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Checking the Boxes with Subordinated Debt

December 16, 2021

How it can help your members AND strengthen your balance sheet

By Steven Houle, CFA, FRM, Catalyst Strategic Solutions Vice President of Advisory Services


New Year’s Day will represent more than the flip of the calendar this year. After six years of discussion and deliberation, the NCUA’s final subordinated debt rule will take effect January 1, 2022. This rule – which applies to all federally insured credit unions – amends various parts of the NCUA’s regulation to permit low-income designated (LID) credit unions, complex credit unions and new credit unions to issue subordinated debt for the purpose of regulatory capital treatment. 

To recap, the issuance of subordinated debt is a valuable strategic tool for credit unions to consider, especially those experiencing the following trends:

  • Diluted net worth ratio due to rapid deposit growth
  • Strong loan demand with a desire to grow the balance sheet
  • Loan concentration limitations tied to net worth
  • Exploration of potential credit union mergers or bank acquisitions
  • Considerations for branch expansion and/or field of membership (FOM) expansion
  • Adverse impact on net worth due to CECL adjustment

Do any of these check boxes apply to your credit union?

If you’re experiencing one or more of these scenarios, issuing subordinated debt might be worth exploring.

To demonstrate the strategic application (and balance sheet advantages) of subordinated debt, let’s put one of the above-mentioned use cases into practice. In this example, imagine a credit union with $1.5 billion in assets and a net worth ratio of 8 percent. Now assume that annual loan and deposit growth have been in the 9 percent range, with a Return on Assets (ROA) of 0.65 percent.

This ROA profile supports 8 percent organic asset growth, without causing dilution to the net worth ratio. The credit union also sees new opportunities to expand its branch network, increase membership, and in turn, generate loan and deposit growth greater than 10 percent annually. With that, receiving approval to issue subordinated debt would provide the capital needed to help the credit union achieve its 10-year strategic plan.

Adding $20 million in subordinated debt immediately increases the net worth ratio to 9.25 percent and supports greater than 10 percent annual growth in loans and deposits. Furthermore, the ability to add more loans will boost income and ROA. Over a 10-year horizon, the subordinated debt supports a larger balance sheet with $400 million more in member loans and a higher earnings profile. See the sample financial projections in the illustrations below. 

Proforma Scenario Comparison
Loans

What do you need to know about the upcoming rule change?

While the final subordinated debt rule carries forward some of the previous requirements for issuing secondary capital, it also introduces new stipulations. This list highlights a few of the combined requirements necessary for approval:

  • Must submit an application and receive preapproval from NCUA before issuing subordinated debt
  • Application must include pro forma financial statements for a minimum of two years
  • If approved, expiration of authority to issue subordinated debt is two years
  • The term of subordinated debt must be at least five years but not longer than 20 years
  • Subordinated debt is considered a security and requires an Offering Document
  • Investors can only be Accredited Investors as defined by the SEC

If your credit union has untapped opportunities or needs additional capital to help achieve its goals, subordinated debt may serve as a valuable tool. Catalyst Strategic Solutions has helped credit unions successfully add net worth to their balance sheets using this strategy – and we stand ready to help you, too!

To find out if subordinated debt is the right fit for your credit union, or to schedule a no-obligation consultation, contact us today.

*Projections used in this article are for example purposes only and may not reflect how issuing subordinated debt will impact your balance sheet and financial profile.