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Improving Access to Finance for Dairy Farmers in Nicaragua
Authors:
Chris Parks, Hiroki Ichikawa, Matheus Terentin, Namiko Sawaki, Natalie
Souffront, Sebastian Posada, and Zhiyue Tu
Faculty Advisor:
Dr. Sara Guerschanik Calvo Prepared for the Inter-American Development Bank by Columbia University, School of International and Public Affairs Spring 2016 Capstone Team
Table of Contents
Executive Summary ....................................................................................................................3
1. Introduction .....................................................................................................................7
1.1 Background and Purpose of the Project ............................................................................ 7
2. Milk Market .....................................................................................................................9
2.1 International Market.......................................................................................................... 9
2.1.1 Current Situation (Actors and Economic Issues) ................................................................ 9
2.1.2 Global Responses ........................................................................................................... 11
2.2 Domestic Market .............................................................................................................. 13
2.2.1 Market Size .................................................................................................................... 13
2.2.2 Domestic Market Characteristics .................................................................................... 14
2.2.3 Nicaraguan Export Market .............................................................................................. 15
3. Value Chain Description .................................................................................................16
3.1 Value Chain and Stakeholders Defined ........................................................................... 17
4. Key Stakeholder Analysis ...............................................................................................20
4.1 Producers .......................................................................................................................... 20
4.1.1 Producer (Associate) Profile............................................................................................ 20
4.1.2 Producers and Credit ...................................................................................................... 23
4.2 Nicacentro (Cooperatives) ................................................................................................ 25
4.2.1 Cooperatives and incentives to be a member ................................................................. 25
4.2.2 Nicacentro and Strategy ................................................................................................. 26
4.2.3 Nicacentro Market Constraints and Infrastructure Needs ............................................... 27
4.3 Banking Sector ................................................................................................................. 29
4.3.1 Banco Produzcamos ....................................................................................................... 30
4.3.2 FDL (Fondo de Desarrollo Local) ..................................................................................... 32
4.3.3 FUNDESER ...................................................................................................................... 33
4.3.4 Loan strategy for Nicacentro .......................................................................................... 34
5. Strategies for Lending Options ..........................................................................................35
5.1 Financing Channels .......................................................................................................... 35
5.2 Financial Model ................................................................................................................ 36
5.2.1 Rationale of the Model ................................................................................................... 36
5.2.2 Assumptions ................................................................................................................... 36
5.2.3 Expected Outcomes ........................................................................................................ 37
5.2.4 Individual loan structures ............................................................................................... 38
5.2.5 Credit Model using a Guarantee fund ............................................................................. 40
6. Conclusion .........................................................................................................................45
Bibliography .............................................................................................................................47
1
2
List of Figures
Figure 1: Global Dairy Trade Price Index .............................................................................................. 10
Figure 2: Government programs for dairy markets ................................................................................. 13
Figure 3: Nicacentro Value Chain .......................................................................................................... 16
Figure 4: Average Cow Productivity ...................................................................................................... 21
Figure 5: Summary of term of loan and interest rate for visited financial institutions .............................. 29
Figure 6: FDL Methods for Loan Servicing ........................................................................................... 32
Figure 7: Lending Channel Comparison ................................................................................................. 35
Figure 8: Model assumptions ................................................................................................................. 37
Figure 9: Calculated performance of lending.......................................................................................... 38
Figure 10: Payoff Profile of two loan types ............................................................................................ 40
Figure 11: Performance at 2% and 1% Excess Spread ............................................................................ 44
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Executive Summary
Agriculture is an important component of Nicaraguan GDP. The dairy industry alone amounts to
around 3.6% of GDP, and agricultural in total, close to 20% of GDP. By contrast all agricultural
businesses in Costa Rica and Mexico account for a mere 6% and 3.5% of GDP, respectively.
This high concentration in agriculture makes it a prime engine for economic growth. Across
Nicaraguan agriculture, there is a large need for technical improvement and affordable financing
to grow businesses. The small and medium-sized enterprises (SMEs) in the dairy sector are
practically unbanked. These are producers that have around 70 ha. of land and a herd of 25-30
milk cows.
The need for change is only increasing. The supply of milk in international markets has not kept
up with demand. In order to compete, Nicaraguan farmers need to produce higher quality milk
and capture more of the downstream CPG (consumer packaged good) revenues. There are
several headwinds which prevent farmers from becoming more competitive.
Producers sell to downstream industrial raw milk consumers either directly or indirectly through
cooperatives. Informal sector producers which have larger production volumes have more
negotiating power and tend to sell directly to downstream buyers. Small and medium sized
farmers, up to around the 25-30 head of cattle have an incentive to join cooperatives.
Cooperatives offer more negotiating power and a number of conveniences. The cooperative can
achieve bulk discounts for purchases of supplies all members need, arrange technical assistance
across a range of topics. The cooperative facilitates the collection and sale of raw milk produced
by its members. They can help open new markets for their producers.
4
Nicacentro, the cooperative focus of our research, has 992 individual members. Through the
team’s inquiry we learned nearly all members lack at least one of three basic milking area
components, namely a ceiling, a concrete floor, and clean running water plus drainage. The
impact of this absence is that otherwise grade A milk may not be grade A by the time it reaches
the collection point. Two components dictate prices paid for raw milk. One is milk content, the
other is bacteria content. The higher the bacteria content, the lower the grade.
The lack of milking facilities interacts negatively with Nicacentro’s collection methods. A
principal inefficiency at milk collection stations which are scattered throughout the region is no
holding area for newly delivered milk. When a lower grade milk is mixed with a higher grade
milk, in the case of bacteria count, the milk is downgraded. This affects the price that everyone
that uses the collection station receives on that day. A holding refrigerator at the collection point
for incoming “pichingas” (a milk can that is frequently used) would help to protect grade A
deliveries.
Nicacentro members are financially conservative, and understandably so. Trying new things
could mean not eating if they aren’t successful. They frequently are not willing to offer property
as collateral for loans; when they do borrow they do so to finance short term business needs such
as food or veterinarian supplies. Credit terms are onerous; most commercial banks won’t make
such small scale commercial or agricultural loans and MFIs charge very high rates of interest for
very short time horizons. Additionally, many MFI loans are structured with a pro-rata principal
pay-down. This means that the largest payments on the loan are in the first months, likely the
hardest to pay. The statement was made that loans are structured this way so that farmers have
to pay less interest. This is true over the life of the loan, farmers do pay less interest. But the
5
savings aren’t very large and when compared to the liquidity crunch of making the early
payments, the difference may be worth the charge.
Another way to bring interest costs down is to reduce the servicing burden. A natural servicer of
loans are the cooperatives that market the production of its members. Most cooperatives likely
have bank accounts and can aggregate funds and pay back providers of credit. This would
reduce servicing costs to almost zero and enable small loans (i.e. $1,000) at reasonable interest
rates and for reasonable terms. From the team’s research, the interbank market doesn’t charge
lenders to the informal agricultural sector more than 10%, and at times charges much less.
Credit guarantees are another method to bring down borrowing costs. PCGs, or Partial Credit
Guarantees, have been offered to cover SME loans in Chile, with a unique auction to set
coverage ratios. Mexico has also used loan credit guarantees. The purpose of such guarantees is
to spur lending along. While empirical results indicate this works, with credit expanding in
markets seeing these sorts of guarantees at work, it is ambiguous whether or not real gains occur.
A more capital efficient way to guarantee SME loans may be to create a reserve fund which
passively tracks the amount of collateral guaranteed, and releases funds back to the entity
offering the guarantee as the guaranteed loan pool pays down (pay downs can include defaults).
Rather than having to ensure that 70% of the value of outstanding loans will be available in times
of crisis, a reserve fund capitalized with a fraction of the balance of loans outstanding can
provide a growing amount of support during good times and a buffer against losses during bad.
To keep the guarantee fund stable, excess spread can be taken out of the loans. For example,
borrowers pay 15% = 13% +2%. The 2% goes to the reserve fund, 13% goes to the lender.
