A credit union's 'troubling' capital plan

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A thinly capitalized credit union in Orange, Calif., is looking to raise $4 million to jump-start its growth prospects.

The $63.4 million-asset Union Yes Federal Credit Union recently launched a capital campaign, offering subordinated debt with fixed and variable interest rates of 4% to 4.5% and durations of five to seven years.

CEO William Byerly declined to disclose how much Union Yes has raised. "We’re still very early in the process,” he said in an email Tuesday.

The effort should be "troubling" for bankers, said Keith Leggett, a retired senior economist at the American Bankers Association who frequently blogs about credit union issues. Leggett noted that, if Union Yes is successful, more than half of its capital would come from temporary sources.

Bankers have argued that any capital raised by credit unions could be used to compete for loans. The move also indicates that the National Credit Union Administration, Union Yes' federal regulator, is willing to sign off on things that the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency would be unwilling to approve.

“This is the opposite of what federal bank regulators are doing with capital," Leggett said.

Banks have made clear that they will fight any steps to make it easier for credit unions to raise outside capital.

Credit unions are member-owned nonprofits, so their capital is typically limited to retained earnings. However, credit unions with a low-income designation, including Union Yes, are permitted to raise secondary capital from investors.

Union Yes’ campaign comes at a time when capital issues seem likely to advance to the forefront of the credit union industry’s agenda. In February 2017, the NCUA issued an advance notice of proposed rulemaking indicating an intent to loosen rules governing secondary capital and provide a way for credit unions to use alternative capital to meet risk-based capital requirements.

While the issue languished through 2017 and 2018 because there were two vacancies on the agency’s governing board, the appointments of Chairman Rodney Hood and Board Member Todd Harper have seemingly removed that impediment. Credit union trade groups have made it clear they want to see movement on the issue.

Secondary capital isn’t widespread, but a handful of credit unions have tapped the capital markets in recent years.

The $648 million-asset Notre Dame Federal Credit Union in Notre Dame, Ind., raised $12 million in secondary capital in late 2017 to fund loan growth. Since then, the credit union’s loan book has increased by 10%, to $522 million. Around that time, the $963 million-asset Jefferson Financial Federal Credit Union in Metairie, La., also raised $12 million, which it has used to expand its portfolio by nearly 14%, to $623.5 million.

Notre Dame and Jefferson are significantly larger than Union Yes and were better capitalized when they raised more capital.

Union Yes has $3 million of capital, or a net worth ratio under 5%, based on its most-recent call report. Notre Dame and Jefferson Financial had ratios in excess of 9% at the end of 2017.

The NCUA requires a 6% net worth ratio to qualify as adequately capitalized.

Union Yes noted in its prospectus that it has received regulatory authority to seek secondary capital. A spokesman for the NCUA said its discussions with Union Yes were confidential.

“Over the past few years," Union Yes "has been experiencing extraordinary growth and needs to raise additional capital to fund new membership growth,” Byerly wrote in the credit union's March 13 prospectus.

Leggett said Union Yes' investors “will get a better deal than" its members, noting that the highest current rate for the 60-month CD is 0.35%.

Union Yes' loan book increased by more than 24% between 2016 and 2018 — with few credit quality issues. Charge-offs totaled just 0.2% of average loans last year, compared to an 0.48% average at credit unions with $50 million to $100 million in assets.

At the same time, high levels of noninterest expense have limited gains in net income. Union Yes’ profit totaled just $736,000 between 2016 and 2018.

“Without the infusion of secondary capital, it is unlikely that the credit union could ever become well capitalized,” Leggett stated.

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