Early buyout on capital credits

November 2002

For the first time ever, the Nodak Board of Directors is going to give the members, past and present, a one-time cash settlement option on their capital credits. This option has been offered by several electric cooperatives in North Dakota in recent years. It has proven to have appeal to many members, and the good thing is that it is totally optional.

Here is how the plan will work. In the next month or two, members with equity in the cooperative will be offered a buyout at a discounted rate. The discount rate will be 16% per year, based on the age of the capital credits. Old capital credits are discounted less because they are expected to be paid out relatively soon. The newest capital credits (those earned in the year 2002) are discounted the most because they are not expected to be paid out for 20 years or more.

When a member accepts a lump sum buyout of capital credits, he or she would take a smaller amount today than the total that would be paid out over many years. We are presently on a 19-year payment schedule, but there are no promises we will be able to stay on that schedule in the future. However, in calculating the lump sum buyout amount, we will assume that we will be able to remain on the existing 19-year schedule.

For a person that has allocated capital credits for each of the last 19 years, the buyout sum is going to be roughly thirty cents on the dollar. This doesn’t seem like a very good deal on the surface, but it makes sense when you compare the immediate buyout in comparison to the expected payout over time.

Two realities must be taken into consideration when you evaluate the value of a future string of payments, such as capital credit retirements. They are as follows:

1. The present value of a string of payments is worth considerably less than the total of the payments. For example, if someone agreed to pay you $100 per year for the next 20 years, the present value of this deal would not be 20 times $100, or $2,000. Because of the future interest value of the money, the present value would be considerably less.

2. While Nodak has a strong history of retiring capital credits each year, there is no guarantee for the future. Nineteen years is a long time, and there is always uncertainty about the future. We certainly hope we continue to be financially strong, and have the ability to pay out capital credits, but the annual payment is indeed contingent on our ability to pay.

With these two realities, the discounted value for an early buyout was easier to understand. The person choosing to accept the buyout will have the money today, and will eliminate the risk that future unanticipated events will cause them not to receive their capital credits. Understandably, this may appeal to some while not to others.

When the final details of the capital credit buyout option are announced, we will also announce a series of information meetings throughout our service area. These meetings will give you an opportunity to ask questions about these issues along with other issues relating to Nodak’s business. Watch for this announcement, and plan to attend one of the information meetings near you.