Because the loans pay down, cash is available for release from the reserve fund. The reserve
6
fund is levered against losses, and its return can vary wildly. But it can cover losses during
normal operating conditions and quickly ramp up additional support once the loans have been
written.
Nicaraguan dairy farmers need production facilities that enable consistency of quality. They
need reasonable financial terms to do so. They need access to markets with more than one buyer
of production. They need to fix the tax code which penalizes cooperatives for growing too large.
They need technical assistance from trusted sources in order to take risks to grow herds. They
need a stronger commercial code to protect the quality of their sales.
Sequencing is important. The list of items needed for growth is very achievable; Nicaraguan
dairy represents a sector with high growth potential if problems can be worked out.
7
1. Introduction
1.1 Background and Purpose of the Project
Nicaragua, like many emerging markets, has an economy that relies heavily on agriculture. The
country has agricultural zones with vastly under-utilized potential. A year-round growing
season, volcanic soil, and more moderate temperatures in the highlands make Nicaragua’s
agricultural zones ideal for all manner of cultivation and livestock. While Nicaragua’s chief
agricultural exports are coffee and cocoa, the dairy industry is a large and important component
of local agribusiness, amounting to 3.6 % of national GDP (Galetto & Berra, 2011); the dairy
industry is a major income source for Nicaragua’s livestock sector. The general livestock sector
accounted for roughly 39% of Nicaragua’s agricultural contribution to GDP and it generated
81,921 permanent jobs in rural areas, amounting to almost 60% of employment in in those areas
(ILRI, 2014). A functional dairy industry needs collection and processing facilities in close
proximity to producers, and most Nicaraguan dairy farmers are small to medium sized businesses
that do not own refrigerated transportation or storage, thus they tend to cluster together. Much of
Nicaragua’s dairy capacity exists within a regional band known as the “Via Láctea”, or “Milky
Way” in English.
The Inter-American Development Bank is exploring the potential for lending facilities to develop
this important part of the agricultural sector, and the Via Láctea region will see some of the most
direct benefits. The dairy industry’s growth can help diversify national agricultural revenues and
provide higher quality dairy products for both export and domestic consumption.
The average Nicaraguan dairy farmer is under-banked. Servicing of loans is difficult and can be
expensive, especially for smaller loan sizes. Many producers require technical assistance; access
8
to credit is not helpful if the loan isn’t used in an efficient way to expand production. The chief
goal of our study is to identify bottlenecks within the raw milk production process which need to
be fixed, and consider what amount of credit, applied through which channels, would be most
likely to be accessible to, and help small and medium producers in the country.
In order to facilitate this study, we have conducted qualitative interviews with key stakeholders
in the value chain, in depth interviews with industry experts, and requested data on the
businesses that operate in the Nicaraguan dairy space, with close attention paid to the
cooperative (coop) Nicacentro and individual producers. We sought to understand the operation
of their dairy-related businesses through their eyes. We took careful consideration of their
international and domestic market concerns, day to day operating procedures, and Nicaraguan
laws regarding health and sanitation, banking, and property. We also considered the food
production health and sanitation regulations of markets they may export to, and the competitive
conditions in domestic markets. Food safety regulations can act as non-tariff barriers to trade. In
consideration of this research, we constructed some basic models of financing, and considered
the impact of revenue improvement on a farmer’s ability to pay to finance those improvements.
We also consider the business condition of several financial actors within Nicaragua, namely a
government-run bank with a development mission, and two independently operating
microfinance organizations.
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2. Milk Market
2.1 International Market
2.1.1 Current Situation (Actors and Economic Issues)
The milk market is a complex market to price. Different grades of milk are used for all manner
of industrial production of dairy consumer packaged goods, or CPGs, and it seems that only the
very lowest grades of milk are discarded. Higher grades of milk are used for producing
pasteurized drinking milk, but the grocery store is awash with all manner of dairy-based CPGs,
from yogurts and cheeses to butters, ice creams, and even curds. Before a global cold chain
network existed, dairy products often had to be consumed locally; marketing dairy products
outside of a particular region was impossible due to the perishable nature of even the most
processed CPGs. This has changed in the past 30 years. Now a diverse array of CPGs can be
created on one continent and delivered to another across oceans. Producers in higher income
countries are responding to this new global market. The European Union (EU) let milk quotas
expire in March, 2015 and did so with the explicit purpose of giving producers access to this new
export market, a market that didn’t exist in the same scale when quotas were introduced in 1984.
As the European Economic Community (EEC) opened up markets for trade the quota system
was a way to cap the production of each farmer, many of who were overproducing, thus offering
a passive price floor as opposed to direct government subsidy. In the press release to remove
quotas, the European Commission specifically states “The primary reasons for deciding to end
milk quotas was that there has been a considerable increase in consumption of dairy products in
recent years, especially on the world market – projected to continue in future – while the quota
regime is preventing EU producers from responding to this growing demand.” (EC,2015). The
release further goes on to state that Korean consumption of EU milk has doubled in 4 years.
10
Source: Global Dairy Trade Price Index
In this environment of increased global competitiveness across the dairy CPG product space,
Nicaraguan producers are facing multi-year lows in price. Demand and pricing is international
in nature, and as local farmers are the epitome of price takers. Local farmers will likely never
make more than the international price absent extraordinary subsidies or price supports from the
local government. If local production costs more than imported milk, sellers of CPGs may
simply import milk until Nicaraguan farmers lower their prices.
Global milk production in 2013 was 636 million tons (AHDB, 2015). The EU, Belarus, New
Zealand, the United States (US), and Australia are top exporters (Workman, 2016). They export
almost 80% of all milk exported. Some countries, such as New Zealand, rely on the export
market almost exclusively and would have trouble expanding consumption domestically (Knips,
2006). The international price of milk has been volatile in recent years but trended to the
downside, with prices at a similar level to the early 2000’s, as shown in the graph below:
Figure 1: Global Dairy Trade Price Index
11
Supply and demand have had trouble finding balance, with recent declines in demand from
China being particularly impactful. Current price levels could see less efficient producers forced
out of the market, as they give up on struggling to hang on while barely breaking even. There is
some hope that such a turnover, in addition to major exporters reducing supply, will lead to
higher prices as demand returns and supply is curtailed by the loss of weaker producers who may
decide to slaughter their herd to sell in the beef market.
2.1.2 Global Responses
In the current environment, producers in countries with some form of price support scheme are
most likely to survive the downturn, as long as the price supports are left in place. Because of
the extended nature of the downturn, and the fact that it extends across many agricultural
products, some countries have taken additional measures to support agricultural producers.
In Uruguay, producers of dairy products have been affected by purchases on credit by
Venezuela, a country whose capacity to pay back loans is suffering from low oil prices. A line
of credit has been designed to help producers fund this $96 million receivable; it can also be used
to finance payables and other bills coming due for the major manufacturing companies
Conaprole, Calcer, Claldy, and Pili during the current environment of extended low prices.
Conaprole, the national Uruguayan dairy cooperative, had a counter-cyclical stabilization fund
designed to help offset downside price volatility for its individual producers. This fund has been
severely depleted due to the unexpectedly long term nature of the downturn. They have also
been forced to idle two plants for lack of demand at economically viable prices. In an effort to
curtail spillover from the slow dairy business, the government has created and maintained a
Value Added Tax (VAT) exemption for the purchases of inputs in the agricultural sector.
12
Argentina has also recently adopted measures to help milk producers. The nation subsidized 50
cents per liter of milk up to 3000 liters per day for producers in February and March 2016. The
VAT on feed and other inputs has been lowered from 6% to 1% for 4 months and extended
subsidies to all dairy producers, a 30% increase over existing beneficiaries. A lending facility
has been created through Banco de la Nación de Argentina to lend up to 100% of the cost of
improving or expanding dairy businesses, with longer maturities out to 8 years and with an 8-
month grace period.
While EU quotas have recently been removed to help EU dairies, causing much of the
oversupply, EU countries are suffering from the low prices as well. Spain and other EU
countries are providing temporary aid through market-oriented assistance commercializing
products and emergency lines of credit to some producers.
