Dairy debt and declining values create an equity pincer

Some weeks back I wrote how the market value of dairy land is declining substantially. The biggest factor is a change in bank-lending policies such that local buyers cannot get funding. The second key factor is that foreign buyers can no longer buy land for dairy farming. A third factor is pessimism about the long-term future relating to environmental issues and labour availability.

The consequence of these factors is that although many dairy farmers would like to sell, there are very few buyers. This is despite three years of good dairy prices and now a fourth good year heading into the home straight with nearly all farmers making operating profits.

In this article, I build on that situation to explore the proportion of farmers who, with declining asset values, have either exhausted or are close to exhausting their previous equity.

The latest Reserve Bank statistics (S31 series) show dairy-farm bank debt has declined from $41.5 billion in November 2018 to 40.8 billion in November 2019. This is also slightly lower than the $41.0 billion of dairy-farm bank debt as at November 2017. So yes, dairy farm debt has apparently now turned the corner. This is consistent with everything I hear that dairy farmers are focusing on debt reduction rather than any further property improvement.

Based on milk producton for calendar 2019 of 1.89 billion kg milksolids, then the bank debt approximates $21.50 per kg milksolids.

In contrast, sheep and beef-farm bank debt increased from $13.8 billion in November 2017 to $15.1 billion in November 2019. Horticulture bank debt increased over this period from $3.6 billion to $4.9 billion. Bank debt for other on-farm types of agriculture increased from $2.1 billion to $2.4 billion. So, the big message from those figures is that agricultural lending is still on the increase but that increase is all about land uses other than dairy.

Whether or not forestry lending has increased markedly I cannot say as there seem to be no statistics on this. However, the likelihood is that forestry investment is being driven by overseas equity investors rather than bank lending. Forestry is a long-term investment not conducive to heavy debt.

One further snippet of Reserve Bank information on dairy debt comes from the Financial Stability Report of May 2019 which states that around 35 percent of dairy farm debt is on farms where the debt exceeds $35 per kg milksolids. The Reserve Bank perspective at that time was that debt of $35 per kg milksolids was their indicator of high risk.

The reason the Reserve Bank expresses information this way is that their concern relates to the overall financial system, rather than the fate of individual farms or even industries. With total dairy-debt capital a little over 40 billion, it is easily calculated that the high-risk sum at that time was considered to be a little over $14 billion.

Much of the drop in land values has been occurring since then. In the South Island there is almost no land now selling at above $30 per kg milksolids, let alone $35. However, some dairy land in both Taranaki and Waikato is still selling above this $35 figure, but only for good quality land, and with sales few and far between.

It is important to note the Reserve Bank statement that ‘35 percent of debt is on farms that carry debts over $35 per kg milksolids’ is not the same thing as having 35 percent of farms with debts at this level.  To Illustrate that point, let’s assume that we have five farmers, all with herds of the same size, where four have a debt of $17 per kg milksolids and one has a debt of $37 per kg milksolids. In that situation, we have only 20 percent of the farmers (one out of five) with debt of over $35 per kg milksolids, but 35% of the debt is on farms with debt over $35 per kg miksolids. This illustrates how maths and its communication can be tricky. Other more sophisticated calculations I have done suggest that an estimate of 20 percent of farms having these particularly high debts is probably not far off the mark.

It is also relevant that most farmers have other dairy assets apart from land. Most have Fonterra shares currently worth about $4 per kg milksolids and, apart from those contracting with herd-owning sharemilkers, they also have livestock (cows plus young stock) typically worth around $5 for each kilogram of milksolids.

The big picture message from all of the above is that however one looks at the data there will now be a considerable proportion of dairy farmers who now have minimal equity in their farming business.

The other key source of dairy-debt information and the way that it is spread among farmers comes from the DairyNZ annual survey. The limitations here are that the latest information is for 31 May 2018, and it is based on a sample of 265 supposedly representative farms. No-one can say whether these farms are truly representative but it is the best information available.

The DairyNZ survey found that at the end of the 2018 dairy-farm financial year (typically 31 May) the average debt was $25.31 per kg milksolids.  This figure of $25.31 is higher than the Reserve Bank figure of around $21.50, with this being at least partly explainable in that DairyNZ also includes non-bank debt wherever there is an expectation that this debt has to be repaid.

Much more important than average figures is the extent of the tail. The DairyNZ analysis showed that at 31 May 2018 there were only 0.4 percent of survey farmers for whom debts exceeded dairy assets, another 13 percent for whom debt exceeded 80 percent of assets, and another 28 percent of farmers with debts between 60 and 80 percent of dairy assets.

Unfortunately, the real world has moved on. In my earlier article I stated that market prices for dairy land had dropped by around 20 percent in the last year and that the signs are they are still dropping with no floor evident. Correspondence since then with various professionals across both North and South Islands has confirmed that situation. Indeed, with no floor evident, I may have been conservative. Also, since May 2018 the value of Fonterra shares, which were already dropping, have declined by a further $1.10 to around $4.

If we apply a 20 percent decline to the DairyNZ asset values, then some 13 percent of farmers now have negative equity. Another 28 percent of dairy farms have equity less than 25 percent of assets, with some of these close to zero.

Should asset values decline a further 10 percent from 2018 values, then around 24 percent of dairy farmers would have negative equity.

None of these figures will be precise and the numbers are a moving target. But there can be little doubt that there are now many dairy farmers whose financial position is highly insecure.

The one piece of good news in all of this is that nearly all dairy farms will be cash flow positive this year and so further debt repayments should be possible after paying tax. Also, a proportion of farmers are able to sell non-dairy assets, which the banks are giving strong encouragement to occur. But it does mean that if the banks do not hold their nerve, and instead get silly about forcing sales based on inadequate equity, then values will drop a lot further. From there, the snowball of growing destruction can only build.

About Keith Woodford

Keith Woodford is an independent consultant, based in New Zealand, who works internationally on agri-food systems and rural development projects. He holds honorary positions as Professor of Agri-Food Systems at Lincoln University, New Zealand, and as Senior Research Fellow at the Contemporary China Research Centre at Victoria University, Wellington.
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1 Response to Dairy debt and declining values create an equity pincer

  1. Nicholas says:

    Another terrific commentary on finance, farming, NZ, Banks and Risk. In conjunction with your considerable common sense, your opinions and writings are really worth my time. Thank you for your work Keith.

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