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Deloitte strategies in cooperative financing and capitalisation


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Deloitte strategies in cooperative financing and capitalisation

  1. 1. Funding the futureEmerging strategies in cooperativefinancing and capitalization
  2. 2. Contents1 Executive summary4 Background6 The need for funds Impact of the financial crisis Shifting funding priorities Intensifying regulatory pressure Access to funding now a cooperative priority Cooperative structure challenges continue14 Sources of funds A diverse array of financing options Increased use of external funding sources International diversification of debt Consolidation as a capitalization strategy Application of cooperative principles to improve access to funding23 Successfully funding the future30 Appendix31 Key contacts32 EndnotesFunding the future: Evolving strategies in cooperative financing and capitalizationwas commissioned for the 2012 International Summit of Cooperatives, held inQuebec City from October 8-11. The study also demonstrates Deloitte’s commitmentto recognizing 2012 as the International Year of Cooperatives.
  3. 3. Executive summaryThe post-2008 economic crisis has negatively impacted the abilityof all commercial organizations to achieve adequate funding. Theunique structure of cooperatives further complicates this reality, andrequires a customized approach to overcome financing challenges.To understand whether cooperatives are facing the same issuesas the larger market; how their unique structure makes it easieror more difficult to achieve adequate funding and what they canlearn from their peers, CFOs and senior executives from the world’slargest cooperatives were asked how their organizations hadfared during the crisis, and how their financing and capitalizationstrategies were evolving to respond to new market realities. Funding the future 1
  4. 4. The survey provided clear evidence that The need for funds financing and capitalization are becoming • The impact of the crisis is real: 65% of respondents identified the global financial crisis as having a negative increasingly important for cooperatives, and impact on access to financing and capital, and 92% expressed concern about their ability to withstand another demonstrated that the cooperative structure financial crisis. places additional constraints on the types • Financing priorities are changing: Survey respondents forecast a distinct shift towards inorganic growth (from 22% of instruments and strategies that can be to 53%) and operational efficiency (from 17% to 43%) as major drivers of funding needs. employed. Despite this, the study found that • Regulatory pressure is intensifying: 75% of financial large cooperatives are gaining experience services respondents reported that Basel III/Solvency II will have a major impact on their business model, and 58% cited with external funding sources and innovative a high level of uncertainty around regulatory change. funding instruments, and view these as • Access to funding is a priority: 68% of respondents listed access to funding as one of the top three strategic critical to achieving their strategic objectives. priorities facing their organizations today. • Challenges related to the cooperative structure will This report focuses on two major areas – continue: The top three challenges to the cooperative funding model were identified as: the need for funds and sources of funds i Significant dependence on surplus and earnings (65%) ii Balancing the interests of an increasingly diverse – with each providing data on participants’ stakeholder group (65%) iii Limited ability to raise capital within the member base responses to questions and placing the (59%) information in a larger context.2 Funding the future
  5. 5. Sources of funds Successfully funding the future• A more diversified array of financing options To improve their access to capital, enhance risk management practices, has emerged: 50% of respondents forecast using and increase stakeholder engagement, cooperatives are encouraged to: non-traditional instruments to meet their financing and capitalization needs. • Review capital needs to ensure that sufficient funding is being raised in response to the evolving economic environment.• There is increased use of external funding sources: Only 35% of respondents are planning to use obligatory • Assess historical financing and capitalization strategies to determine member shares as an equity lever compared to 50% today. their suitability for meeting future capitalization needs. To compensate, cooperatives are expanding the use of other types of equity instruments. 53% are planning to • Update funding plans to ensure that the right mix of debt and issue equity instruments to external investors compared to equity; the right classes of equity; and the right mix of internal and 38% today. external investors are being pursued to satisfy capital needs and manage risk.• Debt is being diversified internationally: Funding via international debt markets is forecast to grow from • Expand the range of financing tools to diversify sources of capital 24% to 53%. and accomplish capitalization plans.• Consolidation is being employed as a capitalization • Educate members and investors on the implications of internal strategy: More than one-third of all respondents expect versus external funding strategies, and help external investors better to use mergers and acquisitions as a tool for meeting their understand and appreciate the unique elements of investing in a funding needs. cooperative.• Cooperative principles are being used to improve • Engage regulators to ensure that the unique structures of access to funding: Recommitting to cooperative principles cooperatives are reflected in new legislation and regulations. such as a longer-term strategic and operational focus, member economic participation; and collaboration among • Strengthen governance processes by ensuring that the board cooperatives were identified as value-added approaches to offers the required competencies, experiences and perspectives with solving a cooperative’s capitalization needs. respect to cooperative strategy, risk profile and operations. Funding the future 3