In times past, countries could simply institute local quotas, or rather production ceilings, in order
to stem the tide of rampant price declines in an oversupplied market. But with modern cold
chains and rapidly scalable distribution and logistics, production quotas typically mean missed
revenue by being left out of the export market. And if the local quota forces prices higher than
the world price, imports can quickly replace locally produced dairy CPGs on grocery store
shelves and in restaurants. Quotas and other attempts to prevent farmers from producing have
undesirable side effects that tend to drive governments implementing such ill-fated programs in
dairy markets to change course. Please see Figure 2 for examples of such programs and their
results.
13
Source: International Dairy Foods Association (2010) *Market quota for the EU was lifted in 2015.
Figure 2: Government programs for dairy markets
2.2 Domestic Market
2.2.1 Market Size
For Nicaragua, as indicated, the dairy market is a sizable 3.6% of GDP, and is one of the
country’s major export sectors (Galetto & Berra, 2011). Nicaragua’s dairy industry is the second
14
largest in Central America after Costa Rica. Nicaragua produced 753,281 tons in 2010. In 2015,
Nicaragua exported 121,956 tons of milk, and in a typical year exports account for around 15%
of total dairy production.
2.2.2 Domestic Market Characteristics
A chief difficulty of the dairy business in Nicaragua is its long history of informality. According
to the Food and Agriculture Organization (FAO), in 2005 86% of the sales of raw milk by small
producers occurred in the informal sector, and 14% was sold by cooperatives or other entities. A
primary disadvantage of the informal sector is its lack of access to affordable credit. The
informal milk sector has shrunk slightly since then but it still accounts for 70-80% of producers,
closer to the practices of producers in neighboring countries. There are several key policy issues
in Nicaragua which need to be addressed to encourage milk producers to abandon the informal
sector. Without such changes, it is unlikely informal practices will recede from the market. In
the long run, cooperatives and formal business practices among producers would likely bring
sustained growth to dairy farmers who have available, yet under-utilized access to a global
marketplace. The recent multi-year decline in internal demand suggest that, at least in the short
run, there is little ability for the Nicaraguan market to absorb additional dairy production
(International Livestock , 2011).
Recent market consolidation has occurred among downstream buyers in the dairy sector. La
Perfecta, a domestically owned 57-year veteran of the Nicaraguan dairy CPG business that
produces milk, processed dairy products, and juices was purchased in early 2016 by Grupo Lala,
a Mexican dairy company with similar business lines. Eskimo, a locally owned 72-year veteran
of the Nicaraguan market producing milk, ice cream, yogurt and beverages, was purchased in
2014 by Grupo Lala. Parmalat was operating a dairy business in Nicaragua until selling it to
15
Centrolac in 2009. These two downstream processors, Lala and Centrolac, buy most of
Nicaragua’s milk production. Currently Grupo Lala alone purchases around 75% of production.
In spite of recent infrastructure investment by Lala, opening a 300,000 liter plant in 2015
(Olivares, 2015), Nicaraguan dairy production faces an oversupply with a growing lack of
processing capacity, especially as regards powdered milk (Central American Data, 2015). Such
creates a further downside risk to price stability.
2.2.3 Nicaraguan Export Market
The Nicaraguan export market seems healthy with steady demand. On a value basis, dairy
products constituted 9% of the total value of Nicaraguan exports. Pasteurized fluid milk exports
increased 70% over 2014 and 2015. The major importers of Nicaragua’s fluid milk are close
geographically. Venezuela, Costa Rica, El Salvador, Guatemala, and Honduras are the largest
buyers of Nicaraguan exports (Central American Data, 2015). Just recently however, Nicaragua
has accused Honduras of a non-tariff barrier to trade in the form of a delay of plant re-
certification by its health service. A move that clearly benefits Honduran producers by blocking
750,000 liters of milk per month from Nicaragua (Central American Data, 2016). As
international prices for milk stay low, Nicaraguan farmers may suffer from emerging
protectionist dairy policies initiated by its principal importers.
Anecdotally, the team was told there is unmet demand for pasteurized fluid milk in the
Caribbean region, but Nicaraguan producers do not produce enough at high enough quality to
sell to this market. United States Department Agriculture (USDA) standards are difficult for
producers to meet in the category of pasteurized milk, and the most commonly produced
Nicaraguan cheeses don’t have an established US market.
16
Source: Adapted and updated from HERRERA MENDOZA, CADENA DE VALOR
Upon examination of the current market for Nicaraguan dairy products, increases in quality and
adding downstream buyers to compete for producer supply would likely benefit producers
greatly.
This is the commercial and business environment that we are considering within the context of
Nicacentro and its 992 producers active market for raw milk and processed goods.
3. Value Chain Description
The Nicaraguan dairy value chain, from the perspective of Nicacentro and its producers looks
like the following Figure 3.
Figure 3: Nicacentro Value Chain
Input
Producers
Individual
Producers
Transportation
Nicacentro
Industrial
Buyers
End
Consumers
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The simplified value chain surrounding Nicacentro contains links at 6 high level groupings, as
illustrated in the table.
3.1 Value Chain and Stakeholders Defined
The leftmost link represents input producers, these are companies that manufacture and sell all
types of products associated with milk production, including food supplements, construction
materials, seed, veterinary supplies, test chemicals and equipment, machine parts, and many
similar items. The company names supplying such are listed in the chart. The geographic
distances between suppliers on the input link and raw milk producers can be significant; the
cooperative mitigates some of this by buying in bulk, shipping, storing and distributing closer to
producers. If major construction projects are to be undertaken through a financing program
offered to many farmers, it would likely be the most economical to plan to supply multiple
projects simultaneously, as warehousing supplies may be cheaper than purchasing and shipping
them piecemeal to individual producers. Additional warehousing capacity for supplies for
cooperative members could be an investment that would pay off in bulk purchase discounts,
convenience, time, and shipping costs.
Second from the left, the link represents the 992 individual producers of the cooperative,
Nicacentro, known as associates. Nicacentro is a dairy cooperative (coop) which operates
collection and refrigeration stations for the benefit of its associates. Nicacentro’s associates are
mostly smaller producers as per the coop business model, with farms averaging around 70 Ha
and possessing a herd of around 25 dairy cows. Associate producers face a wide array of
constraints, from poor local communal infrastructure like paved roads, water, and higher voltage
18
electrical access, to lack of capital or access to financial services to finance the most basic of
farm improvements. Those needed improvements and their potential impact on revenues to
individual producers will be discussed in greater depth later.
Transportation of milk from individual producers to collection stations is accomplished by
“rutadores”, or by the producing associates themselves. This is the third link in the chart. The
“rutadores” are local truck owners who are hired by the cooperative to facilitate this transfer for
producers without delivery assets. Through our interviews, we learned that inefficiencies in this
system are the least pressing among producers, as very little cross-contamination occurs. Cross
contamination between different quality milks stored together can downgrade the whole batch, as
bacteria count is one measure of milk quality, another being fat content. The delivery method is
not the chief source of this problem, but rather collection sites, discussed later.
The 4th
link on the chain and already described in brief, Nicacentro is one of several dairy
cooperatives in Nicaragua. The organization works with the 992 individual associates described
above, and their main service to the value chain is the cooling and storage of the collected milk
until that milk is picked up by a downstream consumer like Grupo Lala. Nicacentro has the
negotiating power their small farmers lack, and fight for the best price for their farmers. They
also try to smooth out price fluctuations between seasons. They offer important services such as
technical assistance, a modest amount of credit at very competitive rates, veterinary services, and
the sale of production inputs purchased from the first link in the chart, input producers.
Nicacentro currently operates 13 storage centers spread through a geographic band known as
the “Via Lactea”. As already noted, the Nicaraguan market is oversupplied due to a lack of
processing capacity. This oversupply has a negative impact on revenues. Another inefficiency
facing Nicacentro’s collection methods is the lack of an ability to store milk until its quality can
19
be verified. Collection centers only have one main refrigerated holding tank and no refrigerated
holding area for individual deliveries to be segregated, so milk must be mixed into the tank
before individual delivery test results are known. When high bacterial count milk and low are
mixed, the result is usually a downgrading of quality, leading to a lower market price realized per
volume of milk sold. Another problem with quality testing is a lack of independent verification
of quality; the dominant price is what the purchasing agent claims the quality to be and there are
only two chief buyers in the market. If an incorrect downgrade is suspected, there is little
recourse as regards changing end buyers or contesting prices paid.
