Ag Debt Monthly Update, 31st May 2009

  • RBNZ data on NZ agricultural debt with registered banks, and NZ Money Supplies as released on the 28/05/09.
  • Monthly agricultural debt data - table and graphs for the period 1998 to the 30th of April 2009.
  • NZD claims and various money supplies graphed to the 30th of April 2009.
  • Monthly changes in Private Sector Claims (PSC) graphed to the 30th of April 2009.
  • April's commentary on NZ's agricultural sector debt i.e. for March data. Commentary for April data will follow in a few days.

April 2009 Commentary on agricultural debt:
March figures for increased agricultural debt are shocking. In brief, bank lending to agriculture in March increased $646 million to $43.49 billion with no additional lending by NBLIs being noticed.

March private sector credit (PSC) at $287.95 billion is down $420 million from February and roughly back to its level in September 2008. Private sector credit has now contractedfor 4 out of the last 5 months.

Food manufacturing reduced claims $335 million to $4.42 billion but also reduced funding $453 million to $682 million. There is little sign of Fonterra's $800 million bond issue showing up as increased working capital.

This analysis started as an attempt to determine the conditions under which it would be possible to reduce farm debt, and an assessment of how that might transpire over the next ten years. It was quickly apparent that the conditions required for farm debt to reduce are simply not realistic for farms with high debt. Even dairy farms with average levels of debt will need favourable conditions to service existing debt - let alone repay it. It is worth noting that Australian dairy farm debt per Kg of MS appears to be less than half that of NZ.

Once again we concentrate on the dairy industry because it is simple to analyse and carries most agricultural debt i.e. 61.5% of the total. On that basis the dairy industry had farm debt of $27,499 million out of $44,714 million at the end of March 2009. NZ milk production will be approximated to 1.3 billion Kg of milk solids (MS).

One approach would would hasve been to consider average farm debt but that would have misrepresented the true situation. Farm debt is anything but average. Rather it is highly concentrated as has been detailed here: Average dairy farm debt is a little over $21.00 per Kg of milk solids produced for those interested.

A better representation of dairy debt is achieved by splitting production into thirds and then apportioning debt as established by the analysis in the link above. That analysis will soon be updated with figures to the 31/03/09 but the distribution of debt will not have changed significantly. The result of using that distribution of debt with RBNZ figures to 31/03/09 is the debt tritiles in the table below.

In case what is represented it is not clear, the 433 million Kg of milk solids representing the most indebted third of production has 75% of the total dairy farm debt. That debt amounts to $20,624 million or $47.59 per kg of milk solids. We expect that level of debt to incur an interest rate risk premium and so unless otherwise stated a 12% interest rate has been used in calculating debt servicing costs.

The model used for anlaysis included changes to equity. For simplicity we will discuss debt-servicing costs and ignore the issue of security for lending. But not before noting that with average debt of $47.59 per Kg of milk solids the most indebted third of NZ’s dairy production is almost certainly already in a situation of negative equity. Decreases in Fonterra’s equity, dairy cow prices and farm values will not help the picture but are unnecessary – understanding future debt servicing costs adequately conveys the gravity of the situation alone.

Two approaches were taken to analysis. The first looking at debt servicing costs by debt tritile for a range of EBIT per Kg of MS at likely interest rates. Representative interest rates were hard to establish being a sensitive subject for both banks and borrowers. Some further explanation will follow later but we used a 2% differential between the least and most indebted dairy farmers giving debt tritile interest rates of 10%, 11% and 12%.

The second approach calculated EBIT-interest rate combinations for each debt tritile that might allow the maintenance of debt at existing levels. Note that we refer to maintaining debt rather than repaying it.

Lest the discussion be confused by comparisons between dairy systems we have used EBIT per Kg MS as the measure of earnings. Whether an EBIT of $1.50 is delivered via a $5 payout and costs before earnings and tax of $3.50 or a $7.00 payout and $5.50 costs makes no difference to the ability of an established farming system to service debt.

The period of analysis is 10 years. Assumptions are made that losses are financed by additional debt and that once debt is repaid any farm surplus after tax earns interest at 6.5% pa.

