Tough times ahead says Reserve Bank

01-06-2009 | Not Specified

Farmers should brace for their bankers toughening up on lending.

They should brace for a sharp fall in land prices, too, the Reserve Bank is urging.

Dairy farms seem most at risk, the central bank says in a report which warns that sharp rises in agricultural debt levels in recent years "may not be sustainable..."

The latest six-monthly Financial Stability Report advises bankers to make adequate provisions and maintain enough capital to absorb unexpected losses.

The agricultural and commercial property sectors "warrant particular attention", it says.

Essentially, the risks in agricultural lending have become more pronounced as lower commodity prices and the weakening world economy reduce export receipts.

BNZ chief economist Tony Alexander in late April similarly spotlighted agriculture as the sector most likely to find it harder to get credit during the global credit squeeze.

He was pleased to see the Reserve Bank echo his concerns in its report.

Alexander's evidence-anecdotal, he concedes-includes his understanding that four rural real estate deals fell through last October.

The farmers had been operating in an environment where they could decide which piece of land they wanted to buy, negotiate with the buyer, sign the deal, and later in the day call the banks to lend them the money.

This time nobody answered the phone-it was right after the Lehman Brothers collapse and credit dried up for a few weeks.

One farmer lost his deposit of about $90,000.

The substantial debt growth in the agricultural sector over the past few years had seemed acceptable, in most quarters, as land prices soared.

More credit became available, too, as Rabobank and ASB moved in to the market.

But lending conditions have changed and Alexander is unsure about the outlook.

No one knows how long it will take for the dust to settle from the global finance collapse or how much credit will be available.

The Financial Stability Report likewise says credit exposures are significant in the agricultural sector, particularly after the surge in rural lending on the back of rising rural property prices during the commodity boom, and sharp decline in farm incomes during the 2008-09 season compared with a year earlier.

Some more highly leveraged farms, notably in the dairy sector, are struggling to service their debt, despite recent declines in interest rates.

Agricultural credit continues to grow, however, thanks to a marked increase in seasonal financing as some farmers deal with a drop in their returns. The use of overdraft facilities earlier this year was higher than usual.

Making prospects bleaker, rural land prices are likely to come under increasing pressure through the rest of this year. The market for farm sales is "very thin"- the number of farm sales is well down on this time 12 months ago.

But default rates on agricultural lending so far have been relatively low and the major banks have signalled their intentions to help rural borrowers through a period of weaker returns.

Some more positive trends have shown in dairy prices recently, too.

The Reserve Bank nevertheless doubts commodity prices will return to the boom levels of 2007-08 in the foreseeable future.

It is telling bankers to brace for farm incomes remaining relatively low for an extended period and:

"Prompt action to carefully manage exposures to financially stressed farms is likely to be necessary."

The continued rise in agricultural debt is accompanied by a trend increase in farmers' debt-to-earnings and debt-servicing ratios.

Indebtedness generally is greatest among dairy farms, especially new entrants to the industry and farms that have expanded through leveraged land purchases in recent years.

But fluctuations in rural incomes influence land prices and lending growth, with varying lags. They are "a key source of risk to both borrowers and lenders in the sector, placing upward pressure on input and capital equipment costs."

The Reserve Bank has reviewed farm returns and mused on market prospects.

Some segments of the agricultural sector - the Reserve Bank cites horticulture - are faring relatively well. Others (including meat and wool) have faced some weakening in international prices, although the effect has been buffered by the Kiwi dollar's depreciation over the past year.

Returns in the dairy sector have fallen sharply. The dollar's depreciation initially provided some offset to falling world dairy prices, but this has been limited by the rebound in the exchange rate in recent months.

The Reserve Bank sees some brighter indications for world dairy prices, but says "the prospect of lower returns persisting beyond the current season remains".

On the positive side for farmers, lower interest rates are easing the strain on their balance sheets.

But debt-servicing burdens are unlikely to have fallen as much as the official cash rate (now 2.5%), because of pressures on banks' funding costs and adjustments to risk margins as conditions weaken in some parts of the agricultural sector.

Some farms may use derivative products to fix interest rates on their borrowing, too, and these will delay the impact of declining interest rates on debt servicing costs.

Moreover, the report notes a strong lift in input costs in the year to December. Lower fuel prices are providing some relief, but the lower Kiwi dollar is pushing up input and capital equipment costs.

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