Nicacentro would like to be able to offer credit to its associates, but it has a very limited
maximum size of its loan book ($150,000), simply due to lack of excess funds to lend. When it
does lend, it lends at rates well below what micro finance organizations charge. Nicacentro will
typically only charge 12-15% for a loan, compared to banks who charge on average 7.5-9.5%
and microfinance institutions 18-36%. Servicing loans is cheap for them because they can net
loan proceeds from the associate’s production, but they lack funds to lend. Another constraint
for Nicacentro is that its collection centers are sometimes provided by Lala, so much of the milk
that goes through those centers is locked up by contract for in-kind financing recoupment.
From Nicacentro’s 13 storage locations, industrial buyers collect each day’s production. That
is the 5th
link in the presented chart. Currently Lala is Nicacentro’s only customer, and they take
all the raw milk produced to their plants for processing. CENTROLAC is cited to be much
worse on a pricing basis to the point that farmers can’t break even; Lala’s bid is the best and only
available. Because Lala has a limited capacity and is the only valid bidder in the market,
Nicacentro is forced to produce below capacity. It also faces the risk of losing its only buyer,
which would be disastrous in the short term. Additionally, Lala is beginning to use additives in
20
in place of raw milk in its dairy CPGs, sold in supermarkets. Retail grocery sellers are the final
link in the value chain.
Not contained within the dairy value chain but having a high impact on it are the financial sector
and regulatory agencies. We will cover financial sector institutions converging with this value
chain in depth later. We did not make a deep survey of regulatory agencies affecting the
Nicaraguan dairy industry, although the absence of independent testing agents to promote fair
treatment of suppliers by large industrial buyers seemed conspicuous.
4. Key Stakeholder Analysis
4.1 Producers
The individual producers and the cooperative, Nicacentro, are the two key stakeholders in the
value chain which we were asked to consider. In many ways, they are the same because
Nicacentro works for the benefit of producers. But in many ways, they are very different.
4.1.1 Producer (Associate) Profile
From our field interviews, and confirmed by the industry expert from SNV, Nicacentro
producers are more conservative than average when it comes to taking on additional business
risks. This includes being slow adopters of new technology, being slow to mechanize, and
lagging behind larger producers on switching the genetics of their herds to enhance production
quality and quantity. Nicacentro producers are smaller than the country average and frequently
raise their herds as dual use, for both milk production and eventual slaughter. Their on-premises
milking facilities may include a stool and a bucket and little else. Nicacentro’s objective is to
have 100% of its associates at least with the basics of a top-notch milking facility including three
items - clean water, a roof, and a concrete floor. Many producers have at least one of these but
21
Source: (Estrada & Holmann, 2008) (Instituto Nacional de Tecnologia Agropecuaria, 2015)
(Agro Informe, 2012)
few have all three. The coop is currently in the process of quantifying these needs among its
members. An accurate survey will allow it to seek better financing terms for participating
associates and purchase needed materials in bulk. We attempt to quantify the impact of such
improvements on revenue later through a simple model. Lowering the bacterial content of milk
is as simple as employing a roof, concrete floor, and clean water. But without these three,
contamination at the point of collection from the cow is a daily risk, and a risk with a reasonable
probability of being realized. With their current genetic profile, the Nicacentro producer’s cows
are the least productive in its relative regional market and within the country of Nicaragua.
Please see Figure 4 below.
Figure 4: Average Cow Productivity
Nicacentro’s producers’ high risk aversion likely comes from their small scale and thin profit
margins from one season to the next. It is understandable that they prefer to rely on proven
methods of cultivation and husbandry, as the consequences of experimentation and failure could
be disastrous to the long term economic outcomes of them and their extended families. They
0
5
10
15
20
25
Nicacentro Nicaragua Costa Rica SouthAmerica
Ecuador NewZealand
Argentina Uruguay
Lite
rs/C
ow
/Day
Average Productivity
22
have little capacity to absorb losses in the quest for longer term gains. This risk aversion further
drives them to avoid financing any parts of their business unless absolutely necessary, and never
to mortgage essential property items such as land or herd. This risk aversion is further enhanced
by the sub-par lending options typically available to associates of the coop.
The coop’s first goal for its associates is to provide all with an opportunity to upgrade their
milking facilities. Many producers are in need of much more technical assistance, but ensuring
quality at the point of milking must come first. Sequencing is important for improving
associates’ revenues. Skipping early steps will inevitably lead to sub-optimal results. Improving
the genetics of the cows before improving their milking conditions is not the most efficient way
to improve prices earned. For more advanced technical assistance, such as changing individual
associate’s herd genetics, changing their planting methods and cattle feeding patterns, associates
need to see very concretely that these changes will not lead to ruin. The industry expert
consulted agrees that a very visible demonstration of these technical assistance changes executed
by a farmer that other farmers trust would go a long way towards fostering the adoption of new
programs. In order for an associate to agree to be a test subject, he will likely need some
insurance he will not come to ruin for it.
Additional infrastructure needs include fence and enclosure improvements, and productivity
enhancing machines such as one known as a pasture mincer. Since cows in the region are mostly
fed by being put out to pasture, the conditions of pastureland can dramatically improve
productivity through food availability. In some cases, pasture is supplemented with other locally
produced feed products or commercial supplements, the use of both is less common among
Nicacentro producers. Rather than providing round-the-clock access to nutrition and water,
23
farmers are frequently constrained to provide less, this can deplete a cow’s productive ability
measurably.
4.1.2 Producers and Credit
Of the producers in the cooperative who have come into contact with financing, their experiences
haven’t always been positive. These past experiences directly affect their views on credit and
their trust of various financial agents offering them credit. Overwhelmingly, associates prefer to
borrow through the cooperative, as opposed to banks or microfinance institutions. It is easy to
understand why. The cooperative is viewed as being aligned with the farmers, and also offers
rates of interest drastically below the market. It is hard for the producers within the cooperative
to get bank loans because they are too small, have difficulty with loan servicing, and are
frequently on the line between formal and informal sector. It is difficult for most associates to
produce the detailed financial records needed for a bank loan. By contrast, a microfinance
institution will lend to associates of the coop but at rates that greatly exceed the rate the coop can
offer when it can offer financing (recall that the max loan book size for Nicacentro is $150,000).
The lowest rate quoted by a microfinance institution (MFI) was 18%, and that was with servicing
through the cooperative or through other specific arrangements as with long term clients. If
servicing is not administered by the cooperative, rates of interest often exceed 24%.
In almost all cases, loan servicing through the coop makes the most sense. Farmers do not have
checking accounts with which to pay periodic loan payments, only 19% of Nicaraguan
population have a checking account (Demirguc-Kunt, Klapper, Singer, & Van Oudheusden,
2014). And no close-by postal route to take the check to the bank. Because of this, physical
collection is needed. Because farmers generate cash by delivering milk, the easiest servicing
method available is to net loan proceeds from deliveries to pay the periodic loan payments, this
24
is also their preferred method. MFIs, if they would agree to expand such servicing, would be
able to lower rates and still be profitable, employ less manpower, and have better borrower
surveillance.
When borrowing, farmers tend to borrow from MFIs in small amounts for production inputs
rather than infrastructure improvements. This is likely driven by the short duration of loans
offered (almost always less than 36 months and frequently less than 24), and high rates of
interest charged. It is difficult for farmers to see the gains from improving productivity through
improving sanitation at the harvest site when short term cash flow burden is high from a short
dated, large infrastructure loan.
Another issue related to financing of infrastructure for farmers is project size. If the size of the
loan goes over a certain threshold, different among lenders but usually no more than $15,000,
more secure collateral can become necessary, including real property. Farmers are almost never
going to be willing to mortgage their land to borrow for facilities improvement as that is their
sole source of survival, and thus never make valuable facilities improvements.
