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Alert CU leaders have seen them coming and been preparing.
Slowly but surely, sizeable waves of regulatory change are starting to take effect. Two of those taking effect in early 2022 are the new subordinated debt rule and new call report forms.
Subordinated Debt Compliance
The National Credit Union Administration’s new subordinated debt rule became effective Jan. 1. Giving credit unions the ability to issue subordinated debt is a good idea but may not be a great opportunity for some CUs because of the relatively high cost of capital, observes CU attorney Michael Edwards, based in Upper Marlboro, Maryland.
“It levels the playing field with community banks in terms of market access,” he points out, “because the NCUA subordinated debt instruments will more closely resemble bank subordinated debt investments that the capital markets are already familiar with. It opens the capital markets to credit unions, and it provides one more option to consider on the funding side.”
Whether subordinated debt is the best option depends on the circumstances, the cost of the funds and the return that can be realized by using those funds to provide capital support for increased lending or bond investments, he says.
Often subordinated debt won’t be the best option, he suggests, but it can be great for a credit union looking to expand a particular lending program while maintaining a high net-worth ratio if the return on investment justifies the capital expense.
How many credit unions will want a bank-like debt instrument that counts as an inferior form of capital, and how attractive will these instruments be to investors? He wonders. CUs in Australia, he reports, have been issuing subordinated debt for years and recently were paying about 7% for it.
“It all comes down to whether the credit union will make or lose money on the deals,” Edwards says. Interest rates in Australia are generally higher than in the United States, but at 7%, the profitable opportunities could be scarce, he suggests, unless that cost of capital is paired with relatively low-cost funding from shares or Federal Home Loan Banks advances to achieve leverage and then invested in relatively high-yielding assets.
When a CU sees a particularly good opportunity to grow, it can expand its capital gradually by accumulating retained earnings to grow conservatively, he explains. But a subordinated debt offering can expand a CU’s balance sheet dramatically and allow it to seize a big opportunity quickly without having a negative retained earnings impact, he points out.
It won’t be useful for struggling CUs that need to rebuild capital, he argues. They would have trouble attracting investors and would have to pay too much in interest, he notes.
But the capital markets deal in big money and hardly recognize CUs as players at this point, so anything that lowers that wall, he suggests, is a good idea, regardless of how useful it is in the short run.
New Call Report Standards
Changes to call reporting, which were to become effective in March, will have a minor but positive impact on CUs, Edwards predicts, particularly for regulatory burdens associated with NCUA’s risk-based capital rule.
“The automation will ease the regulatory burden of risk-based capital calculations once the initial implementation costs for staff time and software upgrades are sunk,” he suggests. The data points are there. The math is not complicated. The calculations will be automated. It will be easier for examiners to see and use the information, and CUs will see more clearly their risk-based capital position.
“I believe,” he says, “that many CUs will realize that their capital requirements under RBC may be lower than they would be under the alternative complex credit union leverage ratio, depending on the make-up of credit union’s assets and off-balance-sheet exposures.”
Richard H. Gamble writes from Grand Junction, Colorado.