Levels of debt overwhelm other factors in dairy farm viability over time whether viability is expressed as any of debt servicing cost, changing equity or profitability. Following are graphs illustrating debt-servicing costs for the three debt tritiles, followed by each tritile in more detail:

The low debt tritile farm still manages to repay debt with an EBIT of $0.50 per Kg of MS, but after 10 years still has debt. Debt of $3.17 per Kg MS has been reduced to $1.15.

The medium debt tritile farm can manage something similar reducing debt per Kg MS from $12.62 to $11.50 after10 years but requires an EBIT of $1.50 per Kg of MS to achieve it.

The high debt centile farm simply gets further into debt even with an EBIT of $3.00 per Kg MS. An EBIT of $3.00 with 2009 costs represents a payout of $6.50 to $8.50 per kg MS depending on the farm system in use. This brings us to the question of whether a high debt centile farm can avoid failing under debt servicing costs. The second approach to analysis provides an answer.

A simple relationship can be established representing breakeven conditions. For a high debt tritile farm this requires very high EBIT or very low interest or a combination of both high EBIT and low interest. At an EBIT of $1.00 - which likely amounts to a good achievement in the next season or three - an interest rate of 2.1% is suffice. At a more realistic 12.6% interest rate an EBIT of $6.00 is needed – equivalent to payouts in the $9.50 - $11.50 per Kg of MS range. In the middle $7 - $8 payouts and 6.3 % interest meets the requirement. The chance of any of those combinations occuring much less being maintained over 10 years is extremely unlikely.

EBIT required for other combinations of debt and interest rates are graphed further below.

Over time EBIT has been trending down as costs have increased, but such breakeven combinations still never existed in the past for such high debt levels unless we adopt “modern” agribusiness thinking. Using such thinking we could have added the $5.00 per Kg of MS annual asset gains that have transpired since Fontera was formed to our $1.00 EBIT and we would have the required $6.00 to break even at 12.6% interest. Using such thinking though in 2009 we would need to deduct $5 - $10 per Kg of MS to account for deflating asset values. That won’t be popular. That past “modern” way of thinking may now be history but the legacy is all too apparent in highly indebted dairy farms that will fail because of it. For an example of “modern” agribusiness thinking refer to:

Nicola Shadbolt & John Gardiner. Farm Investments: Alternative ownership Structures that Address the Liquidity versus Profitability Conundrum. Journal of International Farm management Vol. 3 No. 3 – July 2006:

Consistent with the demise of farming for capital gains and now important at any debt level is farm profitability. While finance costs dominate profitability where leverage is high, EBIT has the major influence within similar debt profiles.

In looking at how to achieve higher EBIT it was obvious that it is the cost component that is most important, and for several reasons:
1. NZ agriculture is in the commodity business and international competitiveness is all important
2. Farmers have little control over the payout they receive
3. Once we get beyond the agribusiness approach there remain major opportunities from applying long established production economics disciplines
4. Costs are stickier than payout

Despite being out of favour for 25 years production economics has made major advances in optimising resource allocation. This is obvious when comparing lower production intensity systems with costs around $3.50 per Kg of MS to high intensity, high resource use sytems with costs around $5.50. The application of production economics to NZ dairy farms is discussed in detail on this page:

The difference at a $5.00 payout is two curves on the graphs above – an EBIT of $1.50 versus $-0.50. That difference being the result of lower production intensity and better resource use from advances in production economics. For low and medium debt tritile farms it is also the difference between gains or losses in equity over time.

While the means to correct high cost over production through optimising resource allocation is well proven though not yet well known, the rise and rise of non- tradable costs are a far more difficult issue and one requiring changes in the culture of government. This is particularly pertinent as many a council considers planned rates increases of 60-80% over the next 10 years, and extensive programs of borrowing. All on the basis that ratepayers – farmers being the majority contributor to rates in some districts – can afford those rates. Something that is patently false. There is potential for farms even with no debt and low cost, low intensity production to become not financially viable.

Farm interest rates are an area that would greatly benefit from more transparency. The margin banks make on local funding is certainly being debated in the media. The RBNZ provides weighted average rates for funding and claims monthly as part of their SSR series and these are graphed below:

Graph of bank interest margins

Data Source: Reserve Bank of New Zealand

Those numbers don’t reflect the interest rates farms are paying. Farm lending is business lending and as we have established, in many case very high risk. Farm lending also requires much higher risk weighted capital than housing. Funding is limited and overseas borrowing is costing 7+% pa. Rabobank is raising finance through preference shares with a minimum interest rate of 8%. Farm lending has costs that borrowers have to cover, but averaging them appears crude.