Nicacentro associates could benefit greatly from facilities improvements. Increasing the
productivity of cows and the quality of production would greatly enhance their revenues. But in
the Nicaraguan economy there is a clear mismatch between the needs of producers like the
associates of Nicacentro and the financial products ready to be offered to them. Nicacentro
producers have unique circumstances and require infrastructure buildout which requires loans
with maturities longer than 24 months, and at interest rates lower than 24%. It is in the best
interest of both financial institutions and Nicacentro associates to find financial products that
25
allow associates to grow production without over-extending their cash flow commitments or
risking their most valuable asset, their production lands.
4.2 Nicacentro (Cooperatives)
4.2.1 Cooperatives and incentives to be a member
In 2001 the government created FondeAgro, a dairy development project to finance the buildout
of the milk cooling and storage network that became the foundations of Nicacentro, along with 3
other dairy coops. This effort to grow production by offering the power of market share to small
producers was successful. Eventually 5 larger coops began competing in the market. Nicacentro
started in 2005 with 288 members, it has grown to 992 members. On average, Nicacentro’s
producers have 70 hectares and 25 milk cows. Each cow produces around 3 liters of milk a day.
The cooperative collects, stores, and markets milk from its associates daily, aggregated at 13
refrigerated collection sites distributed around the region.
Noted in a study from 2007, the cooling network assets in the country, primarily consisting of
distributed collection and temporary storage depos, belong to 3 categories of owner, with 45.2%
owned by cooperatives like Nicacentro, 42.9% owned by private individuals, and 11.9% owned
by the association of cattle producers. Nicacentro’s 13 collection stations would be included in
the above national numbers. It is worth noting that even though a coop may own a collection
center, it may be financed by in-kind delivery to the market’s principal buyer, Grupo Lala. In
such a case, the coop can’t control the destination of the production delivered to the collection
site until it is paid off.
The cooperatives were formed with the idea of improving the bargaining power of smaller
farmers, and allowing collective decision making among producers in a localized area. Some
26
cooperatives also have ambitions to expand downstream and to manufacture dairy CPGs, citing
Dos Pinos of neighboring Costa Rica as an example.
4.2.2 Nicacentro and Strategy
In addition to bargaining power, cooperatives offer some price stability between dry and wet
seasons, working to pay similar prices to farmers throughout the year. By contrast, farmers in
the informal sector experience price fluctuations between dry and wet seasons. Larger farmers
tend to have more bargaining power in the informal sector, driving smaller producers to
cooperatives to compete. The coop’s prices are more stable, but not always higher than the
prices paid to informal producers during low production, high demand seasons. Nicacentro
management recognizes the risk to revenue by this seasonal temptation. Coop members must
commit to selling to the cooperative year round and are sanctioned if they violate their
agreement. The cooperative takes one Cordoba per liter sold through its facilities and passes the
rest on to associates. As of February 9th
, the price for grade A milk posted at a collection station
was per liter was 9.50; an associate would receive 8.50.
The daily production of the cooperative ranges from 56,000 to 85,000 liters per day, while the
total storage capacity of the network it controls is 110,000 liters. According to coop leadership,
associates do have the capacity to produce more but there is simply no bid for higher production.
The demand of buyers who will take delivery of raw milk from Nicacentro, namely Lala
subsidiaries, is limited and shrinking. Currently all milk goes through one of two Grupo Lala
subsidiaries, La Perfecta (66%) and Eskimo (34%). Nicacentro management is rightly concerned
that there is no competition among milk buyers in their market. Prices are negotiated weekly and
agreed to verbally, they have no guaranteed income. In addition to the reduced negotiating
capacity from selling to only one bidder, the coop is also at the whim of Grupo Lala’s business
27
outcomes. Without alternative buyers in the market, production at times must be curtailed. They
have already seen a 4,000 liter a day reduction in demand driven by Lala’s exposure to the
dwindling Venezuelan market. As Lala adopts more non-dairy fillers in its dairy CPGs, the coop
is worried about further reduction in demand.
Nicacentro offers technical assistance and limited financial services to its members. Technical
assistance focuses on topics such as: hygiene, emergency veterinary services, herd management,
animal nutrition, food preservation, and farm skill certifications. The financial services offered
usually come in the form of small loans to producers at below market interest rates, relative to
MFI lending.
Nicacentro adds value to its associates buying power in the form of operating as a distributor of
agricultural inputs. It can act as a bulk buyer and receive a better price and pass on the cost
savings to members, then offer physical products in a location that is convenient to them.
4.2.3 Nicacentro Market Constraints and Infrastructure Needs
In order to alleviate two of the cooperative’s biggest perceived market problems, dependency on
a single buyer and a demand for milk that is lower than the amount the system can produce, the
coop is pursuing strategies to increase quality and utilize more milk. They are trying to develop
their commercial competencies and learn how to promote their products nationally and
internationally. They want to diversify their clients and markets. Milk quality is a major
constraint for developing new markets and maximizing revenue in existing markets, as lower
grade milk is sold locally in the informal market for cheese production. Grade A milk has higher
and more consistent demand than B or C, typically sold on to cheese producers in Honduras or El
Salvador.
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Nicacentro currently faces several constraints to improving milk quality; one comes from within
its own cooling network. The test to grade a milk of type A, B, or C is done using Methylene
blue, a disappearing dye that bacteria consume. The faster it disappears, the lower the milk
quality. In order to find out if a milk has the highest quality, one must wait 4 hours to complete
the test. Nicacentro’s collection stations lack a refrigerated holding area where each milk
delivery can be stored separately until quality can be established. Deliveries go immediately into
the same refrigerated holding tank. This means that grade A milk is potentially mixed with
lower grades upon delivery; the quality of the mixture can be downgraded by nature of bacterial
growth spreading. The only method the coop currently has to mitigate such risk is to suspend
receipt of delivery from consistently low-quality deliverers until they improve hygiene. As
already mentioned in the producer section, system-wide milking facility upgrades at the farm
level would be ideal to improve delivered quality. A refrigerated holding area wound ensure this
upgrade wasn’t wasted with contaminated mistakes which can downgrade a whole day’s
production.
The addition of independent lab testing of batches of milk to ensure that downstream buyers pay
fairly for the right quality level would also help to ensure that an investment in milking
infrastructure would realize returns. There have been mismatches between the tested quality at
the collection and cooling station, and the tested quality by the downstream buyer. The buyer’s
quality test prevails when determining what price the coop receives. An independent testing
regimen would prevent conflicts of interest from arising in how quality control impacts pricing.
A second strategy Nicacentro is developing to better utilize its production capacity is converting
a collection station to a plant to process packaged cheese for sale on the domestic and export
market, El Salvador was cited as an ideal market for such exports. The plan is for the plant to
29
Source: Own elaboration based on information gathered in trip to Nicaragua.
have an initial capacity to process 4,000 liters of milk. The idea is to presell the cheese to buyers
in El Salvador and then raise capital for the plant conversion, an estimated $350,000. It is
unclear who is currently meeting this demand, but there are certainly market risks to this sort of
investment. It would give Nicacentro associates a better price for their lower quality milk and
bypass downstream buyers.
4.3 Banking Sector
There are several financing channels within the Nicaraguan dairy industry by which lent funds
make it to producers. According to International Livestock Research Institute, the number of
livestock producers who receive loans is exceptionally small in Nicaragua, totaling around 3.5%
of producers (ILRI, 2014). Dairy farmers are hesitant to use credit because of negative
connotations, and the credit available to them has terms which prohibit its broader application to
their business. Dairy producers could use credit for all manner of things around the farm,
starting with the cited essential improvements of milking facilities. These consist of water,
ceiling, and floor. Other uses include machinery, and herd expansion. Because of the informal
nature of their businesses, and the small loan sizes required, small Nicaraguan dairy farmers have
few credit options. Banks aren’t interested in the small commercial loans, and MFIs charge rates
of interest that are too high and for maturities that are too short.
