Nobody likes credit union regulator’s debt plan

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Not surprisingly, bankers are pushing back strongly against a proposed regulation that would broaden credit unions’ access to subordinated debt.

The twist is that credit unions also aren’t crazy about the idea.

Credit unions already enjoy an exemption from federal and state income tax, so a plan from the National Credit Union Administration allowing more of them tap investor capital has banks seeing red. Bankers worry access to subordinated debt would fuel large credit unions’ already rapid growth — and give them more wherewithal to acquire banks.

More than 75% of the 169 comment letters the NCUA received during the 120-day comment period — twice as long as the agency normally allows — came from bankers and bank trade groups detailing their intense opposition to the proposed regulation. Virtually all the bank commenters argued the rule turns the logic behind the tax exemption on its head by allowing outside investors to benefit alongside an issuing credit union’s member-owners.

The proposal “seriously undermines the cooperative ownership structure which is the very foundation for the justification for the existence of credit unions,” wrote David Schroeder, senior vice president for federal governmental relations at the Community Bankers of Illinois.

“The introduction of outside investment into complex credit unions … raises the question whether such [institutions] should continue to be entitled to such an exemption,” wrote Chris Furlong, president and CEO of the Texas Bankers Association.

While credit unions with a low-income designation have been authorized to issue subordinated debt since 1996, only a relative handful have availed themselves of the privilege. Including subordinated debt, the industry had just $307 million in secondary capital on its books as of March 31, according to NCUA. Credit unions held assets totaling $1.63 trillion.

The agency’s proposed regulation extends subordinated debt issuing power to credit unions above $500 million in assets that do not already carry a low-income designation. According to NCUA data, non-low-income complex credit unions hold a total of $730 billion in assets, making them the industry’s largest asset class. Credit unions with a low-income designation hold about $630 billion.

“If credit unions can get funding through subordinated debt offerings, they will have more cash to acquire taxpaying banks in communities across America,” Bruce Whitehurst, president and CEO of the Virginia Bankers Association, wrote in a comment letter.

More than a dozen credit unions announced plans to purchase banks in 2019, the highest number ever to do so. Some of those deals ran into roadblocks this year, however, and the number of new deals announced remains in the low single digits. Some transactions that haven’t been completed are also being called off, due in part to economic fallout from the pandemic.

For their part, some credit unions have raised concerns that the subordinated debt regulation could harm the very institutions it aims to help.

To be sure, industry groups support making it easier for individual credit unions to borrow from investors to bolster capital levels. It is the process the NCUA has laid out for doing so that has drawn concern from many. Critics called it overly burdensome, especially since the rule will apply to smaller, low-income credit unions as well as their larger brethren.

Indeed, “a number of low-income credit unions of all sizes have expressed concerns that the changes to the rules could effectively eliminate access to capital for many small credit unions that have a social justice mission,” wrote John Trull, vice president of regulatory affairs at the Northwest Credit Union Association, a trade group representing credit unions in Washington, Oregon and Idaho.

Among other things, the NCUA’s rule would require issuing credit unions to hire a securities lawyer, draft a set of comprehensive disclosures and a prospectus, and develop in-depth policies governing investor relations, securities law compliance and other issues connected to the subordinated debt issuance.

All within reason for a larger institution that might seek to raise $10 million or more, but a real burden for smaller credit unions certified as community development financial institutions that are seeking just a few hundred thousand dollars. Six Northwest Credit Union Association member credit unions currently hold subordinated debt, with the smallest issue being $22,000, according to Trull.

Even executives at larger credit unions say the rule may be a bridge too far for small institutions.

Brian Schools, president CEO of the $2.3 billion-asset Chartway Federal Credit Union in Virginia Beach, wrote that the NCUA’s issuing requirements involve a minimum of “15 extensive and overly detailed volumes of analytical information and support material for a subordinated debt program.”

“By unintentionally creating a thick layer of regulatory requirements, already resource-laden credit unions will have a competitive advantage, which may result in further consolidation of community credit unions,” Schools added.

The NCUA views the requirements contained in the proposed regulation as a critical insurance policy, since investors in credit union subordinated debt are expressly forbidden from exercising any management or voting rights. Critics seek an exemption for smaller institutions, who have traditionally sold their debt to a single individual or a handful of investors, with any questions ironed out in face-to-face meetings, Daniel Prezioso, a partner at Olden Lane Securities in Chatham, N.J., wrote in a comment letter.

The NCUA approved the proposed subordinated debt regulation for comment Jan. 23 and published it in the Federal Register March 10, triggering the 120-day comment period. With the comment period ended, the agency’s three-person board can hold a final vote at any time. The matter is not on the agenda for the panel’s July meeting, and the agency’s August recess means it likely will not be considered until mid-September at the earliest.

One thing that has changed since the NCUA issued the proposal, however, is an increase in the number of banks utilizing subordinated debt.

With interest rates at historic lows, community banks have accelerated their issuances of subordinated debt, which they can use to bolster regulatory capital levels and, for banks with less than $1 billion of assets, make acquisitions. This month alone, at least 13 banks have issued subordinated debt in amounts ranging from $7.5 million to $60 million.

While credit unions argue that expanded access to the same tool would help them undergird their capital structures in an uncertain economic environment — a step banks aren’t hesitating to take themselves — bank advocates say it would leave depositor-owned credit unions looking increasingly like for-profit banks.

“Credit unions are taking yet another step toward being indistinguishable from banks and should thus carry the same responsibilities as banks including paying taxes,” Justin Underwood, senior director, banking policy at the American Bankers Association, wrote in a comment letter.

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Capital Financial regulations NCUA Community banks Credit unions
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