Much soul searching and debate has followed the high profile failure of Crafar Farms. This event highlighted the exposed capital structure of parts of the New Zealand dairy industry.
For cooperatives in all industries, this raises a myriad of other issues, stemming from the fact that co-ops are effectively vertically integrated with the members who control them. This explores the context of indebtedness, and what this means for cooperatives whose members are similarly exposed.
New Zealand dairy farmers had an estimated $10.6 billion of term debt (mostly in mortgages) by the end of the 2002 season. By the end of the 2009 season, this had risen to about $28 billion.
This ﬁgure dwarfs the debt held by dairy companies – Fonterra’s own loans and borrowings amounted to $5.8 billion in 2009, which is less than a quarter of its members’ term debt.
The nearly three-fold increase in debt over a mere seven years is just cause for concern to the industry. In the 2009 season, farmers’ interest and rent accounted for 33% of gross farm revenue, up from 12% in the 2002 season.
Even in the stellar 2008 season of record payouts to dairy farmers, this ﬁgure was 17% of gross farm revenue.
Clearly growth in debt had outstripped growth in the productive asset — so what happened to all the money?
THE COST OF SOIL
The simple answer is that it went into inﬂated land prices. While some of the money was used converting land to dairy farming – the eﬀective hectares of land in dairying increased by 8% over this period — the average farm value increased 130% from $15 to $35 per kilogram of milk solids in 2008.
Both farmers and banks made the mistake of assuming the land had an inherent economic value, when the true value lay in the produce, marketed internationally.
Unfortunately, a year later the average farm sale price dropped abruptly — by at least 10% — when international markets collapsed.
Without any prospects of a quick recovery, the net result for dairy farmers was that having pumped up land values with debt, assisted in this by banks over-willing to ﬁnance them, the 2009 devaluation suddenly reduced farmers’ equity.
More alarming is that these ﬁgures represent average farm debt. Some dairy farmers, particularly the more conservative ones, have virtually no debt at all. However, the more aggressive and acquisitive farmers held significantly higher debt.
A January 2009 article claimed excessive debt loading was concentrated disproportionately in the hands of just 20% of farmers, including many recent conversions. These were estimated to each be in debt to the tune of $7.6m compared to the average farm debt of $1.8 million.
The placement of Crafar Farms into receivership is just the tip of the iceberg.
NOT JUST DAIRY
For cooperatives in all industries, not just dairy, the financial position of members has an immediate bearing on their own conduct and also the long-term character of membership. Key issues include the viability of members on whom the cooperative depends for both patronage and share capital.
Members under financial stress are also less likely to approve retentions for growth, demanding instead the highest possible rebates.
In the long-term, members’ financial distress opens the door for them to be acquired — and consolidated—– by other parties, which has the inevitable effect of changing the character of the cooperative.
How then should a cooperative business react to its members’ increasingly precarious finances?
Obviously the best immediate response would be to generate a superior financial result and thus support members out of the crisis. In the case of dairy farming, a recovery in international markets in 2010 has done just that – which is more serendipity than careful management.
However cooperatives should not rely on serendipity.
It would seem prudent for a cooperative in these circumstances to embark on a dual strategy of lowering the company’s debt-to-equity ratio to more conservative levels, making it more robust to redemption risk, while providing maximum returns or rebates without excessive retentions.
This might necessitate a paring back of non-core growth plans. Accurate, or at least conservative, forecasts might also be helpful, as well as working with financiers to map out a suitable pathway for their members’ recovery.
A significant issue here is that even if the cooperative were to lower its own debt, which is a sound policy, this may represent but a fraction of its members’ debt.
Another response is to use the crisis as an opportunity to emphasise the vulnerability of the cooperatives to redemption risk and seek various means to mitigate this through changes in the structure of the cooperative.
The advantage of such a strategy is that even in the event of the failure of some members, the cooperative can survive relatively unscathed. Also, should the most vulnerable members be consolidated by parties forming powerful ownership blocs within the cooperative, the new structure may well be better able to manage these parties and retain their patronage.
The relevant question though is: will the cooperative still be a cooperative?●
— From the August 2010 Cooperatives News