Figure 5: Summary of term of loan and interest rate for visited financial institutions
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4.3.1 Banco Produzcamos
Banco Produzcamos is in the midst of reconfiguration. Originally created as a state run bank
tasked with lending to domestic financial institutions, it is in the process of focusing itself on
lending to financial intermediary and large end users of funds for the specific purpose of
development. Within that context, its mission aligns with the IDB; Produzcamos could become
an institution through which IDB money can be lent into financial channels. Ultimately, such
lending could benefit dairy farmers and spur economic development of the region in which they
operate. Banco Produzcamos’s loan book is 66% committed to financial institutions, with the
remainder to large commercial entities, and cooperatives. Of the remainder, 70% is lent to
agriculture related businesses. Only around 3% of their current loan book is exposed to the dairy
industry. Banco Produzcamos seeks a return on equity but has no cost of funds, their balance
sheet is primarily financed by equity contributions from government entities. Total asset size is
around $185 million, $145 million of which is financed by equity. Such a structure should make
them more willing to take risk than a commercial structure, although they are explicitly not in the
business of making loans to make losses. As the new management tries to shift the culture of the
bank, they have an opportunity to make better use of the bank’s balance sheet, and new
management is attempting to define a stronger culture and direction.
Banco Produzcamos is willing to use cooperatives as credit intermediaries to make small loans to
farmers and has ample room to increase its exposures to dairy. It recognizes that coops may be
best suited to offer longer term loans to credit-worthy customers by knowing those customers in
an otherwise informal and anonymous market, and is willing to let them underwrite loans and
make credit decisions. Its primary concern with this method of operation, however, is the lack of
corporate governance among cooperatives like Nicacentro. The management of these
31
organizations are untrained in how to run an organization which can be accountable to upstream
lenders as downstream credit agents. Yet coops are uniquely positioned to service loans and
collect surveillance on borrowers by the natural day-to-day operation of their business. So
Banco Produzcamos has planned on offering technical assistance and business education to
coops to facilitate lending through them. Coops are the only credit agents that seem to have the
implicit trust of farmers, thus strengthening the likelihood of repayment. In addition to corporate
governance of cooperatives, Banco Produzcamos is worried about its eventual recourse to end
borrowers should loan performance deteriorate. End borrowers, dairy producers, are highly
informal and it is difficult to seek repayment when end borrowers have no bank accounts, tax
status, or assets collateralizing loans.
Another lending channel through which Banco Produzcamos can make funds available to dairy
farmers is through microfinance organizations (MFIs). These organizations can borrow from
Banco Produzcamos at rates ranging from 7-10%, it hasn’t always been easy to meet the bank’s
requirements for specific lending programs. The proceeds are used to make development loans
to individual producers. MFIs are the principal lenders to the informal sector, as they are willing
to take tremendous risk as regards documentation quality and servicing difficulty. Their tenacity
seems to pay off, as both MFI lenders we spoke with reported exceptionally low default rates for
loans to the dairy sector, especially when considering the high interest rate. These low default
rates are likely driven by farmers’ often cited use of MFI loans, to bridge small short-term input
expenses. The team had the opportunity to speak with two MFIs making loans to the Nicaraguan
dairy industry. FDL and FUNDESER both make small loans to small producers, loans typically
classified as microfinance.
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4.3.2 FDL (Fondo de Desarrollo Local)
FDL makes loans across many different industries, it has 4,161 agricultural loans in its book as
of 2015. For dairy producers, loan servicing is structured in two ways and this determines
interest rate offered and term of the loan. FDL is innovative and used Nicacentro as the servicer
for one of its loan programs, the first of two mentioned here. These loans were typically around
24 months or less and an 18% interest rate was charged. This lower rate, by MFI standards, is
possible because of the coop servicing arrangement. Milk is netted against the loan payments
due, so Nicacentro sends FDL a check after conducting business on behalf of its associates who
have borrowed from FDL. The second method for servicing is cash, and FDL charges 24-28%
for these loans, they are varying term but are offered out to five years on occasion. Please see
the figure below for an illustration of the two cases.
In both types of loans, FDL requires some form of technical assistance to ensure loans are used
to the farmers’ greatest benefit. In the case of Nicacentro serviced loans, the coop acts as the
technical assistance agent. In the case of cash serviced loans, the technical assistance agency
Nitalapa offers technical assistance and provides borrower surveillance back to FDL. Typically,
FDL will make loans for less than $10,000 and sometimes will receive the “carta de venta”, or
registration of ownership of individual cows, as collateral for the loans. For loans greater than
$10,000, physical collateral is usually required.
Figure 6: FDL Methods for Loan Servicing
(Case 1) (Case 2)
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Source: Own elaboration based on FDL’s information gathered during trip to Nicaragua.
4.3.3 FUNDESER
FUNDESER is the second microfinance organization we spoke with. It only uses a cash loan
servicing model and is in the process of deploying an automated system for collecting loan
documentation. It only lends to small, end producers, typically with microfinance sized loans.
In the past it hasn’t had a strong focus on the dairy industry and doesn’t have a significant loan
book dedicated to the business. Loan terms are relatively short, and interest rates range from
18% to 30%, but usually hover around 30%. Fundeser has a cost of funds around 7-9%, and can
borrow from Banco Produzcamos for cheaper. Fundeser hopes to be positively impacted by the
change in management at Banco Produzcamos. Previously, Fundeser found it uneconomical to
borrow from Banco Produzcamos because of documentation requirements. Because Fundeser
lends primarily to the informal sector, its borrowers have low default rates but limited
documentation. Banco Produzcamos has traditionally required collateralization of any loans to
Fundeser be collateralized by loans from Fundeser’s loan book. Because of the poor
documentation, Banco Produzcamos had required 150% of the loan value to be collateralized by
loans from Fundeser’s portfolio. Because of this unsustainable requirement, Fundeser is not in
34
the habit of borrowing from Banco Produzcamos, although it would like to do so. When asked
why Fundeser didn’t simply improve their documentation process to produce a portfolio of loans
that would accumulate enough size to be acceptable to Banco Produzcamos as collateral on a 1:1
ratio, management stated it preferred to let Banco Produzcamos change its practices. At the
same time Fundeser is in the midst of a rollout of technology aimed at increasing efficiency of
producing loan documentation and hopes to create a database of consumer behaviors and credit
history. Fundeser has plans to explore an IPO and is in the process of converting itself to a
potentially public traded company.
4.3.4 Loan strategy for Nicacentro
It would seem that the most optimal lending arrangement for Nicacentro producers would be to
borrow through the cooperative, and Banco Produczcamos could best put its money to work by
charging low rates of interest for longer term loans, breaking the cycle of an inability to finance
infrastructure buildout by milk producers. Educating Nicacentro on how to achieve better
corporate governance and better administer loans could facilitate extensive lending to dairy
producers and rates well below MFIs, with easy servicing and stronger psychological motivation
to pay back loans. Default rates to MFIs are low, yet they continue to lend at 24% or higher, such
risk spreads are hard to justify while claiming to be in the business of facilitating impact
investing and development.
One method of diversifying Nicacentro’s purchaser base will be to improve milk quality, this can
be accomplished through loans to associates which they use to build out milking facilities to
include three essential components, floor, ceiling, and clean water. In order for a lending
program to producers to work, it must fit into their cash flow profile, thus likely have a lower
rate of interest and longer term. We built a basic model to calculate the net benefit a farmer
35
would gain from improving quality outcomes, we assume that improving milking quality will
increase quality across the system. We consider the net present value (NPV) and varying
internal rates of return (IRR) for each producer, given an enhancement to milking facilities using
borrowed funds. Our model allows us to vary interest rate, term, annual maintenance cost, and
additional revenue achieved from consistent quality improvement.
5. Strategies for Lending Options
5.1 Financing Channels
As mentioned, the main financing channels for end borrowers are loans from Banco
Produzcamos to coop as intermediary, or through MFIs which have a range of balance sheet
financing options including Banco Produzcamos loans.
Currently, liquidity for credit financing is ample in the Nicaraguan financial system, so most
borrowers should be able to obtain loans. Pros and cons of each channel are listed below, in
Figure 7.
