In February, GreenState Credit Union (GreenState), the country's 18th largest credit union, completed the private placement of $100 million of fixed-to-floating rate social subordinated notes. The transaction represented the second-largest credit union subordinated debt transaction ever completed in the private market. As the first such offering that adheres to social bond principles, it also signals the potential for a broader alignment between the credit union movement and the growing ESG-eligible investment community.
GreenState's notes were issued in accordance with its social financing framework, which allocates net proceeds to support the credit union's minority homeownership initiative, designed to help close Iowa's racial homeownership gap. S&P Global Ratings, a leading global independent provider of ESG research and ratings, reviewed and verified that GreenState's framework is consistent with the current social bond principles, as published by the International Capital Market Association.
GreenState's CEO, Jeff Disterhoft,
Since 1996, low-income designated credit unions (LICUs) have been authorized to accept uninsured secondary capital from institutions. The capital is intended (i) to provide an alternative — beyond setting aside a portion of earnings — to support additional lending and financial services in local communities and (ii) to absorb potential losses, thereby reducing the potential for a credit union to fail.
As a general matter, LICUs face a twofold growth challenge. First, the unmet need among their target population is so large that LICUs typically grow at higher-than-average rates. Second, the high cost to serve a customer segment with relatively small balances and transactions tends to squeeze return on equity. To meet growing demand, LICUs were allowed to access sources of capital beyond their own earnings.
In 2006, the National Credit Union Administration (NCUA) ushered in a series of regulatory changes, which imposed more stringent guidelines on the particulars of secondary capital notes issued by LICUs. The changes were designed to curtail some emerging high-risk practices. The new regulations preceded a sharp uptick in secondary capital issuance, beginning in mid-2009, as credit unions looked to rebuild capital and liquidity in the wake of the financial crisis. Total secondary capital doubled from Q1 2009 to Q1 2012.
Beginning in late 2017, stronger credit unions began to embrace secondary capital as a growth driver. This awakening, combined with an additional rule change, contributed to the recent explosion in credit union subordinated debt.
Since early 2019, the subordinated debt market for credit unions has exploded, doubling from Q1 2019 to Q2 2021 and then again from Q3 2021 to Q1 2022. The frenzy has been driven by larger and stronger credit unions using subordinated debt to finance acquisitions or stronger rates of organic growth. After COVID, larger credit unions also turned to subordinated debt to maintain net worth ratios in the face of unprecedented deposit growth driven by pandemic-related government stimulus.
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In recent years, investors and other corporate stakeholders have shown increasing interest in environmental, social and governance (ESG) matters. At its core, ESG is a means by which companies can be evaluated against a broad range of ethical and socially conscious efforts. ESG factors measure the nonfinancial impacts of particular investments and companies.
Net flows into funds labeled ESG have skyrocketed in recent years. With consumers and investors placing a growing value on ESG, industry leaders have responded by (1) issuing comprehensive sustainability reports, (2) expanding ESG disclosures in their annual reports, (3) providing information to ESG rating agencies and (4) publicly communicating ESG commitments.
While early ESG efforts aimed to exclude investments in companies with undesirable attributes, the more recent incarnation has aimed to favorably distinguish companies making positive contributions to the elements of ESG. Such an approach highlights environmental and social issues as core elements of a company's strategic positioning.
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Simply, ESG investing can provide investors with the opportunity to align their values with their investments. By investing in companies that prioritize ESG factors, investors can have a positive social and environmental impact while generating financial returns.
The mission of credit unions and the principles of ESG investing share many similarities, making for a natural intersection. As member-owned nonprofit cooperatives, credit unions prioritize serving their communities and promoting financial inclusion and place the needs of their members ahead of profit, aligning them with the social aspects of ESG principles. In addition, credit unions often focus on supporting underserved populations, such as low-income individuals, small businesses and rural communities, akin to the social responsibility pillar of ESG investing.
ESG investing is a growing trend among investors who prioritize companies or organizations that meet certain criteria. As a general matter, the community-oriented mission and focus on social responsibility espoused by the nation's credit unions should be viewed favorably by ESG investors and, as the GreenState transaction illustrates, investing in credit unions that prioritize sustainability and social responsibility can provide ESG investors with a sense of purpose and alignment with their values.
Going forward, credit union subordinated debt offerings which are structured to support the issuing credit union's mission can be an attractive investment opportunity for ESG investors looking to earn a competitive return while supporting an organization that shares their values. The intersection of ESG principles and the mission of credit unions offers a unique opportunity for investors to support socially responsible organizations while earning a competitive return. We expect more of these transactions in the coming months and years.