  6. 6. Background The crisis of capital A significant amount of research has been conducted One of the most significant casualties of the economic in recent years examining cooperative funding from crisis that has gripped the world’s markets for the last a theoretical standpoint, with limited feedback from five years has been ready access to sufficient capital and cooperatives themselves. financing. Organizations of all sizes, all industries and all geographies have been impacted. In a recent survey of • Are cooperatives facing the same financing and North American CEOs, for example, nearly half mentioned capitalization challenges as the wider market? either U.S. or global economic conditions as their most concerning risk, particularly in the Eurozone. • How does the unique structure of a cooperative make it easier or more difficult to achieve adequate Capital scarcity is the result of reduced availability capitalization? from conventional sources and increased need due to a challenging business climate and new regulatory • How can cooperatives learn from their peers in order requirements. Cooperative organizations have not been to optimize their strategies for securing capital? immune to these issues, and face competition from aggressive organizations with increasingly sophisticated Taking the cooperative pulse social agendas. They must build scale and invest in their To answer these questions, Deloitte conducted a global businesses to compete, but their unique structure requires cooperative financing and capitalization survey in the a customized approach to meeting funding needs. summer of 2012, the first of its kind since the 2008 crisis. CFOs or delegates from 36 cooperatives, including some of the world’s largest, were asked how their organizations had fared during the financial crisis, and how their When facing the need financing and capitalization strategies are evolving to respond to new market realities. Responses were received for increased capital in a from four continents and four main industry sectors: agriculture/forestry, banking, insurance and consumer/ competitive and uncertain retail. economic environment, the Survey findings were supplemented with experience gained serving clients in the cooperative and non- cooperative business model has cooperative sectors; interviews of cooperative leaders from around the world; and with complementary peer emerged as both a strategic research. The findings are consolidated in a series of recommendations for cooperatives to optimize their advantage and a challenge. funding strategies.4 Funding the future
  7. 7. What cooperatives told us68%listed access to funding as a priority today 87% anticipate difficulty in accessing financing and capital in the future 75% report Basel III/Solvency II will have a major impact on their business model 53% forecast shift towards inorganic growth in driving the need for capital 43% forecast shift towards operational efficiency in driving the need for capital 50% expect to use non-traditional instruments to meet their financing needs 63% expect collaboration to be an important funding strategy for the future Funding the future 5
  8. 8. The need for funds With over a billion members worldwide, cooperatives play an important role in the global economy. Driven largely by the needs of their membership, they are different from investor-owned corporations in many regards. However, cooperatives increasingly compete with investor-owned corporations in terms of both operations and access to sources of funding. The cooperative business model, while offering the advantages of access to member financing and often impressive customer loyalty, introduces a number of challenges in an uncertain, highly-regulated economic environment. Cooperatives must be true to their mission as they seek to achieve the greater financial flexibility needed to drive growth and compete successfully.6 Funding the future
  9. 9. The global survey confirmed that the financial crisis has In the financial services sector, 27% also reported thataffected cooperative organizations around the world, the financial crisis had a significant negative impact onand provides valuable insight into how regulatory and availability and access to capital. Only 8% of non-financialcompetitive pressures are increasing the need for adequate services cooperatives felt this way, with many (58%) citingfunding while complicating its acquisition. “some” negative impact on the availability and access to financing and capital.The impact of the financial crisisThe 2008 economic crisis has had a profound impact Survey respondents indicated anxiety about their ability toon cooperatives. As expected, the effect was most manage another financial crisis. The concern is especiallypronounced in the financial services (FS) sector, with 63% prevalent in the capital-intensive agriculture sector andin this group reporting “significant or some” negative the financial markets-dependent banking and insuranceimpact on business performance. In the non-financial sectors, where 100% of financial services cooperativessector (non-FS), although no cooperatives reported a indicated they are “somewhat to very” concerned.significant negative impact, 57% did report that it had Similarly, 93% of agricultural cooperatives surveyed“some” negative impact on their business performance. indicated this level of concern about their organization’s ability to withstand a situation similar to 2008.2008 Global financial crisis Impact on business performance Impact on access to funding Significant negative impact 27% 27% 8% Some negative impact 36% 36% 57% 58% No impact 28% 28% 43% 26% Some positive impact 8% Significant positive impact 9% 9% Financial services Non-financial services57%report negative impact of the 2008 financial 66% report negative impact of the 2008 financialcrisis on business performance crisis on access to funding Funding the future 7
  10. 10. Shifting funding priorities External research and survey responses confirm that The global financial crisis experience is impacting the growth presents unique challenges for cooperatives. way cooperatives deploy funding. As with the broader Cooperatives often operate in mature industries with economy, cooperatives reported that their pre-crisis funding defined geographies and specific mandates; many have activities were conducted primarily to satisfy organic formal or informal restrictions on entering neighbouring growth and infrastructure needs. Looking forward, there territories. A growth strategy can also be difficult to is a distinct shift towards inorganic growth (from 22% to communicate and implement in the cooperative context, 53%) and operational efficiency (from 17% to 43%). particularly where the benefits to existing members are not clear or where members perceive the strategy as diverting Within the financial services sector, growth and efficiency resources available for distributions or reinvestment are also important considerations, but these organizations in other priority activities. In certain circumstances, forecast a greater need than the “all cooperatives” group democratic decision-making process may engender a to respond to capital-related regulatory requirements and level of risk-aversion that makes a growth strategy less external rating and market expectations. attractive. Increased focus on inorganic growth Further complicating the pursuit of inorganic growth is Among the cooperatives surveyed, organic growth and the fact that many cooperatives are structurally unable inorganic growth are cited as the top factors driving to issue additional common equity,1 and must therefore the need for funding. The cooperative sector focus on fund acquisitions and other expansion projects through growth is consistent with the larger market; it is generally debt and/or liquid assets. The success of a cooperative in accepted that creating and maintaining economies of managing this and other challenges will impact its growth scale is of renewed importance to cost competitiveness. strategies. As cooperatives compete with non-cooperatives in most markets, they are consequently feeling pressured to remain competitive by acquiring scale. Key factors driving the need for capital All cooperatives Financial services cooperatives 45% 40% Organic growth 52% 40% 22% 10% Inorganic growth 53% 40% Investments in 32% infrastructure 42% 30% Investments in 17% operational efficiency 43% 40% Respond to capital-related 10% 10% regulatory requirements 14% 30% Respond to external rating/ 13% 20% Market expectations 27% 50% Pre-2008 Forecast8 Funding the future
