Some dairy farmers will be forced to sell: Report

Some dairy farms holding too much debt will be forced to sell some or all of their operations, the Reserve Bank warned in its latest Financial Stability Report.

Debt levels within the agricultural sector had risen strongly in recent years, with a doubling of debt levels since 2004, the six-monthly report published today said.

"Very strong rates of debt accumulation within the dairy sector have been a major driver of recent agricultural credit growth, with lending to the dairy sector now accounting for almost two-thirds of total agricultural lending outstanding."

The distribution of that debt was heavily skewed, with many farms holding relatively small amounts of debt, while a smaller proportion were "very heavily" indebted, the report said.

Many of the highly indebted farms were bought in recent years, perhaps in the expectation high dairy prices at the time would continue for some time.

But dairy prices dropped sharply with the onset of the global financial crisis, while the strength of the New Zealand dollar had lowered local currency commodity prices further.

The report noted there had been some recovery in wholesale dairy prices.

Prices at Fonterra's online dairy auctions for whole milk power is up 88% over four months to $US3437 a tonne, but still well down on the record levels of nearly $US5000/tonne reached on spot markets in 2007.

The improving market conditions enabled Fonterra, on Monday, to lift its forecast payout to farmers to $6.05 per kilogram of milksolids, from the $5.10 announced in September.

The Reserve Bank stability report was written on the basis of the $5.10 forecast, which the report noted was higher than the Ministry of Agriculture and Forestry's estimate for the median farm breakeven payout of $4.91/kg for the 2009/2010 season.

That meant most dairy farms were likely to have positive cash flows over the season.

"However, there is a wide distribution of farm working expenses across the industry, with more intensive farms in less traditional dairying areas having significantly higher cost structures than more established farms," the report said.

"Many of these higher cost farms may experience negative cash flows for a second year running, especially those farms with high rates of gearing." A number of farms were experiencing significant financial distress, and working hard to cut costs and reduce debt levels.

Reduced spending by farmers was likely to have downstream effects on rural servicing industries, and the rural economy generally.

Additionally, tight cash flows would limit the ability of some farmers to participate in Fonterra's offer to sell additional shares to members.

Sales of dairy farms were very slow, with only 147 sales recorded in the past 12 months, compared to an average annual rate of 430 sales between 1997 and 2008.

Those farms that were selling were being sold at significantly lower prices than at the peak in 2008, the report said.

"Anecdotal reports suggest some farmers and investors are looking to purchase farms once prices appear to have settled, but it remains to be seen how far prices have to fall to stabilise the market."

Some signs of distress had also shown up in other parts of the primary sector, with beef and lamb prices coming under pressure as a rising exchange rate reduced farmgate returns.

Some sectors of the viticulture industry had been hurt by falling returns associated with a significant rise in global supply that had driven prices lower.

Overall, rural land prices had risen beyond sustainable levels until around the middle of 2008, the report said.

That had created a difficult situation for some of those buyers and would lead to losses for lenders in some cases.

Recent increases in some commodity prices and the willingness of lenders to work with troubled operators should help keep the problems contained.