Our debt tritile analysis suggests there is major cross subsidy of risk premiums within agricultural lending.

While lower debt farmers should be unhappy that their interest rates cross subsidise high debt farmers one would struggle to find a happy rural banker. In last month’s comment we mentioned Rabobank asking dairy clients with in excess of $50 per Kg of MS to make other arrangements. Rumour suggests those farms went up for tender but were withdrawn when no tenders met 50% of the vendors original purchase price. That process may have established something of a pattern for genuine attempted forced sales.

Some farm sales are more in the nature of an exchange of property between the same bank’s clients. The result is the bank finances a new owner with higher equity and just recovers its exposure while the vendor is effectively wiped out. An argument could be made that such sales do not reflect a true market price.

Rumour again suggests Rabobank tried to sell farms with excessive debt and abandoned the exercise. That is soon going to create problems. What happens if we project the high debt tritile group of dairy farms out 3, 5, or 10 years?

At an EBIT of a $0.50 per Kg of MS an additional $7.5 billion of debt accrues by March 2012. The debt compounds savagely. It grows from $20 billion to $60 billion over 10 years. All of it lent against farms already in negative equity and with no prospect of ever repaying debt. This is where the bulk of lending to agriculture is going.

A higher EBIT doesn’t materially change the impact - at $1.50 per Kg of MS debt still grows to $52 billion over 10 years.

On the basis of an EBIT of a $0.50 per Kg of MS, medium debt tritile farms move from $5.5 billion in debt to $12 billion over the next 10 years at which point debt will about equal current equity.

Banks appear willing to flush further into negative equity $2.5 billion (as much as they currently make) a year – or are perhaps simply unaware of doing so. Just on the most indebted third of dairy farmers. That is a very slippery slope to head down, and certainly not compensated by perhaps 5-8% interest rate margins. It is reckless lending and without matching security, but is that fully understood? The Reserve Bank should be concerned.

On a more general note we continue to be concerned by what we consider to be a deterioration in the availability of industry or government provided information on farm profitability, particularly in comaparison to that available for Australia. The suspicion is developing that a consequence of that is NZ agriculture, and NZ agricultural economics in particular, is well off the pace.

Monthly changes in Private Sector Claims (PSC) graphed to the 30th of April 2009.
Understanding NZ agricultural debt is helped by first having some context of NZ's Private Sector Credit (PSC). PSC data as provided by a central bank is an imperfect measure of credit, but the best available indicator of money supply as a driving force for economic activity. This view may be in contradiction to monetarist economic theory which ascribes this role to M0 (monetary base).

NZ's Private Sector Claims saw a remarkable turnaround from expansion to contraction in Q4 2008, a trend which strengthened in January 2009 but then bounced in up February and down again in March and April as shown here:

Trends in New Zealand Private Sector Credit (PSC) to the 31st of May 2009.

Data Source: Reserve Bank of New Zealand

Figures for the change in private sector credit for November 2008 to April 2009 are (in $ millions): -820, -913, -1319, 1339, -420, -1,425. The last time NZ had 2 consecutive months of contraction in PSC was 2003. PSC grew at an average rate of $2.34 billion per month for the 24 months till October 2008, but has contracted at an average of $593 million per month since.

A more detailed image with an expanded scale for the smoothed data is available:

The implications of this turnaround are profound, and here I quote from an unidentified research source translated from German:

On a macro-economic level, the credit contraction or credit crunch is entitled a deflationary spiral. Prices turn negative while loan growth and money supply growth are still positive. This will lead to a contraction in demand for loans to increase production, which further reduces prices, and so a downward spiral is created. A decrease in interest rates by central banks will reduce the economy’s overall interest burden, which has a positive short- to medium-term positive effect on the money supply and the price level. However, this is only temporary, as for any given interest rate, the total interest paid will again start to increase over time. Kutyn summarises that in a debt-based economy, whenever debt stops increasing, the economy will enter a downward spiral.

