"The worrying thing from a prudential point of view - and it is something the banks need to think about - is that half the debt is held by the 10 per cent most indebted farmers."
The report says that under the current Fonterra payout forecast of $5.65 to $5.75 a kilogram of milk solids for the current season, more than a third of dairy sector debt would be held by farms with negative cash flow if their working expenses remained unchanged. That would rise to 64 per cent if the payout fell to $5.
With more than 25 per cent of debt held by farms with loan-to-value ratios above 80 per cent, troubled operations could expect less forbearance by the banks than after the last sharp fall in export prices in 2008, the Reserve Bank believes.
Deputy Governor Grant Spencer said people were reasonably optimistic about the outlook for China right now.
"But if it did come off and brought commodity prices with it, there could be quite a significant part of the dairy sector that would be under stress from a credit point of view." When Wheeler and Spencer appeared before the finance and expenditure select committee National MP Shane Ardern suggested the most heavily indebted dairy farmers might also be the most efficient operators.
To have some kind of debt-to-equity restriction on entry into the industry could favour those from a more affluent background who were often not the best farmers. "It is the young, hungry, aggressive guys, who drive efficiencies in the business, who might potentially be best for the New Zealand economy," he said.
Spencer replied that the bank was not suggesting it would put loan-to-value restrictions on farm lending.
"We are just pointing out there is a concentration of risk in that sector and it is very vulnerable to a drop in the dairy payout and, given that lending is picking up in that sector, borrowers and banks need to be careful not to get overextended."
