Diminishing commodity prices and increased interest rates
March 2019 | SPOTLIGHT | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
March 2019 Issue
On 3 December 2018, five months after China imposed a punitive 25 percent tariff on soybean imports from the US, president Donald Trump declared, via Twitter, that “Farmers will be a a [sic] very BIG and FAST beneficiary of our deal with China . . .” (emphasis in original). The “deal” promoted by president Trump did not end the tariffs but was an agreement between the countries to negotiate increased Chinese purchases of American farm and energy commodities. However, the momentary pause in the soybean trade war could not replenish the damage already done to the farmers and supply chain linked to the export of soybeans.
For example, from January to October 2017, the US exported 21.4 million metric tons of soybeans to China. In that same period for 2018, the US exported only 8.2 million metric tons of soybeans to China. The US has attempted to buoy the soybean market by providing two rounds of bailout funds to the soybean farms valued at more than $7.3bn, not including funds spent by the government on purchase of surplus crops. The current trade war and reliance on extensive government bailout for survival are just two of several simultaneous pressures on the agricultural industry indicating the need for change in this critical industry.
Even before the effects of the superfluous trade war started to hit American farmers, the agricultural industry was being forced to confront a continued decline in commodity prices. Sticking with soybeans, for example, in January 2017, soybeans were priced at $1024.50 per bushel. One year later, a bushel was trading at $995.75 and, on 4 February 2019, a bushel of soybeans was trading at $920.46, a drop of 11 percent in just over two years. Crops were not the only farm commodity in decline: the meat and dairy industries were also encountering precipitous declines. The price of pork fell from $73.50 in January 2018 to $57.15 on 5 February 2019, a drop of 23 percent in over a year. Similarly disheartening is the fall in milk prices from $16.75 in January 2017 to $13.95 in February 2019, a 17 percent decline in value. It does not require an economics degree to discern that these significant declines in commodity value have equally eroded already diminishing profit margins.
Farming requires significant annual capital investment and it is usual practice for farmers to rely on an operating line of credit to pay for the extensive capital to put plants in the ground, prepay rent and prepare for the upcoming season. The line of credit is then paid down as crops are harvested and commodities sold. Low interest rates encourage farmers to take on cheap debt, buy additional farmland, invest in new equipment and cause the price of farmland to increase. The greater economy has been growing steadily for several years, with unemployment historically low, prompting the Federal Reserve Bank to raise interest rates three times in 2017 and four times in 2018. The multiple annual interest rate hikes, while necessary to stem inflation, have put an additional squeeze on profit margins for the agricultural industry, already taking a weighty hit from the declining commodity values and trade wars causing multiple farmers to operate at a loss last year.
To counteract the attenuation of profits, many companies in the agricultural industry have sought to reduce costs through mergers. Over the past 30 years, the number of farms in the US has decreased by more than 130,000, while the size of the farms has continued to increase. In 1991, 31 percent of the value of US farm production came from farms with at least $1m in sales. By 2015, the value of US farm production from farms with at least $1m in sales increased to 57 percent. The more efficient a farm can be on the economic scale, the greater it can increase its profitability – or, at a minimum, return to profitability.
Yet, beyond purely economic factors, demographics are leading to a greater consolidation of traditional farms. Without question, millennials are moving to cities in greater numbers than any prior generation. This migration has caused significant turmoil in generational family farms regardless of size and commodity. As the generational farmer reaches retirement, with no willing heir to operate the farm, the farmer is likely to rent the land to a tenant farmer or, more likely, sell the farm as a going concern, leading to a greater concentration of farms.
In theory, larger, more professional operated farms should be better able to handle the aforementioned scourges on the agricultural industry. However, a recent review has shown that farm bankruptcies are on the rise. The benefits of bankruptcy for farmers of all sizes are readily apparently. For family farmers, a Chapter 12 bankruptcy allows the farmer to pay down its debts for a period of three years. For larger, more sophisticated operations, a Chapter 11 bankruptcy will permit the enterprise to not only extend payments over time but reorganise so that the farm, its equipment and its employees are better situated for the changing global economy.
The agricultural industry is at a confluence of distresses, not unlike those previously faced by the airline and automotive industries. Global economic impacts, technological impacts and aging business models have impeded, if not stopped, the growth and improvements necessary to profitably operate into the foreseeable future. Similar to these industries, a restructuring of debts and reorganisation of operations may enable the more sophisticated agricultural enterprises to meet the modern demands. First and foremost, with any bankruptcy filing, the bankruptcy filing provides the debtor-in-possession the necessary ‘breathing room’ to advocate for the adjustments necessary to return to profitability. All prepetition creditors are stayed from taking actions to collect on outstanding debts while, in certain jurisdictions, the debtor is enabled to pay ‘critical vendors’ to ensure their continued performance.
Additionally, a reorganising Chapter 11 bankruptcy empowers the debtor to get out of burdensome contracts and leases, for underperforming land or antiquated equipment, and free up necessary capital to modernise and improve operations. Moreover, through a plan of reorganisation, the debtor is able to pay its secured creditors the value of its property and not carry the burden of overpaying for undervalued property. A Chapter 11 bankruptcy can enable the large farming enterprise to move forward economically and technologically while leaving behind much of its prior burden.
Likewise, a Chapter 11 bankruptcy case eases the transition and sale of a farming enterprise. Last year, the multigenerational strawberry farm Eclipse Berry Farms, LLC, and related affiliates, filed for Chapter 11 protection in the Central District of California. At its height, Eclipse Berry Farms had more than $230m in annual revenues. Following the passing of the companies’ founders, the heirs no longer wanted to be in the agricultural business. Through the bankruptcy process, Eclipse Berry Farms was able to sell its assets, transition more than 3000 agricultural workers’ jobs to the purchaser and return a significant distribution to creditors.
The agricultural industry is facing a multitude of outside influences. The bankruptcy code was enacted to enable farmers, large and small, to directly face these challenges in a manner that is best for the farmer, its employees and its creditors. A corporate restructuring can provide agricultural enterprises the tools needed to move forward and counteract the outside influences.
Barry A. Chatz and Kevin H. Morse are partners at Saul Ewing Arnstein & Lehr LLP. Mr Chatz can be contacted by email: firstname.lastname@example.org. Mr Morse can be contacted by email: email@example.com.
© Financier Worldwide
Barry A. Chatz and Kevin H. Morse
Saul Ewing Arnstein & Lehr LLP