Trends in New Zealand Agricultural Debt to 31st of May 2009 (Nominal)

Data Source: Reserve Bank of New Zealand

If the table below is poorly rendered, suggestions for correcting this are below the table.

Monthly Data

The table is a small image, and if it appears poorly rendered your browser is likely to be automatically reducing its size in a belief that doing so will not make much difference. In Firefox this is controlled by setting or unsetting Resize large images to fit under Tools, Options, (Windows) or Edit, Preferences, (Linux) Advanced, Browsing. In Internet Explorer, by setting or unsetting Enable Automatic Image Resizing under Tools, Internet Options, Advanced.

Trends in New Zealand Agricultural Debt to the 31st of May 2009. (Percentage)

Data Source: Reserve Bank of New Zealand

NZ Money Supply to the 31st of May 2009.

Data Source: Reserve Bank of New Zealand

NZ Money Supply to the 31st of May 2009 plus Private sector Credit and median house prices.

Data Source: Reserve Bank of New Zealand

March 2009 Commentary on agricultural debt:
Agricultural Debt and private sector credit (PSC) appear to have been in something of a holding pattern during February. There has been something of a dead cat bounce in several areas of the economy, which possibly continues into March.

In brief, bank lending to agriculture in February increased $149 million to $42.84 billion - with an additional $12 million being provided by NBLIs. $149 million is the lowest level of monthly advance to farming since early 2007 and less than half the next lowest month of the past 12. The reduced rate of increased lending in February is a major change, but does not indicate that the $12 million per day of agricultural life support funding alluded to last month is no longer needed. The lower lending figure has almost certainly been achieved in combination with the lower farm banking facilities notified by the National Bank in early January to take effect in February. Yes – some non-essential farm asets will have been sold, and some more farm creditors will not have been paid. That is not a strategy that can be repeated for long. Significantly indebted farmers returning to profitability and paying down lending notwithstanding, meaningful reductions in lending to agriculture will only happen when farms start being sold to new owners with lower levels of debt. That infers a loss of equity on the part of the vendor, and sometimes also on the part of the lender.

Private sector credit expanded in Febraury by an extent that matched its January contraction ($1.3 billion) to give in effect no expansion for the first two months of the year. Of the sectors to expand borrowing housing and agriculture dominated. Manufacturing and finance were the sectors that contracted most. This lack of growth in credit should be seen in the light of PSC expanding at a compund rate of 9.75% for the 20 years from October 1988 till its peak in October 2008 at which point it was averaging growth over $2 billion per month.

Lest one mistakenly believes that New Zealand agriculture's debt problems are revealed under the agricultural sector component of the SSR data (bank and non bank lending institutions statistics) here are balance sheet data for a couple of major players that don't show in there.

Data Source: The respective company's latest interim accounts

The scale of operations is different but the patterns are the same. Fonterra's financial interactions with banks will contribute to the Food Manufacturing classification but most of its debt won't show in the SSR data at all. The announcement of both sets of interim financial data came supported by press releases indicating glowing company performances - widely reported but without further analysis.

Fonterra obtained an A+ credit rating from Fitch in February. How aware Fitch was of the above data is unclear, but Fitch did note that their rating took into account Fonterra's ability to reduce payout to suppliers. Fitch may have been ignorant of or chose to ignore - as does Fonterra's disclosure statement - the fact that Fonterra's future is absolutely dependent on a local dairy industry viable at the payout Fonterra is able to provide.

Questions exist as to the integrity of information that is being provided by NZ agriculture to investors, the public, credit rating agencies and government. Between 31/07/2008 and 31/01/2009 Fonterra added $4.0 billion of liabilities to its balance sheet without reporting anything. Fonterra's bond raising exercise occurred without their interim financial results being published but surely with the broad details known to directors.

PGGW on the other hand has been playing up its increased protibability from lending to agriculture at a time when banks are trying their best to reduce their exposure to the sector.

The country's only AAA rated bank, and one promoting itself on conservative lending, finds itself with dairy farm clients with debts in excess of $50 per Kg milk solids. Those clients have been told to make other arrangements but such levels of debt are simply not servicable and will never be repaid unless asset values exceed debt. Such farms today are clearly in negative equity at current asset values.

