New Subordinated Debt Rules: What it Means for Your Credit Union

By Lori Carmichael, CPA – Shareholder, Financial Institutions Group

Recently the National Credit Union Administration’s (NCUA) board approved a rule clearing the way for all credit unions to issue subordinated debt to investors and use the proceeds to meet regulatory capital requirements.

What’s New with Subordinated Debt

The new rules bring some additional things to consider before taking on subordinated debt, including:

• In addition to low-income-designated credit unions previously allowed to take on subordinated debt in the form of secondary capital, complex credit unions and new credit unions are also now permitted to issue subordinated debt.
• It can only be offered, issued and sold to “entity accredited investors” or “natural person accredited investors.”
• Upon approval to issue subordinated debt, a credit union must create an “offering document” for each issuance of subordinated debt.
• Minimum maturity of the subordinated debt is now five years and maximum maturity of 20 years.
• Generally, a credit union cannot be both the issuer and an investor in subordinated debt.
• Authority to issue subordinated debt is valid for two years after either the date of NCUA’s approval of the initial application or the “approved for use” date in the offering document.

Treatment of Subordinated Debt

Subordinated debt will be treated differently for credit unions based on their membership base and asset size.

• Complex credit unions (Over $500 million in assets): Subordinated debt will be contributed to the risk-based capital ratio under the risk-based capital rule, not the statutory net-worth ratio.
• Low-income credit unions (Membership primarily meets certain low-income threshold): Subordinate debt will contribute to their net worth, similarly to how secondary capital is currently handled.

Secondary Capital as Subordinated Debt

Although the new rule will not take effect until Jan. 1, 2022, it has brought a renewed interest in secondary capital to the forefront.

Secondary capital is essentially an uninsured loan the issuing credit union is permitted to include as regulatory capital, which is taken in the form of subordinated debt. The secondary account holder’s claim must come after any other claims from shareholders, creditors and the National Credit Union Share Insurance Fund (NCUSIF).

However, not every credit union can obtain secondary capital. Today, only those considered a low-income designated credit union are able to obtain it with a proper plan approved by the NCUA.

Often, low-income credit unions would leverage issuing secondary capital as a strategic growth option to restore capital to a regulatory minimum, support future asset growth, enhance earnings or gain operational efficiencies.

During unique times, like those we are currently experiencing due to COVID-19, subordinated debt can be used to help bridge the gap as a result of increased deposits and lower capital.

Is your credit union considering leveraging subordinated debt? Contact Doeren Mayhew’s Financial Institutions Group members to complete a financial viability assessment to ensure it’s the right decision for your credit union.