Between February 2014 and August 2015 global dairy prices fell by more than 65 per cent in US dollar terms due to increased supply, sanctions on Russian imports, and reduced Chinese demand following a build up of inventory levels.
Farmers are facing consecutive sub-$5/kgMS payouts this season, while the average payout needed to break even has risen to $5.40/kgMS due to increased debt levels and a shift to more cost-intensive operating structures.
However there's a wide variation in the breakeven payout across farms depending on debt levels. For example, the top 50 per cent of farms had an average break even of $6.75/kgMS in 2014/15 compared to $4.79/kgMS for the other half.
The Reserve Bank said the cash-flow shortfall for the average dairy farmer is likely to be more than $1/kgMS based on DairyNZ forecasts of $4.15 for effective milk revenue, taking into account Fonterra's latest $4.60/kgMS forecast for the farmgate milk price.
It estimated 49 per cent of the sector operated below breakeven in the 2014/15 season and this season 80 per cent are likely to have negative cash flow, increasing markedly demand for working capital from the banks even with Fonterra's interest-free loan support package until the end of the year.
So far, dairy farm land values have been supported by low interest rates and a largely positive long-term outlook for dairy payouts but more recently land values have started to weaken on limited sales.
"There is a risk that land values could fall if cash-flow pressures persist, especially if confidence in the longer-term milk price outlook deteriorates," the report said.
The risk of non-performing loans in the dairy sector is also higher with those highly in debt most vulnerable. For example, the 20 per cent of debt with the highest debt per kgMS has an average loan-to-value ratio of around 68 per cent and an estimated break even payout of $5.80/kgMS this season.
How many non-performing loans will eventually result in loan defaults is highly uncertain, the bank said. But assuming all non-performing loans do default, the results suggest losses are manageable for the banking sector as a whole with loss rates ranging from 2 per cent of the dairy portfolio under the base scenario, rising to 14 per cent under the most severe scenario.
These losses amount for between 2 and 18 per cent of total before-tax profits of the five largest dairy lenders over a typical four-year period.
These lenders have been required to undertake stress tests of their dairy portfolios and have had discussions with the central bank to ensure they are making realistic provisions for the expected rise in problem loans. These stress tests will be reported on in due course.
A Federated Farmers banking survey out today shows a virtually unchanged level of farmer support for banks during the past three months of low dairy prices with 80 per cent satisfied with banks regarding mortgages, the same as in August.
There was an increase though in the percentage of farmers feeling they had come under undue pressure from their bank, rising to 6.4 per cent from 5.5 per cent in August.
"We're staring down the barrel of an El Nino summer and it seems there are more difficult months ahead for the dairy industry, so we need these high levels of support to continue," said Federated Farmers national president William Rolleston.
