Credit Union and Cooperative Patronage Refunds - Filene ...

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Figure 5: A Comparison of ACA Ratios FCA ratio* FCA minimum 81 ACAs Badgerland AgGeorgia Unnamed Permanent capital 7.00% 13.46% 12.70% 13.75% 16.20% Total surplus 7.00% 12.93% 12.40% 13.50% 16.00% Core surplus 3.50% 12.18% 12.40% 10.47% 16.00% *Standards imposed by the Farm Credit Administration, the regulatory arm that provides oversight to the Farm Credit System and individual institutions like Badgerland and AgGeorgia. the core surplus ratio the inclusion of any allocated equities that are scheduled or intended to be retired during the next three years. 29 Consequently, these regulations are a disincentive for associations to distribute earnings with allocated equity to their members. AgGeorgia Patronage Refunds AgGeorgia’s average annual net income was $24.5M over the past three years, and it has allocated and distributed 70% of that income ($15.1M with cash and QNAs) to members on the basis of patronage. AgGeorgia has distributed 33% of that distribution in cash, and the balance of earnings is retained as allocated equity. Because these earnings were distributed with QNAs, and because we assume the interest paid to AgGeorgia was deductible on the tax returns of its members, AgGeorgia’s members also report this patronage income on their tax returns. Only the cash patronage distribution from the Land Bank subsidiary is reported on the members’ tax returns, whereas the cash and noncash allocated equity distributions from the Production Credit Association subsidiary are reported on members’ tax returns. We assume that AgGeorgia’s board of directors and management has made a calculated decision that paying 33% of the distribution in cash is sufficient to at least pay the income taxes that most members will owe to federal and state governments on these patronage distributions. Recall that the interest payments that members make to AgGeorgia are likely to be tax deductible to the member as a business expense, so patronage income must be reported as taxable income as well. Because AgGeorgia distributes patronage refunds with QNAs that its members pay income tax on, AgGeorgia’s members undoubtedly have high expectations that AgGeorgia will redeem that equity sooner rather than later. Just under half of all of AgGeorgia’s total earned equity ($82.5M; see Figure 3, row 6) is allocated to members. AgGeorgia’s average annual redemption expenditure over the past three years was $13.3M. Hence, AgGeorgia could redeem all of its allocated equity in as little as seven years (see Figure 3, row 6 divided 35
y row 9). All in all, this is a very aggressive posture for a financial co-op. Significantly, AgGeorgia’s patronage refund philosophy is pressuring its capital position. As a percentage of its total loans, the cash that AgGeorgia pays to redeem allocated equity and its cash patronage refund (at 1.9%) is three to four times the average paid by other farm credit associations (.49%) or the 27 credit unions in Callahan’s study (.5%). Badgerland Patronage Refunds Badgerland’s average annual net income was $38.4M over the past three years (see Figure 3, row 3). Badgerland allocates and distributes only 14% of its income on a patronage basis, but its entire distribution is 100% cash; its average annual patronage refund is $5.5M. The balance of Badgerland’s earnings is not allocated, and hence it is used to build Badgerland’s unallocated equity. Because Badgerland does not distribute any earnings with allocated equity, all of its equity is unallocated (undivided) and its members do not expect that Badgerland will redeem equity to them (see Figure 3, rows 6 and 7). Approximately 40% of earnings is related to Badgerland’s nonexempt Production Credit Association and, therefore, exposed to corporate income tax. Badgerland’s members are in a stronger cash position than AgGeorgia’s members in the year they receive the cash patronage distribution from each association (see Figure 4, row 5) because whatever AgGeorgia’s members receive is paid to federal and state governments when AgGeorgia’s members pay their income taxes. In contrast, Badgerland members probably keep 67 cents of every dollar of patronage refund after they pay their income tax obligations from the 100% cash patronage refund they receive from Badgerland. However, AgGeorgia’s members fare better in the long run after the earnings distributed with QNAs are redeemed. The present value of AgGeorgia’s patronage distribution is stronger than Badgerland’s (see Figure 4, row 7) by a factor of more than three to one. Impact on Adequacy of Capital Position The patronage refund philosophies of AgGeorgia and Badgerland affect their compliance with FCA capital management guidelines. Because all of Badgerland’s equity is unallocated (except for the capital stock that members purchase when they borrow money; see Figure 3, row 5), the calculation of its core surplus ratio, which was 36
Page 1 and 2: Credit Union and Cooperative Patron
Page 3 and 4: Copyright © 2011 by Filene Researc
Page 5 and 6: Acknowledgments We appreciate and a
Page 7 and 8: List of Figures 1. Average of 27 Cr
Page 9 and 10: What Are the Credit Union Implicati
Page 11 and 12: Introduction There are many ways in
Page 13 and 14: to us is a philosophical gulf betwe
Page 15 and 16: CHAPTER 1 Patronage Refunds Are Mor
Page 17 and 18: activities with their credit union
Page 19 and 20: members standing on the basis of ow
Page 21 and 22: epayment, and/or if the asset is on
Page 23 and 24: If the co-op’s earnings are not d
Page 25 and 26: principles. When we discuss other c
Page 27 and 28: A recent post to the Filene Researc
Page 29 and 30: Our response to the blog post quest
Page 31 and 32: The subject of this chapter is a th
Page 33 and 34: CHAPTER 4 Tax Differences between C
Page 35 and 36: Figure 2: Contrast Statutes Governi
Page 37 and 38: Patronage earnings that are allocat
Page 39 and 40: When rural electric cooperatives ar
Page 41 and 42: CHAPTER 5 Use of Patronage Refunds
Page 43: Figure 4: Present Value of Patronag
Page 47 and 48: Badgerland, all of this association
Page 49 and 50: AgGeorgia’s members probably expe
Page 51 and 52: All three credit unions use their p
Page 53 and 54: The capital accumulated through ear
Page 55 and 56: As we visited with Hanson, it was d
Page 57 and 58: on share deposits is not a patronag
Page 59 and 60: Patronage Refunds: A Differentiator
Page 61 and 62: Figure 6: Potential Tax Effects of
Page 63 and 64: ather than later, particularly if t
Page 65 and 66: of the cooperative were deducting t
Page 67 and 68: Patronage Refunds and Capital M ana
Page 69 and 70: Appendix Exhibit A: 2007 Newsletter
Page 71 and 72: Due to careful planning and prudent
Page 73 and 74: Think of how much more you, and oth
Page 75 and 76: contrast, the 27 credit unions paid
Page 77 and 78: to redemptions. Think Diamond Walnu

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