Who can claim credit union net worth?

How can net worth be used to maximize member engagement and loyalty?

In our fourth issue of the Principle 6 Newsletter, republished below, Mike Mercer asks the question, “To whom does credit union net worth belong?” We hear three different takes on the issue—from a credit union member, a CFO and a “purpose-driven” CEO. The former President and CEO of Georgia Credit Union Affiliates and 2020 inductee to the Cooperative Hall of Fame leaves readers with a challenge:

At a time when the “traditional democratic elements of cooperative DNA are getting stretched,” cooperators “should be thinking about how net work can be used to maximize member engagement and loyalty,” he writes.

Read the full issue of Principle 6 Newsletter below. And while you’re thinking about “cooperation among cooperatives,” take a moment to consider how you and your cooperative practice this principle. NCBA CLUSA is on a mission to document Principle 6 collaborations across the country so we can identify trends, document best practices and share this knowledge with you—our fellow cooperators!

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Principle 6 Newsletter – Cooperation is Not Natural Behavior

Issue 4 – August 26, 2020

“…the books shall be closed and the pro rata distribution to the members shall be computed. The computation shall be based on the total amount in each share account as of the liquidation date…” – Excerpt, NCUA Rules for Voluntary Liquidation, Section 710.6

“When the cooperative business shows a net profit at the end of its fiscal year, the board decides what portion of the net profit is to be allocated and distributed to each member patron, and what portion remains the property of the cooperative as a whole.” – Cooperative Equity and Ownership, Margaret Lund, University of Wisconsin, April 2013

“We are looking for ways to strengthen engagement with our members. Among other things, we are thinking about the possibilities and implications of partitioning a portion of our retained earnings to give our best members a stronger sense of ownership and another way to benefit from the credit union’s success.” – Diana Dykstra, then CEO of SF Fire Credit Union, circa 2009

It’s easy. A credit union is a cooperative. The cooperative is owned by its members. Ergo, the credit union’s net worth belongs to the members. Case closed.

If not the members, then who (or whom… who knows proper English?)? If a credit union decides to voluntarily liquidate, the last step is to give what’s left (ie: net worth) pro-rata to the members. One doesn’t have to look for the rare occurrence of voluntary liquidation… consider a typical merger where the acquired (usually small) credit union has a high capital ratio. Often, the acquiring credit union agrees to return a portion of net worth to the members so that the merging capital ratios are roughly the same. Members own the credit union… the extra net worth belongs to them!

Obviously, most members aren’t aware or don’t believe that they really have a claim on their credit union’s net worth. If they did, they might rather liquidate their credit union (than merge). They’d conceivably get back their deposits and their cut of ALL the net worth. Then, the former members could likely just join the credit union that wanted to acquire them in the first place, or another with similar benefits.

The easier thing would be for members to insist that the board routinely return ‘excess’ net worth in the form of patronage refunds. A few credit unions use this practice on a proactive basis. While members view it as patronage (appreciation) for their business, the effect is the same… the net worth belongs to the members.

Nearly to a person, directors and management of credit unions (and most other cooperatives) contend that the net worth belongs to the institution as a practical matter. They rightly assert that net worth has been accumulated over many years, on the backs of several generations of members. Its purpose is to get the credit union through the tough times, support growth and finance investment. Net worth is hard to pile up and hard to keep, especially when recessions roll around. And, net worth is always related to total assets and, in recent years, to the riskiness of those assets. Rapid deposit growth relentlessly pulls that capital ratio down. And, regulators are never far.

With their small membership share account, the thinking goes, members obtain the right to use the credit union. They get to vote for the directors and they can expect to be treated with considerably more dignity than bank customers receive. Occasionally, they can even chew out a call center representative. But, they don’t get to think that the credit union’s net worth belongs to them in any tangible way. In fact, one of the reasons for consolidating control in a cooperative is to effectively isolate members from disruptive claims on the net worth.

Credit union leaders believe that they have a duty to protect the institution’s ownership (and sufficiency) of net worth. But most profess to run the business as though the members do have an interest in the net worth. ‘Treat members like they are owners’ is the admonition in new employee training sessions. The operating premise, however, is that the lower right-hand corner of the balance sheet belongs to the institution… and decisions about such will not happen outside the board room or C-Suite!

Two sides of the same coin. On one side, members own the credit union… all of it. On the other, the net worth is an essential/inseparable part of the institution. Here’s the deal… while the credit union is an ongoing concern, its leaders must build and protect net worth. If it ceases to be an ongoing concern through merger or conversion, then the members’ claim on net worth becomes paramount.

Today, in the U.S. credit union system, the federal government provides a tax incentive for building and maintaining strong net worth. From a public policy perspective, credit unions are expected to use this net worth to elevate the well-being of those being served beyond what would be the case in the for-profit (ie: taxable) world. Genuine benefits are expected, especially for those of proverbial ‘modest means.’ Public policy and safety and soundness are material incentives for building/keeping strong reserves.

All this said, the conceptualization of credit union net worth could be ripe for innovation.

At the moment, net worth is just a ledger entry on the books of the credit union… the difference between the accounting valuation of assets and liabilities. What if a portion of credit union net worth was partitioned among the members… updated annually based on a formula that identifies individual contribution to the positive margins generated by the credit union (net income)? Suppose that the final entries to close the books on December 31 would be updates to a subsidiary ledger of members’ “Participation Accounts” (or some other/better name).

A co-op centered leader would likely reflect back on Principle #3. In the words of the International Cooperative Alliance:

3) Member economic participation

Member economic participation is one of the defining features of co-operative societies, and constitutes the third Rochdale Principle in the ICA’s Statement on the Co-operative Identity. According to the ICA, co-operatives are enterprises in which “Members contribute equitably to, and democratically control, the capital of their co-operative. At least part of that capital is usually the common property of the co-operative. Members usually receive limited compensation, if any, on capital subscribed as a condition of membership. Members allocate surpluses for any or all of the following purposes: developing their co-operative, possibly by setting up reserves, part of which at least would be indivisible; benefiting members in proportion to their transactions with the co-operative; and supporting other activities approved by the membership.”

If a member was able to watch his or her Participation Account at the credit union grow over the years, there would likely be a stronger sense of commitment to use the services of their cooperative. In time, special benefits could accrue to those with Participation Accounts. And, perhaps Participation Account balances could be transferred to future generations… maybe even transferred to current generation members. In addition to direct benefits, members could come to view their Participation Accounts as contributing to the well-being of their brother and sister members, a key element of Co-op Principle #3… the idea that members consciously contribute to the well-being of the cooperative. Clearly, something like Participation Accounts would be helpful with differentiation from for-profit firms.

This idea is new to most credit unions, but the practice of attributing some or all of annual net income to members is a common practice among other co-ops. In fact, those that are subject to federal income tax routinely use patronage refunds and dividends as a way to manage tax liability, typically paying out a portion in cash (say 40%) to cover tax liability at the member level… the rest staying on the balance sheet in capital accounts. For credit unions, it may be possible to design an approach where all of the partitions would be non-cash allocations since constructive receipt would be deferred and undeterminable. Tax-deferred wealth accumulation!

There would be many issues to consider, likely some changes to laws and regulations would be required. The purpose here is not to engineer a prototype. Rather, it is to redirect the question of “to whom does the net worth belong?”

Instead, Thought Framers should be thinking about how net worth can be used to maximize member engagement and loyalty… at a time when the traditional democratic elements of cooperative DNA are getting stretched.

BTW, this Letter has been focused on retained capital. Paid-in (supplemental) capital, also of considerable importance to cooperatives, is a topic for another day.

Stay tuned,


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