Is debt doing in dairy farmers?

Fonterra's forecast last week of a 12% drop in its milk price next season sent a shiver down the spine of many dairy farmers. A report by investment bank Macquarie Group on the scale of indebtedness of New Zealand farmers may be one reason for that reaction. Agribusiness editor Neal Wallace reports.

Borrowing by dairy farmers has reached such a level that a leading investment bank says some of the most indebted farmers have negative equity and will never be able to repay what they owe.

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An analysis compiled by investment banker Macquarie Group and published on the Agricultural Production Economics website said dairy farmers owed more than $27 billion, with the most indebted third accounting for three-quarters, or $20 billion, of that total.

The analysis was critical of bank lending and a continued focus on linking farm viability with capital gains, a trend it said was coming to an end.

It was also critical of Fonterra, saying it had not been transparent in revealing its borrowing, and it was "absolutely dependent" on its milk price.

More than 61% of agriculture's current $43.49 billion of debt was being carried by dairy farmers, with some of the most heavily exposed having debts equivalent to more than $50kg of milk solids (kg/ms).

In a blunt assessment of the state of New Zealand agriculture, the Macquarie report said the days of farm viability being linked to capital gains were over, and it was critical of banks, industry and sector leaders for not seeing the change coming.

It used a model based on changes to equity to determine that, as at March, the lowest indebted third of farmers had borrowed $1.3 billion and had debt servicing of $3.17 a kg/ms.

The middle third of farmers had borrowings of $5.5 billion, which required debt servicing of $12.69 a kg/ms, while the most indebted third had debt of $20.6 billion and debt servicing of $47.59 kg/ms.

The bank said of those farmers, the viability of about 10% was of concern and they would be forced to capitalise interest payments, or they had negative equity, accentuated by decreases in Fonterra's share price, lower dairy cow prices and falling farm prices.

The future could be bleak for those indebted farmers.

If farms were generating earnings before interest and tax (ebit) of 50c a kg/ms, an additional $7.5 billion of debt would accrue against the most indebted farmers by March 2012.

In 10 years, total debt would have risen from $20 billion to $60 billion: "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."