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Guest Post: Enacting a Capital Credits Policy Change

This guest post is from CFC’s February 11, 2013 CFC Solutions Newsletter (Vol. 15, No. 6).

FROM THE CFO’S DESK
Enacting a Capital Credits Policy Change

With Frank Skube, CFO, Pedernales Electric Cooperative

When Frank Skube joined Johnson City, Texas-based Pedernales Electric Cooperative (PEC) in July 2011, the cooperative was in the midst of a capital credits policy revamp, planned for implementation in December 2011. Given the short timeframe, finance, legal, IT, communications and member services teams had to work collaboratively from the outset.

CFC: Describe the challenges you faced in this situation.
FS: “The revised capital credits policy included a hybrid method of retiring capital credits, with approximately 50 percent of the retirement representing the oldest patronage capital and 50 percent representing the most recent allocation. With the adoption of this policy, PEC introduced the practice of retiring capital credits to its deceased members, discounted at a rate equal to the cooperative’s weighted average cost of capital, and specified an approximate 30-year schedule of retirement.

“In line with the discounting of deceased member payouts, PEC later considered the return of patronage capital from the most recent fiscal year an early retirement subject to similar discounting. In September 2011, we revised our capital credits policy to maintain a fair distribution system to all members and former members—reasonable to PEC’s financial state.”

CFC: What about this kept you up at night?
FS: “There were myriad concerns related to this change, especially given the targeted distribution date. We needed to draft changes to the approved capital credit policy and obtain board approval to permit discounting of the most recent year’s allocation consistent with the treatment afforded to deceased members for early retirements. We needed to communicate this change to members prior to the proposed distribution date, while providing the mechanism for members to opt out of the discounted distribution.

“Our existing bond covenants restricted the total ‘distribution, payment or retirement’ of patronage capital to not more than 25 percent of prior fiscal-year audited net margins if the equity to total assets ratio was below 30 percent—our equity to total assets ratio was 28.73 percent at April 30, 2011.

“Also, the question remained of whether PEC could rely on previously issued IRS private-letter rulings regarding the discounting of capital credits, or whether we needed to pursue such a ruling specifically on our own behalf.”

CFC: How did it all turn out?
FS: “We successfully completed the capital credit retirement and distribution in December 2011, issuing nearly 217,000 bill credits to current members and 72,000 checks to former members. Roughly 350 members proactively opted out. Combined with some 4,800 checks that went uncashed, the total member opt-outs rose to just over 5,000. At 2011 year-end, PEC’s equity to total assets ratio was 29.65 percent, and the ratio has exceeded 30 percent during 2012.

“Fair treatment of our members under the hybrid retirement method was the primary motivation for this change by our board of directors. As this was the first retirement under the new policy, it was essential that we instituted a methodology from the outset that included the payout of the present value of early retirements that would not require subsequent change.

“We just recently completed our capital credit retirement under the same terms and conditions in 2012.”

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