percent of farmers expected to increase debt. A net 18.1 percent of arable farmers expected to increase debt, compared with a net 2.6 percent of meat and fibre farmers.

Yu said banks had been proactive in identifying which of their dairy exposures were the most vulnerable to a downturn, and worked with those clients to restructure their debts or take other actions to get ahead of the curve.

He said he would be surprised if banks would increase debt to farmers in trouble.

"The banks would have to have quite a reasonable view that this is something that we can work through, otherwise really there is no point for the bank continue to pump in more debt if they really don't think this farm is viable."

A weaker New Zealand dollar would help exporter incomes, and the economy was supported by reconstruction in Christchurch, continued construction activity in Auckland and strong population growth, he said.

Moody's still expects the New Zealand economy to grow above the long-term average of about 2.5 percent, Yu said.

(BusinessDesk)