  11. 11. Investing to improve operational efficiency opportunities for increased efficiency in these networks.Investing in technology and infrastructure to improve This need will likely escalate as mobile banking, contactlessefficiency and meet member and customer expectations payments and integrated cash management become tablehas been identified as another important driver of the stakes, prompting credit unions to invest significantly ifincreased need for funding. 66% of all cooperatives they are to remain competitive with the leading banks.2surveyed rated investment in technology and 61% ratedinvestments in infrastructure as having a medium to high Intensifying regulatory pressuredegree of importance today. One of the most far-reaching responses to the global financial crisis has been the move by multiple jurisdictionsWhile cooperatives and non-cooperatives both view to increase regulatory oversight of market activities,investments in technology and infrastructure as critical particularly in the financial services improving productivity, remaining competitive andgrowing operating margins, the nature of cooperatives Many new regulations do not take into account thecan translate to additional pressure in this regard. Financial unique structure of cooperatives, creating additional andcooperatives, for example, have historically maintained often unnecessary burdens on these organizations. Atextensive branch networks to support strong links to their best, these regulations fail to improve a cooperative’s riskmembers and communities. In our survey, a European profile; at worst, they serve to limit its strategic services cooperative reported the need to exploreDrivers of capital needs Organic growth Inorganic growth 29% 44% Pre-2008 26% 34% 45% 22% 26% 25% Current 22% 41% 52% 34% 16% 22% Forecasted (next 3-5 years) 32% 25% 52% 53% Low Medium High Investment in technology Investment in infrastructure 50% 45% Pre-2008 33% 23% 17% 32% 33% 39% Current 33% 26% 33% 35% 33% 39% Forecasted (next 3-5 years) 24% 19% 43% 42% Low Medium High Importance Funding the future 9
  12. 12. Basel III and Solvency II features will impact external investor perception of their 75% of financial services cooperatives surveyed for capital strength and negatively impact the treatment of the study are working towards Basel III (global capital these instruments for regulatory capital purposes. Adding adequacy standards) and Solvency II (EU insurance to this concern is a lack of clarity on how cooperative- regulation) compliance. In this subset, 75% identified specific accounting treatments will be managed under the impact of these regulations on business model and IFRS. 70% of respondents indicated a “somewhat to strategy as a key concern, with 58% citing uncertainty strong” need for additional guidance and clarification on related to the application of the final regulatory the implementation and impact of IFRS. frameworks to cooperatives. Cooperatives surveyed indicated the need for additional guidance or a Access to funding now a cooperative priority cooperative-specific set of regulations, with 55% saying Survey respondents confirmed that access to funding has that it is “required or strongly required” and a further 18% become more complicated in the aftermath of the 2008 responded that it is “somewhat required.” global financial crisis. Consequently, survey respondents reported an increased level of vigilance relating to IFRS maintaining sufficient access to liquidity and capital. For While the move to IFRS (International Financial Reporting many cooperatives, access to funding is expected to be an Standards) potentially impacts all cooperatives, compliance increasingly high-priority issue, moving from 50% pre-crisis is a particularly critical issue for the financial services to 68% today and 77% in the future. sector. Among cooperatives surveyed for the study, 68% are working towards IFRS compliance. Major concerns The financial services cooperatives surveyed are already include increased volatility in results, and additional cost, placing greater importance on access to funding. While effort and risk associated with models required to derive a slightly larger percentage of this group (56%) ranked fair value information. Cooperatives are also concerned access to capital before the financial crisis as a high that the classification of cooperative member shares as priority, 78% identify it as such in the current environment. liabilities rather than equity due to their share redemption Key concerns with Basel III/Solvency II regulations Key concerns with IFRS standards Financial services cooperatives All cooperatives Impact on business 8% 43% Requirement for fair model and strategy 17% 7% value accounting 75% 50% Level of uncertainty 8% 34% Classification of cooperative related to their application 33% 25% member shares – as liabilities to cooperatives 58% 41% 17% 52% Accounting for Liquidity risk framework 33% 21% distributions/patronage 50% 27% Investments required 25% Complexity of defined benefit 58% in information systems 25% pension plan accounting 15% 50% 27% Meeting leverage ratios, 25% 84% liquidity ratios and capital levels 25% Accounting for mergers 8% 50% 8% Low Medium High Low Medium High10 Funding the future
  13. 13. Not only is accumulation of funding a high priority for in the last quarter of 2011. Since then, Moody’s decisioncooperatives, it is a difficult process, made so by the general to put 114 European banks and eight non-European banksissues of economic uncertainty and increased regulations as on negative watch in 2012 is expected to affect interbankwell as the restrictions imposed by the cooperative model lending, and eventually increase the cost of funding foron the issuance of equity. Of all cooperatives surveyed, 87% borrowers.3 This decision will also constrain the availabilityexpect that accessing sources of capital other than retained of funding for a number of organizations as banks becomeearnings will become “somewhat to very difficult.” This is increasingly selective about the recipients of their financing.significantly higher than the 45% calling it “somewhat tovery difficult” pre-crisis, and the 68% citing it as such today. It is therefore not surprising that cooperatives today are especially concerned about their ability to meet liquidityLiquidity concerns affect lending decisions needs. 26% noted that before the 2008 crisis, it wasSince the global financial crisis, fluctuations in global “somewhat to very difficult” to meet liquidity needs.liquidity have had a major impact on financial stability and Today, 32% of cooperatives feel this way, and 74% expecteconomic growth. As the sovereign debt crisis spreads from to experience difficulty in the future.Portugal, Italy, Ireland, Greece and Spain to core Eurozonecountries, the possibility of a second credit crunch continuesto temper equity markets and impact market liquidity andcredit spreads. European banks’ risk aversion in such anenvironment, coupled with increased capital requirementsowing to Basel III reforms, created tight liquidity conditionsAccess to capital as a priority Difficulty in accessing capital All cooperatives Financial services cooperatives All cooperativesNot a priority/ 27% 33% 55% 6% 11% Not difficult 32% Low 3% 13% 23% 11% Somewhat difficult/ 35% Neutral 26% 11% 58% Difficult 20% 22% 74% Top 3/High 50% 56% Very difficult/ 10% 68% 78% 10% priority Top 3 challenges 77% 78% 13% Pre-2008 Current Forecast Funding the future 11