The next six to nine months look ominous - the dominos involved are becoming clear if not exactly the order in which they line up:

  • The farm asset bubble has burst - asset values have fallen considerably and are likely to fall until farm prices reflect farm profitability
  • There is a huge amount of debt throughout agriculture, and not a lot of profit
  • Agriculture has damaged industry credibility by providing misleading information
  • For farms changing hands the focus will be on profitability rather than asset appreciation – old agribusiness thinking regards farming being about asset management is falling into disrepute
  • Focusing on farm profitability will in many cases result in lower farm production intensity
  • Banks attempting to remain solvent will drive farm sales – possibly to realistic values
  • Fonterra faces extreme redemption risk – setting a realistic share price will be critical
  • There remains a lack of credible leadership at all levels

The crux of all this is that Fonterra is expecting an additional $400 million in equity from share purchases to patch its balance sheet. $400 million appears light to me and suggests a pre-determination of the fair value share price, but Fonterra appear confident they will get the equity and it will be enough. The additional shares are expected from those now currently supplying milk under contract.

For contract suppliers the first question is where will the money come from? The second is why would you spend money on a Fonterra share at $4.47 when next years payout is likely to be only of the same order? Third, it appears a lousy investment given Fonterra’s balance sheet and could be worth only cents within 18 months. In short, over the medium term farming is likely to be far more profitable not producing milk for Fonterra when doing so requires the purchase of Fonterra shares at $4.47 for each Kg of milk solids produced.

For existing suppliers with Fonterra shareholding, a look at the share price and its asset backing would suggest carrying the minimum number of shares possible. Any hint of higher profits from reducing production intensity will be greatly amplified by the prospect of cashing in shares while they still have a reasonable value.

For a prospective buyer of one of those forced dairy farm sales things could be looking reasonable even in todays economic environment: Low intensity production with opertating costs under $3.00 per Kg milk solids, or at least closer to $3.00 than $3.50; Asset values low enough that debt servicing costs are under $1.00 per Kg milk solids and then: Share purchase of $4.47 per kg milk solids. Servicing that extra debt will damage profitability, the likely loss of share value makes the risk untenable to a financier, and suddenly dairy farming under these circumstances makes no sense unless the share price can be deducted from the farm purchase price.

At this point the Mega co-op model will have visibly failed. The share pricing mechanism was always a fundamental flaw in the model.

It remains possible that dairy industry leadership may still emerge in time to avoid some of the the issues suggested, but I have detected no positive signs to date.

February 2009 Commentary on agricultural debt:

RBNZ figures show agricultural debt with registered banks at the end of January 2009 had increased $407 million from December 2008 to be $42.691 billion - $8.41 billion more than one year ago. In January 1999 the total of agricultural debt with registered banks was only $11.198 billion. If we include debt with non-bank financial institutions the total figure is $43.908 billion – year on year a 22.9% increase. Compared to business with an increase of 12.2% or households at 3.8%.

Are these numbers important? Have we become insensitised to the size of NZ agriculture's debt?

The government departments who one might expect to be critically concerned don't appear to be. The farmers and financiers at the sharp end of an industry meltdown in asset values are though acutely aware. Blunt evidence of declining farm asset values is available.

The link is to an article in ruralnews - with input from the real estate industry - suggesting that dairy farm values have dropped 30%. The real estate industry is not known for talking down asset values!

Apart from identifying the major fall in farm values, two other critical points are made: Dairy farm sales have virtually dried up (40 sales in NZ for the last 3 months compared to 159 for the same period one year ago, and only 9 sales in January) and; The higher intensity, higher cost milk production is being cut back because it is not profitable.

November to January is typically a period where agriculture has a low demand for additional funding. Over those three months just past banks provided agriculture with additional credit of $383 million, $348 million and $407 million for a total of $1.138 billion. Which compares – again in $ millions - to the same three month periods in 03-04 (121), 04-05 (386), 05-06 (733), 06-07 (635) and 07-08 (774).

Agricultural debt is dominated by dairy – to the extent that it made up 61.5% of the total when the RBNZ last provided a breakdown. On that basis dairy farms now owe financial institutions about $27 billion. The $17 billion debt for the rest of agriculture is difficult to separate given the limited data we get so at times must be considered to broadly reflect dairy debt, or sometimes simply as noise.

