Dairies ‘Too Big to Fail’

August 24, 2010 11:00 AM

Lenders are tightening up on borrowing capacity, but they aren't abandoning dairies. There's a bigger reason than rebounding milk prices behind bankers' decisions to ride out the storm with their big dairy clients.


Like big banks in the depths of the Great Recession in early 2009, it appears big dairies are also “too big to fail.”

Yes, there have been a few humungous failures—like the fiasco in Colorado with the bank belly up there and undercapitalized Dutch dairies in Indiana. But for the most part, lenders are choosing to ride out the storm along with their big dairy clients. “The blinking has been done,” one lender told me. “I don’t think you’ll see wholesale abandonment of dairies.”
One reason is rebounding milk prices. Lenders are hoping the light at the end of the tunnel is a rebounding economy, and not another train wreck in the making
But the biggest reason? If lenders liquidate dairies, asset values on all of their dairy properties will deteriorate badly. That will put more and more of their portfolio at risk, snowballing into an avalanche that would wipe out all but their stoutest borrowers. If lenders can avoid that, they will do so as long as state and federal bank regulators go along.
As another lender told me, regulators seem willing to play the game. While ag lender equity positions have eroded over the past 20 months, they are still in a much stronger position than banks which have large commercial real estate holdings. If ag lenders start liquidating their underwater dairies, they’ll be in the same mess as their urban cousins.
It’s a good news/bad news situation. It’s good news for those highly leveraged dairy producers who want to remain in the business. It’s bad news for everyone else because the highly leveraged continue to milk cows and contribute to growing milk output.
Even California, which by all accounts should have dropped into the Pacific by now, is rebounding. In July, milk production there jumped a whopping 4.7%--mostly on the strength of more milk per cow, which was up 130 lb., or 4 lb./cow/day. That came despite 41,000 fewer cows from year-earlier numbers.
The assumption is that every dairy in California was and still is bleeding red. Not true, says Michael Swanson, an ag economist with Wells Fargo, which finances a large number of dairies in the West. 
It is true that the average feed cost in California is about $10/cwt., he says. But there’s a $3 to $4 swing in feed costs depending on how smart, savvy or lucky an individual producer was in buying feed. Total cash cost of production can range from $13 to $18/cwt., depending on the individual dairy, he says.
So if most producers have weathered the storm, does this mean we’ll see widespread expansion? Absolutely not. Dairy profits, fueled by cheap money and cheap feed, had a pretty good run since the mid-90s, say my lender sources. Yes, there were bumps in the road, but highly leveraged dairies were able to cruise over those potholes with little damage—until last year.
Now, lenders are tightening up. Any new expansion will have to be secured with 50% equity—after the expansion is complete. In other words, lenders will be requiring a whole new level of liquidity to withstand the increasing volatility in feed and milk prices. 
In reality, access to capital will become the industry’s new supply management program. Only the very best managers, who can manage cows, labor and risk to bank consistent profits, will be rewarded with more borrowing capacity. That’s the way it should have been all along. 
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