CoBank's equity management is more complex than CHS's equity management because each year CoBank's Board of Directors makes a comprehensive evaluation of CoBank's need for capital before CoBank decides how much patronage earnings to allocate or how large of a cash patronage refund to pay from Its patronage earnings for the year just ended. CoBank's comprehensive evaluation includes an annual reconciliation of the amount of patronage earnings It will distribute with QNAs, and the amount of patronage earnings It will distribute with non-qualified written notices of allocation (NQNAs). Together, QNAs and NQNAs must equal 100% of patronage earnings (including the cash patronage refund of at least 20% in the case of QNAs)
In time and with practice CoBank can be expected to further reduce its annual expenditure for redemptions of QNAs to the amount needed to redeem the QNAs of members who (1) leave CoBank and obtain financing from other financial institutions, or (2) dissolve and are not acquired by or merged into other CoBank members. We can expect, therefore, that the amount CoBank redeems annually for QNAs is likely to continue falling below the $7.0 million it redeemed in 2009 (but some annual variation should still be expected).
Each year CoBank must make judgments between the amounts of equity that its members will provide with QNAs to meet CoBank's base capital requirements, and the amount of permanent equity that CoBank will provide with NQNAs to be redeemed only if CoBank dissolves. Members and patrons pay the cash patronage / income tax obligations on the QNAs. CoBank pays the income tax obligations on the NQNAs.
CoBank has done all that it can financially – not just for the year but for eternity - if in eight and one half months following the year when patronage earnings are generated CoBank distributes all of the excess cash it can afford to pay to members and patrons on a patronage basis. CoBank made a cash patronage distribution that approached 70% of allocated patronage earnings in 2009, nearly twice CHS's cash patronage refund. There is no reason to believe CoBank will have more cash available in subsequent years to redeem any more QNAs distributed from this year’s earnings. So each year, CoBank ties off equity redemptions and does not have to revisit them in the future.
That’s not to say, however, that CoBank cannot tweak and re-approach its equity management principles on a case by case or year to year basis.
In other words, if CoBank is wrong, if in subsequent years CoBank makes more patronage earnings and accumulates more capital than CoBank expected it would generate, CoBank can pay an even stronger cash refund to the members and patrons that contributed to CoBank's earnings that year. If CoBank is consistently wrong year after year, if, that is, CoBank is continually generating far more earnings and capital than it needs, CoBank could amend its bylaws, redeem some of the NQNAs, and distribute more patronage earnings with QNAs in the future.
Consequently, CoBank’s approach leaves open a number of variables that CoBank's Board can manage to maintain the value proposition and capital structure it seeks.
At the end of the day, CoBank's allocated equity obligation is tightly controlled and is being reduced to the maximum extent possible. Its allocated equity obligation increased by only 25% from the end of 2003 to the end of 2009. CoBank's 2009 equity redemption expenditure was the lowest in the last decade or more, even though its patronage earnings were one of its strongest on record. Hence, CoBank does not have a looming allocated equity obligation.
In contrast, CHS has a looming allocated equity obligation. CHS's allocated equity obligation more than doubled over the past six years, increasing from $1.0 billion to just over $2.3 billion. CHS redeems everything at the back end, leaving it for a future board to figure out how to redeem its allocated equity in twenty to fifty years, a point far enough into the future that the present CHS Board has no idea what the Co-op's economic and financial metrics will look like or whether redemption of that allocated equity will serve CHS's interests or not at that time.
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