Excerpted from NCBA’s Cooperative Business Journal
Editor’s Note: Sheldon C. Petersen has been chief executive officer of the National Rural Utilities Cooperative Finance Corporation since March 1995. Petersen joined CFC in 1983, as area representative, providing financial management consulting services to CFC members in Minnesota, Wisconsin, Montana and the Dakotas. Petersen answered questions for CBJ about CFC and the cooperative utility sector in June.
CFC has $18 billion in assets and is an A+ rated financial institution. Yet most of those outside the utility co-op community have never heard of you. Could you briefly say what CFC is and what it does?
CFC was born out of a specific need in the mid- to late-1960s.
Electric utilities are very capital-intensive businesses. Our job at CFC is to provide a connection between the capital needs of electric cooperatives and the capital markets. We do that in a variety of ways. We’re probably not very well known outside of those circles. But we’re rated A+—or the equivalent of A+—by all three rating agencies. Two of them, Moody’s and Standard Poor’s, have us on a stable outlook. Fitch Investor Service has us on a positive outlook. A major goal here is to maintain a very good credit rating, because that affects our cost of funds and the availability of money. The typical investors in CFC securities are pension funds, insurance companies, bond funds, money market funds, and most of those are repeat investors. CFC is referred to as a well-known, seasoned issuer. That means we’re in the market all the time and working with a lot of the same investors over and over.
Many people might say utility co-ops already have the Rural Utility Service in the Agriculture Department. Why do they need CFC as well?
The Rural Utility Service, or what used to be called the Rural Electrification Administration, was the foundation that allowed the cooperatives to actually get formed. These companies were formed with essentially no resources whatsoever, except what was provided by USDA. It became obvious in the mid- to late-1960s, however, that Congress was not willing to provide all the money that was needed for cooperatives. Cooperatives were growing very fast, and there was a concern about the availability of capital to meet growing needs, if the program was to rely solely on the federal government. At that point, co-op leaders undertook a study to evaluate different options to provide capital to electric cooperatives, in addition to what was available through the federal government. It found a very clear gap between the need and what the federal government was providing. That led to the creation of CFC. Then, shortly after CFC was formed, President Nixon pulled the rug out from under the rural electrification loan program, and CFC was there as a safety net. That reinforced the benefit of having this backup public/private partnership. USDA ultimately got back in to the lending business, of course, but dial forward to today. There are about 235 distribution cooperatives that don’t use RUS funding anymore. They’re either all CFC or CFC with some other supplemental lenders. So CFC has helped to take the pressure off of the government loan program. Also, CFC today provides interim credit while generation and transmission cooperatives wait to get funding from RUS. In these cases, CFC is not supplanting RUS money, but bridging it.
“The Cooperative System Integrity Fund…is a representation of the strength that cooperatives have when they work together.”
CFC has something called the Cooperative System Integrity Fund. Talk about what that is.
The Cooperative System Integrity Fund is a tool that CFC can use to help fight challenges from other utilities that are interested in taking over a cooperative or part of a cooperative service territory. You have a small cooperative that is confronted with a challenge from a large investor-owned utility, and there’s obviously a resource issue there. The Cooperative System Integrity Fund is a mechanism where any electric cooperative can contribute to a pool of money used to help fund some of the defense activities, if a cooperative gets challenged. Most of the co-ops contribute by earmarking a portion of their CFC patronage capital refund; some also write a check to the fund. Let’s say an investor-owned utility makes a pitch to the membership of the electric cooperative that they want to buy them out. The Cooperative System Integrity Fund will help fund the defensive efforts as the electric cooperative tries to fight off the investor-owned utility. If it’s a situation where another utility is encroaching on a cooperative service territory, a lot of times you have to defend that before a court or a public service commission. We help provide the resources to do that. But it’s money that’s been contributed by the electric cooperative movement, and we simply administer the fund. It’s been in existence 20 years and about two-thirds of our members participate.
Do you think there is a lesson in that for some other co-op sectors, like credit unions?
It is the classic “cooperatives working together” story. Individually cooperatives have limited resources. But when they choose to fight a situation jointly, they can have enormous resources. We’ve said many times, “If you pick on one of us, you’re picking on all of us.” The Cooperative System Integrity Fund is money, but it also really shows the people who are challenging us that we’re a group. We’re going to fight for each other, protect each other. I would like to think the existence of the fund itself has been a deterrent in some cases, keeping investor-owned utilities or municipals from challenging us. It is a representation of the strength that cooperatives have when they work together.
CFC is one of the few co-ops that Wall Street is familiar with. Do you have trouble getting them to take you seriously? Is it hard to get them to understand what a co-op is?
You’ve just described what we do here from day to day. It’s a constant challenge because most finance MBAs don’t come out of college having majored in cooperative business structures. So there is continuous education about what is a cooperative, why do we have a financial position that might look differently than an investor-owned utility, and what kind of credit quality we represent. Then, after you have explained that, you have to talk about rural electrification, and why our utilities look different from investor-owned utilities. It was a real challenge to the founders of CFC. They spent a lot of time convincing the rating agencies, the investors, and the banks that farmers could form utilities that have the discipline to work in the capital markets. Once we got an operating history under our belt, I don’t want to say it was easy, but electric cooperatives have an enormous amount of credibility among the investors today, and that extends beyond Wall Street to the European capital markets. It probably comes as no surprise, particularly in the European markets, that the idea of a cooperative utility sells pretty well. Initially it was a real challenge. But the enormous support electric cooperatives demonstrated for CFC, by agreeing over a 15-year period to invest equity capital, was what jump started the concept.