Figure 7: Lending Channel Comparison
Through Nicacentro Through MFI
Benefits Trust from producers
Relatively long debt term and low cost of
borrowing for producers (about 12%)
Low default rate
Better debt management ability
(available in-house financial
expertise)
Risks Risky for banks, due to Nicacentro’s
1. Weak corporate governance
2. Unclear ownership
3. Insufficient workforce (low financial
Trust issue
High interest rate (around 30%) and
short debt term for producers
No previous lending experience to
36
expertise) milk industry
No employees who can process
appropriate documentation
Unattractive lending term for it to
gain fund from BP and IDB
Source: Own elaboration based on market research in Nicaragua.
5.2 Financial Model
5.2.1 Rationale of the Model
The model attempts to roughly estimate the total financing needs of all coop members by
modeling a typical borrowing member’s cash flows. The inputs include producer information on
the number of producers, average number of cows per producer, and percentage of producers
who need each infrastructure and the cost of infrastructure. The cost of each infrastructure item
was established through some basic market research, and the estimated increases in quantity and
quality are used to calculate increases in revenue.
The input and maintenance costs are netted from estimated production benefits for each producer
and are modeled into cash forecasts for an average producer. Loan servicing is included in cost.
Finally, these net benefit increases are discounted back to the present using an appropriately high
rate considering the borrower risk profile. And an internal rate of return is calculated, assuming
both levered and unlevered return. It is unlikely that many borrowers will contribute equity so
IRR will typically consist of cash flows on investment through debt. Please find a description of
model assumptions in Figure 8 on the following page.
5.2.2 Assumptions
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Figure 8: Model assumptions
Items Assumptions Reasons
Percentage of producers needed
improvement for floor
60% of producers Based on estimation, can be verified
with survey results
Percentage of producers needed
improvement for ceiling
60% of producers Based on estimation, can be verified
with survey results
Percentage of producers needed
improvement for water pump
60% of producers Based on estimation, can be verified
with survey results
Lending interest rate Through Nicacentro:5%
Through MFI: 5%
Additional interest rate charged by
Nicacentro
7% Based on current standards
Additional interest rate charged by MFI 13% Based on current standards
Maintenance as percentage of total capital
cost
2% of total capital costs Estimation, need verification
Useful life for maintenance 10 years Based on experience
Discount rate 20% Based on risk level of this project
Debt investment ratio 100% of total investment Based on willingness of producers
Percentage of milk from C to B 40% of total quantity of milk
produced
Estimation, need verification
Percentage of milk from B to A 20% of total quantity of milk
produced
Estimation, need verification
Source: Own elaboration based on market research in Nicaragua.
5.2.3 Expected Outcomes
On the following page, borrower outcomes are listed in aggregate in Figure 9, with the
assumption that all coop members borrow to increase milking facility quality. This is a measure
of a maximum capital deployment necessary to build out needed improvements. Aggregate
38
performance of various loan terms and interest rates are represented. A 20% discount rate was
used for NPV.
Figure 9: Calculated performance of lending
through Nicacentro through MFI
Debts needed (in Córdobas) 115,248,272 115,248,272
Debts needed (in US$) 4,033,690 4,033,690
Interest Rate for Producers 12% 18%
2-Year Debt
NPV of Net increase in profits (in Córdobas) 61,046 47,588
Unlevered IRR 26% 26%
Levered IRR 6.84% 5.85%
5-Year Debt
NPV of Net increase in profits (in Córdobas) 73,644 50,737
Unlevered IRR 26% 26%
Levered IRR 5.95% 3.88%
10-Year Debt
NPV of Net increase in profits (in Córdobas) 87,239 54,136
Unlevered IRR 26% 26%
Levered IRR 3.92% -0.92%
Source: Own elaboration based on model results.
Based on estimated costs, total debt needed to finance the improvement of milking facilities
under our assumption of need was around $4 million. The model quantifies the need for longer
term and lower interest to make it feasible for associates to finance infrastructure improvements.
5.2.4 Individual loan structures
39
An additional consideration when contemplating the viability and effectiveness of loans is
payback terms. As it stands, MFIs tend to lend for 36 months or less, and frequently the loan
terms prescribe pro-rata principal payments (principal/term=payment) as opposed to a level total-
payments. That translates to a declining payment every period, as opposed to the same payment
every period. The cash flows of the loans are front-loaded, meaning the largest payments are due
when the farmer least has the ability to see realized production gains, especially as regards a
livestock loan. This form of pro-rata principal payment means less interest due for the farmer,
(at 30% this is impactful) but also means lower risk for the MFI, they get more principal back at
the beginning rather than the end in the case of a level periodic payment. But for a producer, this
payoff profile may cause hardship at the beginning and thus make them less likely to borrow.
Using the example of a $5,000 loan (C$140,000), with a term of 36 months and an interest rate
of 30%, the farmer pays more per month initially with a pro-rata principal repayment plan than
level pay. The pro rata payment is $263.89 (C$ 7,388.89) for the first month. For level pay, by
contrast, every payment every month is $212.26 (C $5,943). In the first payment due, the farmer
owes $51.63 more (C$1,455.67). This difference declines, and eventually crosses over in the
16th
month to realize the level pay amount being more per month by the end of the loan. Before
the crossover, the producer would pay 409.88 more than a level pay plan. By the 36th
month, the
periodic amount due on the pro-rata pay is $142.36 vs the same $212.26, a difference of $69.90
(C $1,957). The important point here, however, is that the payments in the front months can be
lowered dramatically if the loan structure changes. Changing the structure makes sense, because
the farmer can easier bear the first months of ramping up productivity gains. Especially in the
case of a calf purchase, as such can’t be put into production for close to three years. There is a
cost to this option borne in the additional interest for principal being outstanding for longer. For
40
the example loan of $5,000, this amounts to around $2.28 per week, over the life of the loan
totaling $329, for the option of paying a minimum of $212.26. Of course the farmer can pay
more if they want, that ultimately shortens the time until the terminal payment. Please see Figure
10 below for an illustration of payoff profiles over 36 months with no prepayment of principal.
Figure 10: Payoff Profile of two loan types
Source: Own elaboration based on model results.
5.2.5 Credit Model using a Guarantee fund
One way to encourage greater lending to the dairy space is to reduce the credit risk faced by
lenders. If credit risk to lenders is reduced, lower rates of interest can be charged, and more risk
can be taken. While it is not ideal to create moral hazard by providing lenders a bail out of their
0.00
50.00
100.00
150.00
200.00
250.00
300.00
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
Pro-rata Loan
Interest
Principal
0.00
50.00
100.00
150.00
200.00
250.00
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
Level Pay Loan
Interest
Principal
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bad risk decisions, neither is it ideal to constrain credit to the economy on the basis of the severe
information asymmetry that exists between lenders and informal-sector borrowers.
Credit risk faced by lenders can be reduced by creating a guarantee, or reserve, fund for loans. A
risk in offering such a guarantee fund is that it ties up resources that could otherwise be used for
lending, imposing an opportunity cost. Another risk is that it is difficult to gauge how much a
guarantee will ultimately cost; it is also difficult to dis-incentivize reckless lending practices in
the face of credit support.
A model of basic cash flows and a reserve fund to guarantee those cash flows was built. In it,
defaults and losses are applied to loans in constant annualized rates to simulate defaults and
recoveries.
The structure is simplified; in the model realized losses are refunded monthly, along with missed
interest from defaults. If loans produce losses, but if no losses are sustained by lenders, the cash
flows to lenders will be the same in amount as initially scheduled, but different in timing. Losses
and recoveries come back as prepayments. The model includes a switch to cover or not cover
missed interest due with guarantee funds.
Currency is irrelevant for the sake of this model; any currency can be implied by the model. The
basic mechanics of it are as such, start with a pool of loans, for example $1,000,000 outstanding.