  14. 14. Cooperative structure challenges continue Balancing funding requirements with stakeholder Opinion was divided on how the cooperative business interests model impacts its ability to raise capital. Although almost 73% of the survey’s non-financial services respondents half (48%) of all respondents felt that a cooperative’s agreed that balancing a cooperative’s financing and capital structure and restrictions are not a competitive capitalization requirements with interests of various disadvantage, 59% felt they had limited ability to raise stakeholders is a challenge. One of the cooperatives funds within their membership base. interviewed mentioned that achieving alignment between management and members on strategic priorities can As cooperatives are often funded primarily through be an issue, especially as it relates to inorganic growth. obligatory member capital (on which members do Members may see expansion as a risky endeavour not expect a rate of return), and debt (where interest and hesitate to support related investments, while payments can be tax deductible), they typically enjoy a management could view growth as a necessary response lower cost of capital. Not surprisingly, only 30% of all to a competitive marketplace. respondents felt they had an intrinsically higher cost of funds than their non-cooperative competitors. Although the overlap between the constituencies in a cooperative – with members being owners, but also Ownership structure limits access to equity clients, suppliers and employees – could serve to simplify The ownership structure of a cooperative results in limited decision-making when interests align, it can complicate sources of traditional equity capital. Cooperatives do not issues when they do not. The balancing act becomes typically issue common equity shares to external investors, as further complicated when external investors with differing ownership and control must reside within the membership investment objectives are introduced to the mix. base. As a result, cooperatives have historically relied significantly on retained earnings to fund growth, which limits Robust governance required the rate of capital accumulation and the ability to grow.4 The decision to pursue innovative financing options requires added oversight and risk management Although 62% of respondents in the non-financial services capabilities. However, external research on the topic sector felt they had limited ability to raise capital within concludes that cooperatives vary widely in the robustness the member base, ranking it the top challenge, financial of their governance structures. While the one member/one services cooperatives did not identify this particular factor vote principle enabled cooperatives to better withstand as a challenge. Differing perceptions may be due to the the financial crisis through risk aversion, consideration global financial crisis, but could also be structural – a large should be taken to prevent an overly conservative and/or agri-foods respondent indicated that the preference of insufficiently rigorous approach to risk management.5, 6 agricultural cooperative members is to limit investment in the cooperative to their trade commitment. Top 3 challenges linked to cooperative capital structure Non-financial services Financial services cooperatives 33% 17% Significant dependence Limited ability to raise capital 5% is placed on internally 16% within the members base generated equity 62% 67% 45% Accounting standards and/or 33% Significant dependence regulatory capital requirements is placed on internally 10% 17% are putting cooperatives at a generated equity 45% competitive disadvantage 50% 27% Cooperative capital 33% Need to balance interests structure characteristics and 37% 33% of various stakeholders restricitions are a source of 36% competivie disadvantage 33% Low Medium High Low Medium High12 Funding the future
  15. 15. Top 10 shifts in attitude pre-crisis versus forecastThe table below presents the “Top 10” issues where the cooperative perspective, as provided bysurvey responses, has shifted most significantly before and after the global financial crisis (GFC). Change from Topic pre-crisis to forecast Details 26% of the cooperatives noted that it was “somewhat Meeting liquidity needs + 48% 4 difficult” to meet their liquidity needs pre-GFC. This number shot up to 74% for the future. Only 35% of the cooperatives felt it was “somewhat Difficulty accessing sources of capital + 39% 4 difficult” to access sources of capital pre-GFC, while 74% expect this to be “somewhat difficult” in the future. Organizations placing high importance on inorganic growth Inorganic growth + 31% 4 grew from 22% pre-GFC to 53% in the future. Prioritization of The prioritization of access to capital as “high” increased access to capital + 27% 4 from 50% pre-GFC to 77% for the future. Importance of investing in operational efficiency grew from Operational efficiency + 26% 4 17% pre-GFC to 43% in the future. The perceived importance of developing new financing New financing markets + 30% 4 markets grew from 23% pre-GFC to 53% in the future. Employment of international debt markets grew from International debt markets + 30% 4 23% pre-GFC, to 53% in the future. “High” support for issuing new types of financing and New types of financing & capitalization instruments + 24% 4 capitalization instruments grew from 26% pre-GFC to 50% in the future. External, non-member Perceived importance of issuing equity to external, investors + 20% 4 non-member investors grew from 20% to 40%. Support for collaboration with other organizations Collaboration with other organizations + 16% 4 (including cooperatives and non-cooperatives) grew from 47% to 63%.Although the overlap between the constituencies in a cooperative– with members being owners, but also clients, suppliers andemployees – could serve to simplify decision-making when interestsalign, it can complicate issues when they do not. The balancing actbecomes further complicated when external investors with differinginvestment objectives are introduced to the mix. Funding the future 13
  16. 16. Sources of funds As cooperative organizations seek to satisfy their increased need for capital, they are exploring a variety of new options. This section highlights some of the advantages of the cooperative model as it relates to financing and capitalization; outlines conventional and emerging options available to cooperatives; and presents examples of how cooperatives are finding innovative solutions to their funding needs.14 Funding the future
