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The Value of Unretired Capital Credits

The concept of capital credits is interwoven into the entire fabric of the rural electric cooperative industry. One key issue involves recognizing that unretired capital credits, which represent the major component of a cooperative's total equity capital, are of value to the member. whether the member is a transmission system, distribution system or retail member. "Capital credits is perhaps the most discussed, argued, misunderstood, important, fascinating, and unique term included in the lexicon of rural electric and telephone cooperatives. It is also one of the most complex--involving accounting, finance, legal, tax, political and certainly member relations problems. It is a subject alien to every person newly arriving upon the electric/telephone cooperative scene--directors, employees, attorneys, auditors, whoever. It is a subject seldom completely mastered by any of these but in any event needful of being revisited by all of them frequently and in depth." William T. Crisp The cooperative philosophy with regard to capital credits takes the form of an agreement between the cooperative and the member. As with any business, the cooperative needs equity capital. It is the member who agrees to provide this equity capital through the rates the member pays for electric service. By paying an amount greater than the cost to provide this service, the cooperative will realize a margin. The accumulation of margins is how the cooperative builds equity. The cooperative agrees to use this equity to help finance new construction and improvements to the system and, at some future date, the cooperative will return the equity back to the member. The cooperative also agrees to operate on a not-for-profit basis and the members have a say in the affairs of the cooperative. It would be impossible to address all of the facets of capital credits in this article since entire courses, books and seminars have been devoted to the subject. This article will focus on the aspect of the value of unretired capital credits, or equity capital, to the cooperative member. Even though this article will not address all of the reasons for and methods to retire capital credits, it is only through the retirement of capital credits that the cooperative's responsibilities are fulfilled in the agreement between the cooperative and the member. How many times have you heard someone call a G&T cooperative's capital credits "funny money" because the G&T is allocating margins as capital credits to its distribution member systems but not retiring them? How many times have you heard someone call a distribution cooperative's capital credits "funny money" because the distribution system is allocating margins as capital credits to its retail members but not retiring them? The answer to the first question is often, but the answer to the second question is seldom. If one calls these G&T capital credits "funny money," then one must also call these distribution system capital credits "funny money" as well. Why? Because in both cases. the party receiving the allocation has yet to receive a return of their equity investment by the receipt of a retirement and, therefore, believes their equity has no value. However, the premise of this article is that no capital credits should be called "funny money" because they are of value to the party receiving the allocation even if the capital credits have yet to be retired. To make this point, it is necessary to outline the capital credits allocation process, discuss the emergence and the purpose of the Modified TIER and Modified Equity ratios, and then discuss the reasons why unretired capital credits are of value to the member. THE ALLOCATION PROCESS The allocation of capital credits is merely a notification to a cooperative member that the cooperative recognized a margin for the fiscal year and, in accordance with its bylaws, is allocating a pro rata share of the margin to the member, usually based on the member's patronage or KWH usage. …