Capital credits, competitiveness, and member loyalty.

• Author: Luecal, Scott

When making financial decisions, directors and managers increasingly must focus on one key question. Ultimately, competitiveness means that if given a choice, consumers choose us. Your system's key question becomes, "Does your approach to rates, capital credits and equity increase the probability that your consumers would choose you as their power supplier?" To answer this question, systems need to establish a long-range capital credit retirement plan which supports the goal of maximizing the system's competitive position and enhancing the sense of loyalty on the pan of members.

As cooperatives organized under section 501c(12) of the Internal Revenue Service Code, your system has the responsibility to allocate annual margins, the excess of revenues over expenses, on a patronage basis, to those patrons receiving service during the year. Allocation, therefore, is a record-keeping process in which the cooperative assigns margins to each member's capital credits account and must notify each patron of their annual allocation. The allocation of annual margins as capital credits preserves your cooperative's not-for-profit status.

To the author's knowledge, no rural electric cooperative has lost its not-for-profit status from failing to retire capital credits, or the return of allocated capital credits in the form of a check or a credit to an active member's bill. The strategic issues of competitiveness and member loyalty are the reasons cooperatives must consider whether to retire and by what method(s) to retire capital credits. The focus of this article is threefold:

1. To examine the trend of capital credit allocations in our industry.

2. To evaluate possible approaches to capital credit retirements.

3. To identify the issues relevant to developing an effective capital credits retirement plan which identifies the retirement method(s) which will allow your system to enhance your competitive position and member loyalty.

   EXAMINING THE TREND OF CAPITAL CREDIT ALLOCATIONS

   REA Bulletin 1-1 for the years 1980 through 1993 was examined to determine the trend of capital credit allocations and the amount of capital credits retired by distribution cooperatives to their members. As will be explained, the vast majority of capital credit activity has occurred since 1980. Therefore, pre-1980 trends are a representation of one cooperative. The graph in Figure 1 shows the annual margins allocated as capital credits from 1935 through 1993 by our industry, and clearly reflects the dramatic increase in annual margins staffing in 1980. Figure 2 illustrates the cumulative capital credits allocated since 1935 and reflects the fact that approximately 50% of all margins allocated as capital credits have been allocated since 1985.

   To clarify, as of December 31, 1985, distribution systems had allocated a total of $7,119,007,000 in capital credits to their members. As of December 31, 1993, distribution systems had allocated a total of $14,124,127,000 in capital credits to their members. Therefore, $7,119,007,000 divided by $14,124,127,000 equals 50.4%. Additionally, the examination of REA Bulletin 1-1 shows that approximately 85% of all capital credit retirements have been made since 1985. Several implications stem from these facts.

   * Rural electrics have achieved a FIFO cycle by retiring old, small allocations in years of large margins, the 1980s.

   * When designing rates, the primary components of total revenue requirements are cost of power, departmental operations and maintenance expenses, "fixed" expenses including depreciation, interest and taxes, and margins. Systems in competitive environments and/or rate disparity situations have realized that the amount of margins included in rates are equally as critical as any other component of revenue requirements, and that their competitive position could be hurt if members are required to provide too great a margin. Instead of realizing increasing levels of margins, these systems may levelize or reduce margins. Therefore, these systems will be greatly challenged when they try to retire late 1980s margins in the next 10-15 years with margins of equal size.

   * Over the next decade, as efforts are made to curb the growth in equity or possibly reduce equity, the shape of the accumulated capital credits line in the graph in Figure 2 will flatten. Gradually, our industry will be faced with retiring large margin years with...