NZ banks to come under pressure from second season of low dairy prices, Moody's says

Fonterra's move this week to cut its forecast payout to farmers for the 2015/16 season to $3.90 per kilogram of milk solids.

New Zealand banks will come under increased pressure from a second season of low dairy prices, as global milk supply exceeds demand, according to ratings agency Moody's Investors Service.

Fonterra Cooperative Group's [NZX: FCG] move this week to cut its forecast payout to farmers for the 2015/16 season to $3.90 per kilogram of milk solids, from a previous estimate of $4.15/kgMS, "is credit negative for New Zealand banks because a lower payout reduces the income that farmers receive, thereby threatening the asset quality of banks exposed to the dairy sector," Daniel Yu, Moody's vice-president, senior analyst, said in a Credit Outlook report.

Agriculture makes up about 14% of New Zealand banks' total loan portfolios as of January, and is the largest sector concentration in bank loan portfolios behind housing, according to Reserve Bank data. Bank of New Zealand had the biggest exposure at 15%, followed by ASB Bank and ANZ Bank New Zealand, both on 11%, and Westpac New Zealand with 8%. Dairy loans make up about 70% of total agricultural loans. Those banks are all rated Aa3 with a stable outlook.

"A deterioration in the asset quality of dairy loans would have a material effect on the banks," Mr Yu said. "Moreover, a weakened dairy sector risks having a meaningful second-order negative effect on New Zealand's economy."

He noted that banks' agriculture nonperforming loan ratios spiked to 3.92% of total loans in September 2010, following a sharp drop in the dairy payout in 2009, from just 0.2% in September 2008. Still, despite the sharp drop in the milk price in the 2014/15 season to $4.40/kgMS from $8.40/kgMS, agricultural non-performing loans had remained relatively stable as farmers knew well in advance that 2015 prices would be lower than 2014 levels, allowing them to manage down expenses and defer any significant capital expenditures, Mr Yu said.

"That said, we expect the asset quality of those banks with dairy exposures to come under pressure as farmers face a second consecutive season of low dairy prices and are likely to have less capacity to reduce expenses further," he said.

There are already signs of "emerging stress," he said, noting that Bank of New Zealand's parent company National Australia Bank announced its non-performing loan ratio rose to 0.68% at December 2015 from 0.63% at September 2015 owing to the inclusion of a number of dairy exposures as impaired but with no loss currently expected.

Moody's didn't change its credit ratings for any of the banks in its latest report.

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