  17. 17. A diverse array of financing options New funding optionsOrganizations generally have four options for financing Merger with another 19%new growth and operational investments: operating organization (cooperative or non-cooperative) 38%capital (e.g. retained earnings); debt (e.g. bank loans,issuance of debt instruments, securitization); equity; Equity issuance to external, 20% non-member investor 40%and hybrid debt/equity instruments (e.g. convertible Issuance of new typesbond offerings). Cooperatives have historically focused of financing and 26% capitalization instruments 50%on funds from operations and debt or equity from theirmember base. However, as the survey responses indicate, Development of new 23% financing marketscooperatives are now looking beyond traditional financing 53% (e.g. internationally)approaches to improve their capital positions and enable 47% Use of cross-guaranteesgrowth. 56% Collaboration with 47%Many are identifying new financing markets and issuing other organizations 63%new types of financing instruments. They are evaluating Debt issuance to external, 55%the issuance of equity to external, non-member investors, non-member investors 74%and collaborating with other organizations – bothcooperative and non-cooperative – at higher rates. Pre-2008 ForecastRather than relying solely on bank debt, the percentageof cooperatives seeking to issue debt to external, non-member investors jumped from 55% pre-crisis to aforecast level of 74%.Expanded equity options Comparison: Utilization of top equity leversMany cooperatives depend on retained earnings as the 88%primary source of equity financing. Obligatory member Retained earnings 91%shares are another key source, particularly when the 94%minimum investment is greater than a nominal amount. Member financed: 53%However, survey respondents indicated that obligatory Issuance of obligatory 50% cooperative member shares 35%member shares, historically the most common source ofcapital after retained earnings, will decline in significance. Member financed: 35% Issuance of non-obligatory 35%Only 35% expect to use these as a top equity lever membership capital 45%compared to 53% before the crisis. Cooperatives 48%decreasing their reliance on obligatory membership capital External investors: Issuance 38% of equity instrumentsare expanding the use of non-obligatory member capital 53%and capital from external investors. Historical Current Forecast Funding the future 15
  18. 18. Cooperative equity and debt instrument options (non-exhaustive) The table below identifies potential cooperative debt and equity instruments for quick reference. Instrument name Description • Acquired by members as condition of membership Conventional (obligatory) • Issued and redeemed at nominal value cooperative membership • Typically adheres to one member-one vote principal shares • Earns return in the form of patronage and other dividends • Generally considered Tier 1 capital as long as redeemable under limited circumstances • Issued exclusively to members • Redeemed at nominal or market value Preferred shares and • Typically non-voting certificates – members • Earn priority interest • Perpetual, non-cumulative type generally categorized as Tier 1 • Acquired by third-party investors that are not members of the cooperative and may not use its services Preferred shares – non- • Redeemed at nominal or market value members • Could include voting rights • Priority right to earnings • Perpetual, non-cumulative type generally categorized as Tier 1 • Transfer of assets to an investor-owned firm in exchange for stock • Listing of minority portion of cooperative shares or shares of some entities on a regulated Tradable cooperative market shares and investment • Traded at market value certificates • Could be voting or non-voting • Earn return through dividends • Generally constitutes Tier 1 capital • Could be issued to members and non-members • Redeemed at nominal or market value Senior debt issuance • Non-voting, unless hybrid • Earn return through interest which could be floating or fixed • Loans (or securities) that rank below other loans (or securities) with regards to claims on assets or earnings Subordinated debt • Typically issued to outside investors by large organizations issuance • Non-voting • Fixed or floating interest rate • Debt instruments secured by a pool of assets, such as mortgages or loans, held by special Covered bonds (FS) purpose vehicle (SPV) that guarantees repayment of the covered bonds in case of default by the issuer • Process through which an issuer creates a financial instrument by pooling other financial Securitization (FS) assets (e.g. mortgages) and then markets different tiers of cash flows relating to the repackaged instruments to investors16 Funding the future
  19. 19. % of respondents Currently issuing Forecast Remarks50% 20% 43% • Primary motive of the acquirer is to conduct businessFS and non-FS FS non-FS with the cooperative rather than get financial returns • Enable cooperatives to raise discretionary equity70% 19% 40% 48% • Could be issued directly by the cooperative or by aFS non-FS FS non-FS separate legal entity40% 36% 60% 50% • Enables the cooperative to bolster its equity positionFS non-FS FS non-FS80% 60% 89% 70%FS non-FS FS non-FS50% 34% • Could help with bank’s liquidity position but does notFS up from 17% pre GFC FS reduce leverage ratios • Drop in usage mainly due to significant contraction in33% 33% securitization markets following the global financial crisisFS down from 50% pre-GFC FS rather than the cooperatives choosing not to access this market Funding the future 17
  20. 20. Outlined below are some examples of how cooperatives Issuance of preferred shares/certificates have diversified their funding sources by using non- to members traditional types of financing instruments. Member certificates are non-obligatory instruments that allow members to increase their investment in the Issuance of conventional cooperative cooperative. The certificates can have a fixed maturity date membership shares or can be perpetual in nature. They earn a set percent Membership equity shares, typically issued to establish annual dividend that is discretionary, but must be paid the ownership interest of members, are usually one of the before surplus payments to members. Certificates can be cheapest sources of financing as members do not expect a cumulative, meaning that if the dividend is not declared market rate of return. Membership equity shares generally one year, it will accumulate with the following year’s enforce a one member/one vote ownership structure. In dividend, or they can be non-cumulative. some jurisdictions, legislation allows cooperatives, when required, to make mandatory assessments for long-term Issuance of preferred shares/certificates membership shares that do not give additional voting to non-members rights but pay small dividends.7 As noted above, surveyed Similar to certificates issued to members, those issued to cooperatives are decreasing their reliance on obligatory non-members are uninsured, perpetual, non-cumulative cooperative member shares and increasing the use of and carry no voting rights. Rabobank issues hybrid capital other types of equity levers. (similar to certificates) via a trust to outside, non-member investors in exchange for a defined rate of return based Membership equity shares in a financial services on prevailing government bond rates. Investors