Capital risk management

Last time we talked about managing price risk when you pre-buy inputs but that’s not the only risk element you face. You also face a capital risk if you pre-buy but don’t take delivery. Put simply if you give somebody $100,000 in return for a promise that he will deliver inputs at some time in the future, what happens if he goes broke between now and then? Well what happens is you get to stand at the back of a very long line and likely you won’t get anything in return for your hundred thousand bucks.

Obviously you can manage that risk by taking the inputs home. That’s relatively easy to do with chemicals although you may have issues with safe storage or need heated storage. With fertilizer it’s a whole different matter. Most of you can’t take home a year’s supply of anhydrous ammonia no matter how good the price is. Even a year’s supply of urea or UAN takes up a lot of room and requires handling and storage equipment. You may also require blends that make it impractical to store your whole year’s requirements or you may simply not have the capital necessary to purchase the storage.

Leaving money with your retailer at yearend has become a standard practice across the industry but be aware that you assume a risk when you do that. You only have to think back to the scramble that happened in January 2003 when it looked like Sask Wheat Pool was going to go broke. Every farmer who had pre-pay money deposited with the Pool was frantically trying to secure his position by taking home farm supplies. Don’t ever think that bankers don’t know that retailers are loaded up with cash at yearend. It is no accident that the Pool’s financial crisis happened in January when they had all that prepaid money on their books. And don’t think that you could necessarily secure your position at the last minute by taking inputs home. If the worst had happened and the Pool had entered bankruptcy the court would have had the power to unwind transactions that happened immediately prior to the bankruptcy. That’s not to say they necessarily would have come out to the farm and taken the inputs back but bankruptcy law clearly allows them to do that.

So how do you secure your position? The simplest solution is to take the inputs home. If that is possible then you probably should do it. You pay your money and you take the stuff to the farm. There’s no pre-pay transaction so there’s nothing to unwind if the shit hits the fan – you just bought farm supplies like any other farm supplies you purchase. That’s not always possible though for a variety of reasons.

If you intend to leave prepay money with a retailer then you should start by doing your own due diligence. Your suppliers aren’t shy about asking you for financial statements if you want credit from them so why shouldn’t you ask for similar disclosure when you lend them money? That’s exactly what you are doing when you give them a cheque at yearend and don’t expect delivery until spring – you are lending them money.

I’ve never seen it done but there is no reason why you couldn’t register a PMSI against the supplier. For those of you that are pre-buying substantial amounts you should at least ask your lawyer about this possibility. PMSI stands for Purchase Money Security Interest. PMSI legislation gives priority to lenders (you in this case) who extend credit that enables the debtor to purchase something else.

Typically a supplier will use PMSI security to obtain an interest in a growing crop. If he supplies the inputs that are used to grow a crop then obviously he can’t repossess the inputs but he can claim security in the crop under PMSI security. Similarly a company that supplies a business with inventory can register PMSI security against the proceeds from the sale of that inventory. The neat thing about PMSI security is that it often ranks ahead of secured creditors – in fact it usually ranks ahead of just about everybody.

If you are lending your supplier $100,000 or more at yearend think about PMSI security. At the very least ask the question “How do I know that I will get the inputs that I am paying you for?” It may not make your supplier happy but it’s just business. Isn’t that what they tell you when they want you to sign all those forms?