The Benefits, Costs and Trade-Offs To Supplemental Capital Discussed

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SAN ANTONIO-What could credit unions in the U.S. do if there was widespread access to supplemental capital?

Some answers were offered regarding the pros and cons of building a sustainable financial institution using supplemental capital by CUNA Mutual Group's John Lass during America's CU Conference last week.

Lass, SVP-strategy and business development at CUNA Mutual, noted that most U.S. credit unions generate capital entirely through retained earnings, yet major financial cooperatives elsewhere effectively use subordinated debt that can count as capital and it doesn't violate cooperative principles.

"Supplemental capital can enable individual credit unions to grow even if capital has been drawn down," Lass said. "There are many examples of financial cooperative systems around the world that have effectively used alternative capital to build sustainable financial models."

Lass cited Desjardins, which is based in Quebec and is the largest Canadian cooperative, as one of several examples of financial cooperatives that have successfully utilized subordinated debt to strengthen their businesses and gain market share. Other cooperatives such as DZ Bank of Germany, Rabobank of the Netherlands and the Farm Credit system in the U.S. have also tapped the capital markets to infuse their businesses with capital.

"As with any other debt, a business's subordinated debt has expenses tied to it in the form of interest rates that are determined by the capital markets," Lass said. "If a credit union is going to raise supplemental capital it must have a solid business plan in place to show an ability to repay the cost of the debt."

A Look At Who's Eligible

For federally insured, natural-person credit unions, only those with a low income designation are currently able to include debt capital as part of their regulatory capital. Low-income designated credit unions only comprise 15% of all federally insured credit unions and 4% of assets.

Lass said supplemental capital has its potential benefits but with it comes costs and tradeoffs. In addition, because credit unions are tax-exempt, they do not benefit from interest payment tax deductions enjoyed by for-profit institutions.

There are also non-financial costs associated with raising supplemental capital. Lass said subordinated debt may involve restrictive covenants that constrain future management options.

"The important thing to remember about raising alternative capital is that it's not an end-all silver bullet. In order for it to even be an option, a credit union must have the combination of a strong financial structure and a strong value proposition to members and prospective members," Lass added.

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