in this cooperative have been generally considered Tier 1 capital type of instrument do not have the right to convert their for Basel requirements as long as they are redeemable securities to ownership shares in Rabobank, and hold no under limited circumstances, and the redemption does voting rights. Another example is CHS, a leading U.S. not reduce capital below a fixed level. Redemption of cooperative owned by farmers, ranchers and other coops. membership equity shares usually requires board approval. Since 2003, CHS has issued non-voting preferred shares to outside investors that can be traded on NASDAQ. The Another closely aligned category is patronage equity shares entitle the owner to receive an 8% dividend on the shares. These are investment shares issued in lieu of par value of the shares.9 patronage dividends, and are themselves eligible for dividends. The individual caisses (credit unions) of For smaller cooperatives, an investment pool is a useful Canada’s Desjardins Group give their members the approach. As part of an experiment in 2006, twenty-one option to receive surplus dividends as membership Australian credit unions created a purpose-built entity to certificates instead of cash. The membership certificates issue preferred shares to institutional investors and offered are non-voting, but give the holder the right to an returns based on a spread over BBSW (Australian financial interest rate voted on by the members and conditional markets reference rate). The credit unions provided the on the caisse generating a surplus. Another example is a entity with a loan reserve equal to 10% of the aggregate North American dairy cooperative that grew to over face value of the issuance. Given that the credit unions $3B in revenues relying significantly on member capital; had no history in this type of instrument and therefore no its current capital structure includes over $500M in track record of payment, the reserve provided additional investment shares.8 The cooperative’s patronage shares comfort to the market with respect to the preferred are eligible for dividends and can be transferred among shares.10 members.18 Funding the future
  21. 21. Issuance of tradable cooperative shares and respondent noted that they established a secondaryinvestment certificates market to enable trading of membership certificates,Tradable cooperative shares and investment certificates which were required to be non-redeemable in orderrequire the cooperative to transfer all assets to an investor- to qualify as Tier 1 capital. To allow holders of theseowned firm in exchange for stock. A minority portion certificates to opt out and to eliminate the need for aof the stock is then sold on the stock exchange to raise liquidity premium, the cooperative trades membershipcapital directly from outside investors. Cooperatives retain certificates quarterly at a market value derived from bidscontrol of the organization by holding the majority of and offers received through the quarter.outstanding stock while accessing outside capital. As anexample, Crédit Agricole S.A, listed on the Euronext Setting up a secondary market requires a significant effort(Paris) was created to represent all of the Group’s business and ongoing administration. Cooperatives must determinelines and components. As of December 2011, 56.2% of eligible instruments (e.g. membership shares, preferredCrédit Agricole S.A was owned by the regional banks that shares or common shares); establish a system to processmake up the Federation of Crédit Agricole, and 38.7% orders; decide on the frequency; set up a clearing housewas owned by institutional and individual investors.11 to match buyers and sellers and update records (oftenDanish Crown, a Danish food processing company and outsourced); and determine the share valuation.Europe’s largest pork producer, voted in October 2010 toform a limited company wholly owned by the cooperativefor the purpose of opening up external investor financingoptions over the long term.12Deployment of secondary markets to enabletrading of cooperative instruments 35%Secondary markets, such as a regulated stock exchange,allow investors to purchase cooperative securities fromother investors rather than directly from the issuingcompany. Secondary markets enable the trading of expect to rely on obligatory cooperativecooperative capital, thus providing liquidity to membersand investors. A secondary market for cooperative capital member share, declining from 53% pre-crisisinstruments such as preferred shares/member certificateswould make these instruments more attractive to bothmembers and external investors. While only 9% of non-financial services respondents provide secondary markets 74%for their investors, 25% of financial services firms currentlydo so. This is partly driven by regulatory requirementsfor Tier 1 capital. One European financial services Forecast to issue debt to external non-member investors, a jump from 55% pre-crisis Funding the future 19
  22. 22. Expanded use of debt instruments Issuance of subordinated debt to non-members Credit lines and loan facilities are expected to remain Subordinated debt is typically issued to outside investors the top debt lever used by the cooperative sector. with a defined long-term maturity. It is non-voting with Among cooperatives surveyed, 94% currently use a fixed or floating interest rate. In most cases, only large these instruments, and 91% expect to use them in the organizations are able to generate sufficient scale to issue upcoming three to five years. However, over-reliance on stand-alone subordinated debt. However, similar to trust bank loans can be problematic in light of regulations such preferred shares, an investment pool approach can be as Dodd Frank and Basel III. These regulations decrease used for smaller organizations. leverage ratios and increase reserve requirements for banks, reducing the amount of capital that they are Of the cooperatives surveyed, 74% are expecting to willing to put at risk and increasing the cost of debt for issue debt to external, non-member investors. This is borrowers. This de-leveraging threatens to decrease the especially true in the agricultural sector and in North availability of loans for non-cooperatives and cooperatives America. The benefits of issuing long-term debt include alike, and further bolsters the case for increased debt longer maturities than bank loans, which increases diversification.13 Surveyed cooperatives are considering flexibility for CFOs, and an opportunity to diversify the issuing more non-loan debt and hybrid instruments in the investor base. For example, Canada’s Desjardin Group future – 75% and 22% respectively compared to 67% and issued a significant amount of subordinate debentures 14% today. on the American capital markets via Capital Desjardins,14 a wholly-owned purpose-built subsidiary. The proceeds were then invested in subordinated notes issued by Utilization of top debt levers (historic vs forecast) Desjardin’s member caisses, effectively allowing them to 81% raise financing when needed. Rather than going through Short-term borrowing 84% the process individually, the member caisses deal with 70% Desjardins Capital which issues on a consolidated basis. 