The three months to the end of January 2009 was a period typically with low requirements for additional credit. There were virtually no farm sales, and no drought. Dairy farm development had largely ceased. Sheep and beef prices were good, and Fonterra made progress payments on the basis of early predicted higher payouts. Low world demand for dairy commodities didn't impact farmers as Fonterra simply stockpiled product. Banks restricted lending to agricuture as much as possible.

Those circumstances provide us with a basis to view increasing agricultural debt without it being obscured by asset gains, property churn, or significant development expenditure. And it looks ugly on a profit basis or without capital gains. Strip away farm asset appreciation or the associated development and much of NZ agriculture is on financial life support to cover debt servicing, operating and living expenses.

Despite relatively benign cash flow circumstances over the period November to January NZ agriculture required additional credit in excess of $12 million per day. There are no excuses and no way to hide the fact. Taken collectively, NZ agriculture was a loss making proposition through the most profitable period of the year. The main reason being the compounding of forty four billion dollars of interest bearing debt.
From there it gets worse as we look at declining equity. Declining equity implies less security for lenders therefore higher risk and increasing interest rates. If you can find a lender.

When Fonterra was formed dairy farm asset value was $16.5 billion for milk production of 1.1 billion Kg milk solids ($15 per Kg MS). At their peak in 2008, dairy farm asset value was $78 billion for milk production of 1.3 billion Kg milk solids ($60 per Kg MS). If dairy farms have lost a third of their value that is an equity reduction of $26 billion. A third of their value is what farms have lost already, but there is little to suggest the decline in values will stop any time soon. Loss of equity is not limited to farm value – a decline in value of dairy cows to $1,200 counts in excess of $4 billion. Then there is the falling value of Fonterra shares – already $2.5 billion in the last 2 seasons. All against gross dairy farm revenues that will over the next 3 years range between $5 billion and $7 billion per year.

There is no upside. Fonterra has made more in progress payments than is justified by likely final payout so there will not be the normal dairy income through the winter. Next season's payout will be less than this season's. While some input costs have declined from their peaks, the cost structure of NZ dairy production is still trending up. Non tradeable costs rose 0.8% last quarter. Steeply rising marginal costs mean that increasing production intensity is not viable. In fact, decreasing milk production will improve the profitiability of most dairy farms. Decreasing total NZ milk production though means significant share redemptions which will threaten Fonterra's viability. Fonterra also has excessive debt and declining equity, and will be relying on dairy farmers to provide more capital.

The days of farm viability being based on capital gains are over. The adjustment is going to be severe – those with excessive debt will fail. The asset value collapse was inevitable, and there are no excuses for industry leaders not seeing it coming. The same culpability also lies with those in government or government departments and those advising either.

The dynamics of debt are unforgiving under deflation, and deflation is here. Private sector credit is in full scale retreat.

NZ agriculture has two broad options: Understand, accept and then adjust to a new reality or: Deny, hope, make excuses and spin. Which prevails is will largely be dependent on whether new industry leadership shows up.

While there is no short to medium term upside, positive long term outcomes are possible but absolutely dependent on accepting that new reality. Without it an appropriate epitath to NZ agriculture and the dairy industry may be: An industry which believed it could forever bluff its gamble with asset bubbles.

January 2009 Commentary on agricultural debt:
NB: RBNZ corrected November claims figures for the agricultural sector up by approximately $30 million and for food manufacturing down by a similar number.

RBNZ figures show agricultural debt with registered banks at the end of December 2008 increased $348 million from November and is now $42.284 billion - $8.16 billion more than one year ago and $12.6 billion more than two years ago. In November 1998 the total of agricultural debt with registered banks was $11.141 billion – a drop of $80 million from the month before. The last month when NZ's agricultural producers reduced their cumulative debt was February 2001. The November increase in debt is the second month of almost normal growth after eighth consecutive months of exceptional growth in debt.

Sectors with major increases in debt for the month were ($ millions): Agriculture, 348: Food manufacturing, 287; Transport, 274 and; Total Household, 404.

Sectors with major reductions in debt were ($ millions): Wholesale trade, -121; Retail Trade, -331, Finance, -761 and; Non Residents, -972. For all sectors listed these changes were consistent with the month prior.

