Debt Securities

All co-operatives have power to borrow from commercial lenders, members and the public. Some older co-operatives have the power to take deposits from members. There are very few of these co-operatives, as deposit-taking is a federally regulated activity under the Banking Act. Hence, credit unions are called Authorised Deposit Taking Institutions (ADIs).

There are no legal restrictions on the terms and conditions of the loan arrangements a co-operative may make with commercial lenders. As a borrower in this market, co-operatives are no different from any other borrower. The board of a co-operative, however, is obliged to make careful business decisions in the best interests of the co-operative.

In addition to borrowing from a commercial lender, co-operatives can also borrow from their members or the general public by issuing debt securities.

Co-operatives can issue debentures or Co-operative Capital Units (CCUs).

Debentures

Debentures are loans, usually specified in dollar units and subject to repayment of the capital loaned after a period of time (the debenture ‘term’) and the payment of interest on the amount borrowed.

Debentures do not have any voting rights attached to them, other than a vote at a meeting of debenture holders37. Debentures may or may not be secured against specified assets of the co-operative, and there are requirements in respect of the manner in which a debenture can be described based on any security backing that it may have.

Debentures are commonly transferable under the co-operative’s rules and subject to a fee and approval by the co-operative board.

Both distributing and non-distributing co-operatives may issue debentures. The payment of interest to debenture investors in a non-distributing co-operative is not impacted by the prohibition on distributing to members, because the interest paid on debentures is merely a borrowing expense and not part of the co-operative’s surplus.

Significantly, debentures issued by a co-operative may be offered to either members or to any member of the public, although a public offer will be governed by different disclosure requirements. The ability to offer debentures to the general public overcomes restrictions, either real or perceived, from active membership requirements.

Where interest is payable on a debenture, it is payable whether the co-operative is profitable or not. It is no different in this respect from a loan through a commercial lender. Interest payments are tax deductible, as are the costs of issuing the debentures. By contrast, dividends are only payable on shares if there is a surplus, and not all costs associated with a share issue are tax deductible.

A debenture is usually issued in small denominations. For example, the face value of the debenture might be $100, and investors may acquire 1 or more debentures in multiples of $100. The co-operative will issue a document as evidence of the debenture and maintain a register of debenture holders.

The rights attaching to a debenture are determined by the co-operative in a manner that accommodates its funding requirements, its ability to pay interest installments, repay capital and the target investor market. Like any borrowing it may be structured to accommodate known or expected cash flows either by a variable interest rate, the periods when interest will be paid or an expected surplus from the project to be funded. Debentures may be issued at a discount to face value, but will be repayable at the face value at the end of the term, thereby deferring the ‘interest component’ until the time for repayment. This flexibility permits the issue of debentures in some cultures that prohibit the payment of interest.

Generally, issuing debentures is a source of finance for a co-operative that will cost less than borrowing commercially, primarily because a commercial borrower seeks to make a profit from the business of lending. Certainly, investors expect to receive interest from their investment, however, the community targeted for investment will be likely to invest for the same reasons that they invest in community shares – because they want to support the co-operative’s objectives.

In the unfortunate event that a co-operative is wound up, the monies owing to debenture holders (particularly if they are secured against specific property) is paid prior to any repayment of share capital to members.

In any borrowing, the lender will require information about the borrower’s financial position to ensure that the loan will be repaid. In a commercial borrowing situation, the lender will dictate what information must be provided or disclosed. In a debenture issue, the CNL dictates the type and quality of disclosure required for such an activity.

The disclosure requirements and procedure for a debenture issue is different according to whether the issue is targeted at members only38 or whether the offer is made to the general public. There will also be additional requirements and costs if the debentures are to be secured against specific assets of the co-operative39. The different disclosure requirements appear complex, but they pursue the same objective, namely to provide sufficient information to enable an investor to make an informed investment decision.

The disclosure requirements for debenture issues are the same for an issue of co-operative capital units.

Co-operative Capital Units

Co-operative capital units or CCUs are relatively new types of securities that may be issued by co-operatives.

CCUs are defined in the CNL as ‘an interest in the capital (but not the share capital) of the co-operative’.

CCUs were only able to be issued by co-operatives in New South Wales up until the commencement of the CNL40. There is little information about CCUs and this will remain the case until the sector begins to use this power to issue securities.

They were initially introduced in the 1990s to assist co-operatives to overcome the barriers to accessing capital and so may be structured to look like shares, but they may not carry any voting rights. By being able to structure these securities to have characteristics of equity or debt and by providing that these securities may be quoted on a stock exchange, it was anticipated that they would overcome the problems for co-operatives to access capital.

Limited ability to issue this hybrid form of capital, until recently, means that CCUs have not been considered for capital funding and the finance market has no familiarity with these instruments as an investment tool. There have only been 7 issues of CCUs by co-operatives since their introduction to NSW law in 1992, with one issue being quoted on the Australian Stock Exchange. Terms of issue will determine whether the CCUs can be classified as debt or equity on the co-operative’s balance sheet according to current Australian accounting standards, although the application of the accounting standards to co-operative securities generally may come under review in the near future.

CCUs have been likened to redeemable preference shares because they tend to be issued under terms where the capital is repayable and they may carry dividends but do not carry a vote in the co-operative’s affairs.

The transferability of CCUs, particularly through the Australian Stock Exchange (ASX), and the ability to issue them to the general public gives them liquidity for an investor. These aspects of CCUs however, do not make them necessarily useful in the community investment market, unless the enterprise is one requiring  substantial capital, perhaps in the renewable energy sector.

CCUs, like their name suggests, are securities that create an interest in the co-operative’s capital. Arguably this is the core capital of the co-operative that would normally form part of the indivisible capital of the co-operative referred to in the third co-operative principle41. The terms of issue of CCUs may specify a priority for repayment after the priority for debentures and unsecured debts. CCUs with this level of priority would be similar to risk capital.

If CCUs are structured to look like risk capital, they could also be issued on similar terms to share capital, namely they would carry an interest equivalent to a dividend that would only be payable if the co-operative operated with a surplus.

CCUs have potential to enable a broader target community for investment. Their flexible structure and the ability to issue them to non-members means they can ‘look’ like community shares, but are not subject to active membership requirements (see Part 4)42.

Both debentures and CCUs can be repaid by issuing debt securities with the same terms, thus creating a revolving loan fund. As for company securities, debentures and CCUs may also be convertible to shares where the holder of the debt security is also a member and the co-operative has a share capital.