Reserve Bank asks banks to stress-test dairy loans

New Zealand's major lenders are able to cope with a protracted downturn in the dairy sector, which the Reserve Bank estimates could cause credit losses of as much as 18% over a four-year period.

The central bank has requested the five biggest lenders to the dairy sector – ASB Bank, ANZ Bank New Zealand, Bank of New Zealand, Westpac New Zealand and Rabobank New Zealand – to stress-test their portfolios, which the Reserve Bank sees as a growing risk to the health of the nation's financial stability. The regulator was encouraged by "realistic provisions" set aside for the portfolios, and its modelling suggests a sustained downturn would be manageable for the wider system.

"The dairy sector faces a second consecutive season of weak cash flow due to low international dairy commodity prices," governor Graeme Wheeler said in a statement issued with today's Financial Stability Report. "Prices have shown some recovery since August but many indebted farms are coming under increased pressure, which would be exacerbated if low dairy prices are sustained or dairy farm prices fall significantly."

The Reserve Bank has previously cited concerns about the level of indebtedness among a core group of dairy farmers, with about 10% of farms accounting for a third of the sector's debt, and six months ago warned the high level of farms operating in negative cashflow could lead to an increase in foreclosures.

Lenders are currently working with dairy farms under financial stress on an expectation future payouts will be "significantly higher" than those in 2014/15 and 2015/16 seasons, the report said. That has increased debt levels by about 10% over the past year, and banks' watchlist loans now account for about 5.8% of outstanding dairy lending.

The Reserve Bank's initial modelling shows non-performing dairy loans will increase to 7.8% of sector debt under the base case scenario, which projects a quick recovery in the payout over the next four years.

Under a severe scenario, where the payout stayed at or below $5 per kilogram of milk solids for the next four years, that would rise as high as 44%, due in part to a sharp drop in farm values.

The Reserve Bank said it was highly uncertain how many non-performing loans would result in defaults though loss rates for the banking system would range between 2% and 14% of all dairy lending. That would amount to credit losses of between 2% and 18% of pre-tax profit for the five biggest lenders, "suggesting that they are manageable for the system as a whole," the report said.

The results of the private lenders' stress testing is expected to be completed before the end of the year, and will be reported on in due course, the Reserve Bank said.

(BusinessDesk)