94% Desjardins Capital’s short form base prospectus allows Credit lines and loan facilities 94% it to issue senior notes and Class C preferred shares.15 91% Similarly, some of the agricultural cooperatives in 73% France that previously relied solely on bank debt have Debt issuance 67% started accessing bond markets, and many are analyzing 75% this option. 10% Other hybrid 14% Expanded use of cross guarantees instruments 22% Cooperatives are projected to increase the deployment of legally-binding cross guarantees to connect different Historical Current Forecast entities of the group as a risk management tool. In a cross guarantee arrangement, individual entities are liable for each other’s obligations. Rating agencies tend to view Issuance of senior debt to members this type of arrangement as less risky since the entire Senior debt issued to members typically has a defined organization is viewed as a single consolidated risk unit. long-term maturity and a fixed or a floating interest Liquidity management is performed by a central function rate. Rabobank has successfully issued senior debt to its for the collective. Survey respondents forecast an increase members who value both the attractive rate of return and in cross guarantee arrangements from 47% pre-crisis to the opportunity to contribute to the financing of their 56% in the future. cooperative.20 Funding the future
  23. 23. Increased use of external funding sourcesAn underlying theme of the move to more innovative Making the cooperative attractive to memberfinancing instruments is the employment of external and non-member investorsfunding sources. This trend is expected to continue as As cooperatives move away from obligatorycooperatives grow in size and the complexity of their membership capital towards non-obligatory sources,capital needs increase. Cooperatives who embrace this they must strive to make the cooperative an attractivestrategy must also ensure that their debt and equity investment for member and non-member investors.issuances are presented in a market-friendly manner – As an executive of a European food cooperativeparticularly to investors unfamiliar with the cooperative noted, the usual debate within the cooperativemodel – or they risk creating tension between internal and sector is whether external investors should beexternal stakeholders with different strategic priorities. allowed to invest in a cooperative, but another important question is whether investors would wantInternational diversification of debt to invest. This respondent’s cooperative has activelyThere is a clear trend towards cooperatives crossing engaged external investors by building a track recordnational borders in search of capital. Large cooperatives of performance and investing in branding andin particular are becoming comfortable issuing debt in technology to stay competitive with non-cooperatives.foreign-denominated currencies. While this may reflect theemergence of multinational cooperatives and customers, Engaging with investors and rating agenciesinternational debt issuance is increasingly being used to Building relationships with investors and lenders willsupport funding strategies such as currency hedging, support a cooperative’s ability to access financingdiversification of the investor base, interest rate exposure at competitive rates. The relationship with ratingand access to lending markets. Prior to 2008, only agencies is especially important for cooperatives23% of respondents reported accessing international primarily financing themselves through debt, or fordebt markets. That number is forecast to be 53% of all those seeking to issue debt in the future. Keepingsurveyed cooperatives and 65% of those in the non- investors and rating agencies educated and updatedfinancial services sector. through regular communication and discussions in the form of meetings, presentations, roadshows and results calls can enhance this relationship.Use of international debt markets All cooperatives Non-financial services cooperatives 77% 85% Never 76% 74% 47% 35% 10% 10% Rarely/Occasionally 17% 26% 23% 35% 13% 5% Fairly often/Frequently 7% 0% 30% 30% Pre-2008 crisis Current Forecast Funding the future 21
  24. 24. Consolidation as a capitalization strategy exhibit or emphasize a stronger sense of purpose and Consolidation is not a new concept for the cooperative a firmer focus on their longer-term strategy than non- sector. Scale is a strategic imperative for many industries, cooperative businesses. This can prevent over-reacting to and inorganic growth can be an effective tool. As an short-term issues and opportunities. For example, while example, the number of credit unions in Canada dropped European cooperative banks have a 21% market share, from 3,700 to 370 between 1966 and 2012, while they only accounted for 7% of all the European banking at the same time, the percentage of Canadians who industry’s write-downs and losses between the third were members of a cooperative more than doubled. As quarter of 2007 and the first quarter of 2011.18 economies of scale can improve access to funding and lower the cost of funds, financing and capitalization The longer-term focus may translate to less volatile pressures are projected to accelerate the consolidation earnings and greater risk aversion, as member-owners process. generally rank quality of service over return on investment. While not specifically asked in the survey, multiple studies As noted previously, inorganic growth was cited by survey have found that the risk-averse nature of cooperatives was respondents as a major driver of capital requirements. a factor in their ability to better withstand the 2008 global While some level of consolidation will be achieved through financial crisis.19, 20 However, as discussed earlier, a focus the purchase of non-cooperative entities, unleveraged on risk aversion can be more successful when balanced mergers of cooperatives is a more obvious method of with exploration of innovative funding strategies. strengthening a balance sheet and building a platform for growth. The ongoing merger of cooperative banks in the Member economic participation Philippines into a single viable entity is one example of Member economic participation is one of the defining how capitalization needs are driving consolidation in the features of cooperative societies. Members have the cooperative sector.16 responsibility to contribute equitably to their cooperative, and to exercise democratic control. Members often receive Application of cooperative principles to limited compensation on capital subscribed as a condition improve access to funding of membership. However, by exploring innovative Adherence to cooperative principles among the instruments such as non-obligatory member equity, cooperatives surveyed remains strong. The huge range in cooperatives are providing opportunities for members to operating models, industries and geographies make broad strengthen their cooperatives while offering a market rate generalizations difficult, but elements of the cooperative of return. These strategies can revitalize the membership model can be seen as assisting an organization’s funding base as an enabler of growth and stability. efforts. Survey respondents confirmed the importance of the International Cooperative Alliance’s (ICA) cooperative Cooperation among cooperatives principles17 to their organizations, with 69% reporting that The principle of “cooperation among cooperatives” adherence was formally tracked and only 6% reporting can be an important financing tool. For example, cross that these principles were not considered. guarantees between vertically-aligned cooperatives can be used to reduce trade finance capital requirements and free Long-term strategic and operational focus up capital for other uses. Pooling of assets and liquidity Cooperative management is expected to act as an programs via structures such as credit union centrals intergenerational steward of a healthy business, and is another example of how cooperatives are working prioritize the long-term viability of the organization over together to manage their capital requirements. short-term market/investor pressures. Cooperatives often22 Funding the future
