Over the last decade, credit unions have experienced decreasing capital levels as their assets continue to grow, putting them at risk with regulators if their capital ratio falls below the minimal percentage. As a result, the National Credit Union Administration (NCUA) passed their Final Rule in 2022, allowing many credit unions to issue subordinated debt as a means to raise additional capital.
The NCUA’s Final Rule is a game-changer for complex and new credit unions, giving them the tools to thrive, grow and confidently navigate the financial landscape. Learn how this new capability can benefit your credit union as we review its benefits.
What is subordinated debt?
Subordinated debt is typically an unsecured loan issued by a financial institution. It is treated as regulatory capital because it ranks lower in priority than other forms of debt regarding repayment.
Unlike banks, credit unions cannot sell stock to raise capital but must rely on increasing capital through member deposits. Through the Final Rule, these eligible credit unions can now sell subordinated debt to accredited investors and use the proceeds towards the NCUA’s updated risk-based capital ratio that went into effect in January 2022.
Subordinated debt’s impact on compliance
The potential risk of falling below minimal capital ratios loomed large for credit unions before the Final Rule was rolled out. With the recent changes, credit unions with assets over $500 million are now required to maintain a risk-based capital ratio of at least 10% of their risk-weighted assets.
Proceeds from issuing subordinated debt can be used to meet this requirement imposed by the NCUA. This ensures that credit unions maintain a strong and compliant capital position, reducing the risk of regulatory intervention.
What are the benefits of an alternative capital source?
In addition to helping credit unions increase regulatory capital, the proceeds from subordinated debt allow them to be more strategic through growth initiatives in their markets. Increasing capital could help credit unions acquire other branches, banks or fee-based institutions.
Before the Final Rule, many credit unions attempted to maintain the minimum capital ratio by managing operating expenses, or by eliminating certain services for their members. Rather than trim their offerings, credit unions can raise capital through subordinated debt to expand services, open new branches or invest in technology to support growth. This allows the credit unions to stay competitive in the market and focus on growing their membership base.
Taking the first step with subordinated debt
While the Final Rule has been in effect for two years, many credit unions have not yet taken advantage of issuing subordinated debt. The opportunity presented by this alternative capital source is worth considering if your credit union aims to bolster regulatory capital levels or increase flexibility with member offerings on your path to growth.
Engaging with the Financial Services team at RKL can help you navigate the benefits of subordinated debt and create a plan for raising additional capital.