Non bank lending to agriculture in the December quarter was down $326 million dollars from the September quarter to $1,200 million.

Given bank efforts from October 2008 to reduce exposure to agriculture, the continued increase in borrowing must be causing considerable dismay. Worse is to come with Fonterra effectively adding a requirement for dairy farmers to fund an additional $900 million of co-operative debt through delayed progress payments till October 2009. Fonterra's reduced payout forecast of $5.10 will have decreased dairy farm income projections by another $1.1 billion.

The question of bank lending security will be compounded by the contraction in private sector credit putting great pressure on asset values, and by an expectation of further falls in Fonterra share values.

It remains hard to explain the continued growth in agricultural debt other than being largely from conversion of unpaid interest to principal.

December 2008 Commentary on agricultural debt:
RBNZ figures show agricultural debt with registered banks at the end of November 2008 increased $352 million from October and is now $41.905 billion - $8.1 billion more than one year ago and $12.3 billion more than two years ago. In November 1998 the total of agricultural debt with registered banks was $11.221 billion. The last month when NZ's agricultural producers reduced their cumulative debt was February 2001.

The November increase in debt is the first month of almost normal growth after eighth consecutive months of exceptional growth in debt averaging increases of just under $30 million per day. Spread across 65,000 farming or horticultural properties that equated to growth in debt of $460 per property per day. This from a sector that MAF data suggests is in total only making $2-3 million per day ($40 per day when spread across 65,000 farming or horticultural properties). The November data doesn't tell us what is currently going on in NZ agriculture, but perhaps suggests an imminent change.

Across all sectors, NZ banks reduced their lending by $670 million in November while funding increased by $4,296 million. Over the 12 months to November 2008, agriculture accounted for 25% of increased claims after starting the year having less than 12% of the total.

RBNZ data for agricultural debt does not include forestry, fishing or food manufacturing. In the two months from September to November - a period when cash flow should be strong - food manufacturing increased debt by $762 million or 20%. Funding dropped by $354 million - against normal trends.

From October to November, the weighted average interest on claims across all sectors dropped from 8.91 to 8.69 percent (0.22%). Weighted average interest on funding dropped from 6.79 to 6.53 percent (0.44%). For the 4 months from July, weighted average interest on claims has dropped 0.45%, and for funding by 0.88%. Bank interest margins have improved by 25% to an average of 2.16%.

Extraordinary Note
Data from November represents a situation that has since changed markedly, and now looks dire. Anecdotally, during December: Banks started reducing lending to agriculture to the extent of pulling funds from farm trading accounts and applying them to mortgages; Expectations for milk solids payouts plunged; Farm sales died; Demand for NZ agricultural commodities evaporated and; Fonterra at least of the food exporters accumulated large stockpiles of product.

Publicly, the RBNZ indicated a willingness to directly fund major corporates; Dairy commodity prices continued to fall and; Fonterra indicated an intention to raise money from retail bonds.

Processors for the most part continued to pay prices for animlas and milk that appear to be above those that can be justified by world demand. How this has been financed is unclear, but the extent of the shortfall between sales receipts and payout is likely beyond that which can be accounted for by the changes in funding and claims for food processors indicated by RNZ data.

In the case of dairy, high early season payouts will need to be corrected by reduced late season payouts. A reduction in dairy payout by $2.50 - or to a little over $5.00 per Kg milk solids - is a reduction of more than $3 billion dollars in income to dairy farmers, but far from their biggest financial loss. More important will be any unwinding of dairy asset values: Their $6 billion value in Fonterra shares; Possibly $4 billion off the value off milking cows and; Conservatively - maybe $25 billion in farm asset values.

Extra Extraordinary Note - 13/01/01
As of early January, bank's withdrawal of lending facilities to agriculture has become widespread and in some cases very aggressive. ANZ National appears to be targeting all farm lending irrespective of the level of security held. Notification gives only weeks to repay and is coming from head office rather than local bank branches.

The impact is likely to be a drop in livestock prices as assets are liquidated. Sales of second properties, farm or residential, are inevitable. The impact on property prices could be dramatic given the shortage of finance available to prospective purchasers.

These changes will not be fully reflected in lending statistics until the RBNZ releases its bank SSR data at the end of March.