Create a guarantee fund that collateralizes a percentage of total loans, for example guarantee
10% of the balance with cash or cash-like instruments. If we have an overcollateralization
amount of $100,000 on $1,000,000, we have a 10% credit support amount. The reserve fund is
capitalized by the guaranteeing party. If future defaults and losses can be accurately estimated,
there is no need to provide 100% credit support. Such would be fully guaranteeing the loans,
42
dollar for dollar. In the proposed structure of a partial guarantee through overcollateralization,
the lender is still exposed to risk and hopefully such will mitigate moral hazard coming from a
guarantee.
Additionally, in the model the guarantee fund receives excess spread from the loans every
month. This is accomplished by charging borrowers one rate, taking a nominal amount of the
payment, then allowing lenders to claim the rest. If borrowers pay 15%, the reserve fund is paid
2%, and the lenders receive 13% on the outstanding balance. This 2% helps to recapitalize the
guarantee fund in the event losses begin to deplete it. This excess spread can be set to any
amount.
The reserve fund is leveraged against defaults and losses. A 5% guarantee fund’s return is
levered 20x against losses, a 10% guarantee is levered 10x, and a 20% guarantee is levered 5x.
What this means is that a 1% loss wipes out 20% of the reserve fund in the case that it is a 5%
reserve, but only 5% in the case of a 20% reserve
This leverage generates spectacular returns to the reserve fund if the loan pool is high
performing, and losses if the pool performs poorly. This makes sense within basic thoughts
about credit and interest rates, namely higher risk needs higher returns to attract sponsorship.
The reserve fund is a partial credit guarantee scheme, but it is structured to operate more
efficiently than PCGSs implemented in the past. Rather than offer a high coverage ratio, and
force lenders to shoulder some of the default, it is a dynamic fund which adjusts the support level
over time and attempts to cover principal losses and interest losses in each period. Rather than
offering a coverage ratio of 50-70% of principal exposure, it covers 10% of an outstanding
43
balance. It is designed to passively rebuild itself and also release excess funds back to the
guarantor.
Several countries have tried using PCGS, or Partial Credit Guarantee Schemes, to ensure at least
partial repayment of loans in the event of a borrower default. Typically lenders have to shoulder
some of the responsibility for default, with PCGSs shouldering 50-70% of exposure.
PCGSs have been successful at increasing credit deployment and reducing interest rate to
borrowers, but some criticisms exist. One is that the credit guarantees primarily help businesses
that were already able to get economically viable credit terms. The second is that they create
moral hazard, by encouraging lenders to take risk up to the point that the guarantee fund is
liquidated, as they can make more money on volume and the missed interest payments on a high
balance, until the fund is liquidated. Offsetting this moral hazard, lenders are incentivized to
avoid abusing the guarantee due to the small size of the guarantee fund and their likely inability
to estimate how much risk would lead to borrower losses vs simply liquidating the fund. Thirdly,
while it is undeniable that guarantees frequently increase the amount of loans outstanding, there
is limited evidence to support that credit guarantees help the situations of economic participants.
In the case of guarantee programs in both Mexico and Chile, leverage to focus sectors has grown
and expanded with the usage of guarantee funds, although results are inconclusive.
Chile’s guarantees are allocated via auction, with bank demand setting guarantee levels (Cowan,
Drexler, & Yañez, 2010). The reserve fund we are modeling is different from Chile or Mexico
(Armenteros, Artellini, Hoppe, Urizar, & Yaros, 2014) (Benavides & Huidobro, 2008). Rather
than protecting a percentage of each loan, it protects the full balance of the loans by covering lost
principal and interest as losses occur over the life of the loan. This way, less capital can be tied
44
up while offering superior protection. The trick to making such a guarantee fund (or account)
work is an appropriate estimate of defaults and losses. An accurate estimate of such is essential
to understanding how to correctly size the guarantee fund.
Please see the below performance tables, The first table uses 2% excess spread, the second table
uses 1% excess spread. We assume no recoveries on the defaults. Guarantor performance
indicates the performance to the guarantee fund. Lifetime losses are to the whole loan pool, as
evidenced by the below, the loan pool can lose money in the proposed structure without lenders
taking losses.
Figure 11: Performance at 2% and 1% Excess Spread
There are many switches that can be added to such a fund. Triggers which reload capital or
release it are common, for example rather than releasing funds every month to keep ratio of loans
to guarantee the same, the fund could wait and not release, letting the underlying loans pay down
Borrower Rate 15% OverCollat % 5%
Lender Rate 13% OC Amount 50,000
Servicing % 2% Loan Balance 1,000,000
Annual Default Lifetime Lifetime Excess Guarantee Guarantee Guarantee Losses to Lender
Rate % Default % $ Losses Spread G/L Implicit CPN % Return % Lender Return %
0 0.00 0 56,986 56,986 40.00 40.00 0.00 13.00
0.5 1.42 17,516 56,469 38,953 40.00 27.87 0.00 13.00
1 2.81 34,824 55,956 21,132 40.00 15.43 0.00 13.00
2 5.55 68,825 54,943 -13,882 40.00 -10.55 0.00 13.00
Borrower Rate 15% OverCollat % 5%
Lender Rate 14% OC Amount 50,000
Servicing % 1% Loan Balance 1,000,000
Annual Default Lifetime Lifetime Excess Guarantee Guarantor Guarantee Losses to Lender
Rate % Default % $ Losses Spread G/L Implicit CPN % Return % Lender Return %
0 0.00 0 28,493 28,493 20.00 20.00 0.00 14.00
0.5 1.42 17,775 28,235 10,460 20.00 7.50 0.00 14.00
1 2.81 35,339 27,978 -7,361 20.00 -5.39 0.00 14.00
2 5.55 69,847 27,472 -42,375 20.00 -39.07 0.00 14.00
45
and passively over-collateralizing the structure. For example, If I have 1,000,000 worth of loans
with a 10% guarantee (100,000 fund), I can let the loans pay down, while accumulating excess
spread to the guarantee fund so that after several periods the loan balance has declined while the
guarantee fund has stayed the same or grown from excess spread delivered to the account, thus
providing a larger guarantee without contributing additional capital. It might make sense to tie a
build-up trigger like that to delinquency levels.
There are other decisions which have to be made which are not modeled here, such as how to
handle actual flow through of losses. Does the guarantee foster timely payment of principal and
interest, or does it just make sure that losses are covered at the point they are realized. How do
we compare what is good performance? Do we include defaults as prepayments with 100%
recover when looking at a good cash flow for comparison? All these affect performance and
return. It is important to note that cash flow timing for an overcollateralization scheme can be
much different than we have modelled here. Large waves of defaults can overwhelm the fund’s
resources if such is larger than anticipated at the fund’s creation.
6. Conclusion
Nicaragua has a climate conducive to agricultural production and an economy that is reliant on
agricultural industries. Growing production and increasing quality are key goals across sectors.
The dairy industry particularly has room for tremendous gains through improving efficiency and
utilizing existing idle capacity. In order to improve dairy industry efficiency, farms must be
extended financing terms which aren’t so onerous as to make borrowing untenable. Basic
changes to production methods could drive large gains in productivity and prices earned per
46
volume of milk produced. Changes in the tax code could help encourage reinvestment of profits
into growing the business. Right now, large cooperatives are penalized.
The magnitude of asymmetric risk due to the informality of the sector is daunting for lenders.
Plans to spur lending to improve production must include plans to reduce risk and costs to
lenders, allowing them to charge lower rates for longer terms. A dynamically structured partial
credit guarantee may allow more efficient use of guarantee funds and allow the offeror of funds
an opportunity to make an outsized return in exchange for assuming a leveraged exposure to
losses. Servicing loans through milk collection provides a low cost alternative to more
expensive servicing techniques of MFIs. Innovative servicing initiatives could make a big
difference in overall borrowing costs.
The rewards for successfully improving production quality and volume are obvious – access to
export markets and more competition among downstream buyers. Such should hopefully lead to
better prices earned for milk produced. Transitions to larger volumes of Grade A milk could
achieve the goal of broader market access and better revenue. In order to get there, producers
much have the means to consistently produce a superior product; they are unlikely to get there
without access to long term, low interest loans. Improved revenues will benefit the whole “Via
Lactea” region, up and down the value chain.
47
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