New Zealand dairy farmers are set to become the next source of bad debt for Australia’s largest banks. Australian banks are already seeing a jump in stressed loans from New Zealand’s dairy farmers. In the last half year, National Australia Bank (NAB.Australia) recognized $522 million of impaired dairy loans, while stressed agriculture loans at Westpac BankingCorp.(WBC.Australia) jumped by almost 4 percentage points to 7.8%.
This is because global milk prices have been tanking. Between February 2015 and August 2015, global dairy prices fell by more than 65% in U.S. dollar terms. New Zealand farmers are particularly sensitive to global prices because they export 95% of their milk overseas (New Zealand simply doesn’t have enough people!). Australia, by comparison, exports only 34%. Citi Research estimates about 80% of New Zealand’s dairy farmers are already cash flow negative.
Australian banks are exposed to New Zealand’s dairy industry because the farmers have been heavily reliant on debt financing. There has been an expansion in kiwi dairy debt since 2008, from just NZ$18.8 million in 2007 to NZ$41.3 in 2016; to make matters worse, 30% of the debt outstanding is held by just 10% of the farmers. Australia and New Zealand Banking Corp.(ANZ.Australia) has the biggest agriculture portfolio, with 18% of its loans going into that industry.
So what would happen if dairy conditions don’t improve?
Citi Research uses two stress scenarios outlined by New Zealand’s central bank. First, a mild scenario where the Fonterra payout remains below $5 until the 2017/18 season and land prices fall by 25% by the end of 2017; second, a severe scenario where the Fonterra payout remains below $5 until the 2018/19 season and land prices fall by 45% by the end of 2018.
Citi finds that under the mild scenario, the cumulative losses over the period were just 3% of Australian banks’ total exposure. Therefore, Australian banks will on average suffer only a 1% fall in earnings and their tier-1 capital ratio will be impacted by only an average of 20 basis points. In a nutshell, no big deal.
Curiously, in the report, Citi did not run a sensitivity analysis on the severe case at all. Is this wise? Dairy land prices are already down 15% since the beginning of the year. The mild stress scenario only allows a 25% fall by the end of next year.
But perhaps the bank’s analyst Craig Williams and team are not ready to trash Australian banks yet. They have a buy rating on ANZ and NAB and neutral rating on WBC andCommonwealth Bank of Australia (CBA.Australia). Year-to-date, the iShares MSCI Australia ETF (EWA) has risen 3.3%.
This is because global milk prices have been tanking. Between February 2015 and August 2015, global dairy prices fell by more than 65% in U.S. dollar terms. New Zealand farmers are particularly sensitive to global prices because they export 95% of their milk overseas (New Zealand simply doesn’t have enough people!). Australia, by comparison, exports only 34%. Citi Research estimates about 80% of New Zealand’s dairy farmers are already cash flow negative.
Australian banks are exposed to New Zealand’s dairy industry because the farmers have been heavily reliant on debt financing. There has been an expansion in kiwi dairy debt since 2008, from just NZ$18.8 million in 2007 to NZ$41.3 in 2016; to make matters worse, 30% of the debt outstanding is held by just 10% of the farmers. Australia and New Zealand Banking Corp.(ANZ.Australia) has the biggest agriculture portfolio, with 18% of its loans going into that industry.
So what would happen if dairy conditions don’t improve?
Citi Research uses two stress scenarios outlined by New Zealand’s central bank. First, a mild scenario where the Fonterra payout remains below $5 until the 2017/18 season and land prices fall by 25% by the end of 2017; second, a severe scenario where the Fonterra payout remains below $5 until the 2018/19 season and land prices fall by 45% by the end of 2018.
Citi finds that under the mild scenario, the cumulative losses over the period were just 3% of Australian banks’ total exposure. Therefore, Australian banks will on average suffer only a 1% fall in earnings and their tier-1 capital ratio will be impacted by only an average of 20 basis points. In a nutshell, no big deal.
Curiously, in the report, Citi did not run a sensitivity analysis on the severe case at all. Is this wise? Dairy land prices are already down 15% since the beginning of the year. The mild stress scenario only allows a 25% fall by the end of next year.
But perhaps the bank’s analyst Craig Williams and team are not ready to trash Australian banks yet. They have a buy rating on ANZ and NAB and neutral rating on WBC andCommonwealth Bank of Australia (CBA.Australia). Year-to-date, the iShares MSCI Australia ETF (EWA) has risen 3.3%.
Source: Barron’s Asia