And now the flip side of that question. You have about 235 people working at CFC. These are experts in capital markets and finance. Do you have a problem instilling the cooperative culture in them?
If you look at our turnover, it’s extraordinarily low for the area and for the type of business we’re in. I can only attribute that to the fact that the people, once they come to CFC, get engaged with the mission. They adopt the mission with the spirit and philosophy that you see in cooperative circles, and for that reason, they stay here. That’s not answering your question directly, but it’s an indication of what we have here. Also, it’s relatively easy to communicate the significance of what we do here, because a lot of our people are talking with our electric co-op members on a daily basis. They see what they’re doing. Once people understand that what they do here really means something to people who are trying to provide utility service in very challenging parts of this country, it’s not a problem to get them enthusiastic about cooperatives. And the turnover supports that notion.
Demutualization is a hot topic among farm co-ops and credit unions, but the utility sector has essentially avoided the problem. Why is that? Is it just chance?
I don’t think so. The nature of our business makes it more challenging for us to be demutualized than, say, a producer co-op. We’re the classic consumer co-op. Some of what you’re seeing in the co-op community today is driven by outside interests, management, and boards of directors. In electric co-ops, there’s a very strong commitment to the cooperative culture. We’re utilities, but we’re co-ops at our very heart and everybody is brought up through that. In practically every state, multiple co-ops operate as kind of a family. They reinforce to each other the benefit of being a cooperative. Also, electric co-ops have done a good job of communicating long-term value to their members. Anybody can make a business decision to quickly reap a reward, but the cooperative business model yields its benefit over the long term. In addition, to the extent electric co-ops have been challenged, we come together and we fight it. There was a demutualization six or seven years ago. Cap Rock Electric in Texas. But we haven’t had the movement that you’ve seen in other areas. The Cap Rock Electric conversion was driven by management and the board and it wasn’t very popular among the rest of the cooperatives in the state. And there’s another big reason as to why you haven’t seen wholesale demutualizations on our side. We place a great deal of importance on financially communicating the value of a cooperative to a member. When you are giving a consumer evidence of the benefit of his ownership in the form of a check, that reward is continually out there. If you’re in a cooperative that doesn’t focus on distributing the benefits of the operation to the members, the members can start looking around and say, “Well, how do we monetize that?” The only way to monetize it is to sell it or demutualize it. CFC and the National Rural Electric Cooperative Association have been major promoters of patronage capital retirements, so that the members get to see evidence of their ownership. And CFC definitely walks the talk here, as well. We aggressively retire our margins. Seventy percent is retired after the close of each fiscal year, and that other 30 percent is retired over a 15-year cycle. Our goal is to make sure we get the broadest access to capital for the cooperative and then at the lowest possible cost. The way we do that is by rapidly retiring earnings.
The equity capital needs of utility co-ops and credit union have been met internally. But other sectors are equity capital deficient. Is there a way for the cooperative community to come together and solve the equity capital needs of the sectors that are deficient?
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The National Rural Utilities Cooperative Finance Corporation is one of the few co-ops that is a household name on Wall Street. Formed in 1969, it is a member-owned, not-for-profit financial institution that provides loans and other financial products to approximately 1,000 electric cooperatives nationwide.
CFC was organized to provide a supplemental source of financing loans provided by the federal government. Today, it has outstanding loans and guarantees that exceed $18 billion and its member-owners have invested more than $3 billion in CFC securities.
Headquartered in Herndon, Va., outside Washington, D.C., CFC uses its member equity and investments to raise loan funds through the sale of multiple financing vehicles on Wall Street. By maintaining high credit standards and credit ratings, it delivers superior products at reasonable costs.
CFC is governed by a 23-member board made up of cooperative utility directors and managers. It has approximately 235 employees, including field staff.
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I think there is. The first thing we have to understand is, we don’t have to make ourselves look like shareholders, or stock-held companies, to meet that need. Still, Wall Street is an extraordinarily creative venue. Fascinating finance structures are being developed every day. To some degree, we have assumed that we need to redesign the cooperative so that it fits a concept of equity that Wall Street holds. We ought to devote our efforts to working with those creative people on Wall Street and developing instruments that fit the cooperative model.
“We ought to devote our efforts to working with those creative people on Wall Street and developing instruments that fit the cooperative model.”
And you’ve been able to do that?
We’ve done some of that. We have securities that are traded on the New York Stock Exchange as a cooperative. We’re traded on the New York Stock Exchange because we sell a deeply subordinated debenture that has characteristics of equity, but it doesn’t dilute the voting ownership of our members. The rating agencies give us a degree of equity credit for these securities, so that is a mechanism for structuring something that meets the needs of the co-op, as opposed to the reverse. You can sell these Quarterly Income Capital Securities or these subordinated debentures to institutions or you can sell them retail. For the most part, we’ve sold them retail. Mom-and-Pop investors are buying these in $25 increments.
Anything else you would like to say to a co-op audience?
The genuine, rock-solid commitment to the cooperative business model in the electric cooperative movement makes me very proud. I don’t have a way of judging the intensity in other types of cooperatives. But, if other cooperatives could get that same intensity that I think is evident in the electric cooperative movement, cooperatives would really thrive. My dad spent 41 years with an investor-owned utility. When I first started working for an electric co-op in southwest Iowa, the manager knew my family history. About two years after I started at the co-op, at dinner one night the manager said, “I’m sure you’re going to work for us another year or so and then try to find yourself an investor-owned utility job.” It really caught me off guard. I said, “You have to be kidding me. I’ve found a place where we can actually focus first and foremost on meeting member needs. I’m not going to leave this for anything.”