  25. 25. Successfullyfunding the future As the 2008 financial crisis and aftershocks including the Eurozone debt crisis continue to disrupt global markets, cooperatives around the world are being forced to re-work their approaches to financing and capitalization. This study has reviewed the factors behind the increased need for capital, and explored the innovative ways that leading cooperatives are addressing the problem. Funding the future 23
  26. 26. How can cooperatives use this 1 Review capital needs information to enhance their organization’s financing and Survey respondents clearly indicated that their capital needs are increasing due to greater competition, capitalization capabilities? regulatory pressures and complexity of operations. To reduce the risk of inadequate capitalization, it is Evidence suggests they should examine important that these new conditions be considered in an organization’s capitalization plans. Cooperatives should their current strategies and methods, ask themselves: and identify opportunities to integrate • Do we have the liquidity necessary to meet our normal operational and financial commitments? What innovative approaches. contingencies have we built into our plan? • Are we considering inorganic as well as organic growth? Provided below are series of questions • If inorganic growth is being considered, do we have cooperatives should ask about their sufficient capital to fund the purchase, or will it be a non-cash merger? current capitalization strategies. The • How will the funding of future acquisitions affect our questions have been grouped into credit rating and access to capital in the future? a seven-step review process, which • Will our planned investments in operational efficiency be sufficient to maintain our competitive progresses from high-level strategy to position? tactical implementation. Many also • Have we adequately projected the capital impact of proposed regulatory changes? apply to non-cooperatives, but in • Have we adequately planned for both short-term and aggregate the questions are customized long-term capital needs? for the unique needs of cooperative organizations.24 Funding the future
  27. 27. 2 Assess historical financing 3 Update funding plans and capitalization approachA solid understanding of historical capitalization With an understanding of your historical capitalizationapproaches is an important step in the strategy process, approaches and projected capital needs, cooperativesparticular to identify why a particular mix of debit/hybrid/ need to review their funding plans and assess theirequity and internal/external funding approaches has been suitability for meeting future capital needs. Cooperativesused in the past. Given that the range of instruments should ask:also varies by the complexity of each cooperative, itis important to understand the track record of these • Do we understand the key performance metrics andapproaches. Cooperatives need to look into their recent disclosures of relevance to our internal and externalpast and consider: investors?• How difficult has it been for us to access sufficient • Do we know how we compare to other coops and capital? Has the perception of lenders, investors and non-coops in our industry? rating agencies changed? • Do we have access to adequate stable financing• What are the key factors affecting our credit rating? based on our capital plan?• Do we have any important credit facilities coming to • Do we have the right mix of retained earnings, debt, term? What impact would renegotiation have on equity, and hybrid instruments? availability of capital? On cost of capital? • How must this investment mix change to match our• Are sources of capital diversified enough to allow for capital needs? changes in financing conditions? • Do we have the right classes of financing and• Is our cost of capital competitive with our peers, capitalization to meet our regulatory needs? given our risk and operating profile? • Are we overly dependent on internal or external investors for our capital needs? • How well positioned are we to withstand another financial crisis? Do we have sufficient liquidity and contingency provisions? • Does our membership understand and support the financing and capitalization strategy? Funding the future 25
  28. 28. 4 Expand the range 5 Educate members, investors of financing tools and rating agencies When choosing the method of raising capital, cooperatives While all commercial ventures require the support of can no longer expect to rely on what has worked in their investors, it is particularly important in the case of the past. They should consider various alternatives to cooperatives. A strategy that embraces obligatory and generate opportunities, lower cost of funds and mitigate non-obligatory member capital, for example, relies on operational risk including: explicit member support for success. In many cases, this will involve convincing members to accept a wider strategy • Non-traditional debt instruments than the one they originally endorsed. External investors, - Senior debt to members and non-member investors in contrast, require a certain amount of hand-holding to - Subordinate debt to members and non-member be educated on the unique structure of cooperatives and investors appreciate their value. To review the success of current engagement strategies, cooperatives should consider the • Non-traditional equity instruments following questions: - Preferred shares/certificates to members and non-members • Do our members understand the implications of - Tradable cooperative shares and investment internal versus external funding? certificates • Do our members understand that retained earnings • Exploring new financing sources (e.g. external may be insufficient to meet capital needs? investors) • Do external investors understand what makes our • Issuing debt in foreign geographies/currencies organization different/unique? • Establishing purpose-built entities to enable external • What is our investor reporting strategy (annual fundraising reports, quarterly reports, relevant metrics, etc)? • Formal and informal collaboration with other • What is our engagement strategy for rating organizations (e.g. joint ventures, cross guarantees, agencies? supply chain financing) • Mergers with other cooperative organizations • Acquisition of non-cooperatives26 Funding the future