Controlling
Counterparty Risk

How country elevators can protect against the downside

By Paul Narduzzo, Executive Vice President
CoBank, Regional Agribusiness Banking Group

Editorís note: Narduzzo oversees the financial services provided to
CoBankís U.S. agricultural cooperative customers and the institutional
lending relationships with agricultural credit associations.
CoBank is a $58-billion cooperative bank that provides loans,
leases, export financing and other financial services to agribusinesses
and rural power, water and communications providers in all 50
states.


deal is a deal. But what happens if one of the parties in that deal canít uphold his or her end of the bargain? In rural America, even in the best of times, it can mean the difference between a profitable season and financial ruin.

In todayís economic environment, businesses of all sizes and across every sector of the economy have ample reason to worry whether supply-chain partners can deliver on their contracts. American agribusiness is not immune from economic challenges, and now is a critical time for country grain elevators ó a linchpin of the U.S. grain handling and grain marketing system ó to evaluate their business relationships and to take steps to protect themselves from counterparty risk.

ďCounterparty riskĒ is a term that has received a great deal of media attention in recent months in relation to the financial crisis that rocked Wall Street last year. At the most basic level, one of the driving forces behind the credit crisis was the failure of complex hedging strategies ó used to mitigate counterparty risk ó employed by large banks and insurance companies. The consequence: some of the most storied names in the financial world were brought to their knees and forced into bankruptcy or liquidation.

The concept of counterparty risk, however, is not limited to Wall Street, and it isnít new to the nationís agribusiness complex. During a commodity price run-up in the mid- 1990s, some country grain elevators experienced a string of producer defaults. That specter reared its head again in recent years as soaring commodity prices spurred fears that some producers who locked in sale contracts before the dramatic market run-up might walk away from contracts in order to sell their corn, soybeans or wheat to another buyer at a higher price.

Fortunately, those fears did not turn into reality in terms of any kind of meaningful trend.

Situation for 2010
For the 2010 growing season, the situation has changed. The national and global downturn has reduced demand for some products produced by U.S. agribusiness, putting some sectors of the agricultural industry under significant financialSituation for 2010 For the 2010 growing season, the situation has changed. The national and global downturn has reduced demand for some products produced by U.S. agribusiness, putting some sectors of the agricultural industry under significant financial stress. Commodity prices, while still volatile, have softened dramatically from the record highs realized in 2008. Corn, which peaked near the $8-per-bushel level, is now trading between $3 and $4 per bushel. Wheat and soybean prices have also retreated sharply.

As a result, the nature of counterparty risk in agribusiness has been transformed as well. From our standpoint at CoBank, as one of the largest financiers of grain in the country, we believe the new counterparty risk for elevators is on the selling side of the house.

The reality is that, in some cases, once-dependable customers for country grain elevators are facing difficult market conditions. Dealing with this new risk requires managers and boards to shift their way of thinking and employ available risk management strategies. In Cobankís view, grain elevators need to consider taking the following steps:




March/April Table of Contents