Catalyst News

Investing in subordinated debt can offer credit unions greater yields than typical investments, with spreads sometimes ranging up to 400 basis points higher than U.S. Treasuries of the same maturity. This type of attractive yield was among the benefits mentioned in a recent webinar on the current landscape and the risks and benefits of subordinated debt.

“Subordinated debt investments offer wider spreads than typical investments commonly purchased by credit unions,” said Jonathan Jackson, Catalyst Corporate Manager of Brokerage Services. “Keep in mind, every deal is different, but typically spreads are credit based and range from +175-400 basis points over U.S Treasuries.”

Jackson opened the webinar with an overview of subordinated debt notes and the NCUA’s Subordinated Debt Rule, enacted in January 2022, which replaced the Secondary Capital rule. He defined subordinated debt notes as uninsured and unsecured loans or bonds permitted to temporarily count towards regulatory capital. Usually, these notes hold up to a 20-year final maturity, but the most common structure for a credit union is a 10-year maturity.

Potential sub debt investors should first ensure eligibility. NCUA regulatory requirements for investors include:

• No outstanding subordinated debt issuances
• Well capitalized
• Must be an accredited investor
• Maximum investment amounts; the lessor of:
  • 25% of net worth
  • Dollar amount of net worth above 7%
• Have established written policies
• Obtain board approval prior to investment

In addition to attractive yields, Jackson unraveled other benefits of investing in subordinated debt, including: no extension or contraction risk, diversification and supporting the credit union movement.

Jackson noted that as an investor in subordinated debt you have access to predictable cash flows that are not interest rate dependent. When interest rates are more volatile, investing in subordinated debt would allow for a relatively high-yielding asset on the balance sheet.

“There are a lot of ways to diversify an investment portfolio,” Jackson said, “but subordinated debt investments are a completely different asset class. Balance sheet diversification gives credit risk to an institution versus an individual borrower.”

The bonus is that investing in a credit union’s subordinated debt issuance supports the credit union movement, Jackson said. A credit union issues subordinated debt, in most cases, because they have the capacity to grow but are limited by their capital position. Regardless, the opportunity to support growth for fellow credit unions exemplifies the “people helping people” mantra.

Jackson noted that the benefits of investing in subordinated debt do not come without risk. Such risks include interest rate, liquidity, regulatory approval and credit risk.

“Subordinated debt is becoming an effective tool for credit unions. Even if your credit union is not looking to issue, investing in subordinated debt may be an attractive asset allocation opportunity,” Jackson said.

Check out the Investing in Subordinated Debt- Performing Due Diligence webinar on-demand to learn more about the benefits and risks associated with investing in sub debt today.