Regulator proposes additional capital option as subordinated debt for some credit unions

A 275-plus page – and controversial – proposal to give some federally insured credit unions the ability to issue subordinated debt to help them meet their risk-based capital requirements was issued for a 120-day comment period Thursday by the federal credit union regulator.

The proposal, issued after a unanimous vote by the National Credit Union Administration (NCUA) Board, would allow well-capitalized credit unions to count subordinated debt as capital for risk-based net worth purposes (which is the fundamental capital pool for mitigating credit union risk in their lending and investment portfolios).

Some among credit union advocates argue that the use of subordinated capital will encourage eligible credit unions to attract loss-absorbing forms of capital that they would otherwise have to forego.

Those opposing the proposal (mostly in the competing banking industry) argue that the plan would increase risk to the financial system and taxpayers.

Among the key provisions of the subordinated debt proposal are that it:

  • Permits low-income-designated credit unions (LICUs), complex credit unions, and new credit unions to issue subordinated debt for purposes of regulatory capital treatment.
  • Allows for a maximum maturity of 20 years to be imposed on debt issued (with a minimum maturity of 5 years), and a minimum denomination of $100,000. The agency noted the maturity limit helps to clarify that the financial instruments issued are debt – and not equity in the credit unions (which are solely owned by the members; credit unions do not issue stock).
  • Prohibits a credit union from being both an issuer and investor unless the credit union meets certain conditions related to mergers.
  • Adds a new section addressing new rules and limits for making loans to other credit unions, including investing in subordinated debt at those credit unions.
  • Includes an expansion of the borrowing rule to clarify that federal credit unions can borrow from any source.
  • Makes revisions to the final risk-based capital (RBC) rule and the payout priorities in an involuntary liquidation rule to account for subordinated debt and grandfathered secondary capital where applicable.
  • Inserts cohering changes to part 741 of agency rules to account for the other changes proposed in this rule that apply to federally insured, state-chartered credit unions.

In discussing the proposal with the board, agency staff noted that federally insured, state chartered credit unions (FISCUs) would be eligible for applying to issue subordinated debt if their state laws and rules allow it.

The agency also estimated that the cost of adopting and implementing the proposal would be about $1 million a year, which would include adding two senior staff with securities law experience and retaining outside counsel about securities law. The agency said it expects, if the rule is finalized, to see a shift in subordinated debt applications from low-income credit unions, to applications from complex credit unions – applications, the agency said, which will necessarily be more complicated.

NCUA said it adopted the relatively long 120-day comment period (rather than a more typical 90-day period) to account for the relatively complex nature and length of the proposal. At more than 275 pages, the proposal is one of the longest the agency has ever published.

According to the agency, there are 2,628 LICUs (complex and non-complex) that are “currently eligible” for subordinated debt under the new rule (LICUs may already build regulatory capital from outside sources). The new rule would also open the door to as many as 285 additional non-LICU, “complex” credit unions (281 existing, “complex,” and an estimated four new credit unions) to be eligible to take advantage of the new rule.

NCUA said up to 2,409 non-complex (and non-LICU) credit unions would not be eligible to issue subordinated debt.

Proposed rule: Subordinated Debt

Staff presentation: Subordinated Debt Notice of Proposed Rulemaking

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