Dairy portfolio stress testing Bernard Hodgetts Head of Macro - PowerPoint PPT Presentation

Dairy portfolio stress testing Bernard Hodgetts Head of Macro Financial Department

Dairy stress tests - objectives • How would the banks’ dairy sector asset quality evolve under stress scenarios? • How would banks respond to a rise in defaults? • Stress tests an input into bank risk management.

Dairy sector debt Dairy sector is around Debt levels remain elevated 10% of bank lending relative to incomes [Total banking system loans = $348 billion]

Two stress scenarios Fonterra payout Dairy land price (% change) ($ per kgMS) Scenario 1 Scenario 2 Scenario 1 Scenario 2 2014-15 4.65 4.65 10 10 2015-16 3.75 3.00 -15 -20 2016-17 4.75 4.00 -10 -15 2017-18 5.25 4.50 0 -10 2018-19 5.75 5.00 0 0 2019-20 6.00 5.50 0 0

Stress scenarios Farm land price Fonterra payout $/kgMS $/kgMS Index Index 10 10 300 300 Scenario Scenario 250 250 8 8 200 200 6 6 150 150 4 4 100 100 Scenario 1 Scenario 2 Breakeven Scenario 1 2 2 50 50 Scenario 2 0 0 0 0 2001 2004 2007 2010 2013 2016 2019 2001 2004 2007 2010 2013 2016 2019

Three stages in the evolution of problem loans Rating Default Write-off downgrade • Loan collateral is • Assessed risk • Breach of loan sold. agreement increases. • Could be • e.g. 90 days past • Profits decline voluntary. due. due to general • Written off • Profits decline provision. balance sheet. due to specific • Required capital provision. • Profits adjusted if increases. actual loss differs from provision. Increasing bank oversight and ongoing negotiations between bank and farmer

Capital held against dairy loans would increase in the near-term Banks continue to provide Assessed portfolio working capital risk increases % Index 12 1800 1600 10 Current 1400 8 1200 2015-16 - 1000 Scenario 1 6 800 2015-16 - 4 600 Scenario 2 400 2 200 0 0 Portfolio growth Risk weight (RHS)

Banks provision for losses during first three years of the scenarios Cumulative bad debt charge (% initial exposure)

Some stressed loans are written off in later years Cumulative loans written off (% initial exposure) % % 25 25 Scenario 2 Scenario 1 20 20 15 15 10 10 5 5 0 0 2015-16 2017-18 2019-20

Some observations • Modelled scenarios are intentionally severe. • Reported loss rates manageable for banking system. • Losses largely absorbed through profits. • Resolving stressed assets could take longer. • Stress tests useful input to bank risk management.