Sub debt rule adopted by NCUA after years of work by agency, states

(Dec. 18, 2020) Well-capitalized, federally insured credit unions could count subordinated debt as capital for risk-based net worth purposes under a new rule approved by the NCUA Board at its meeting Thursday.

The decision has been long sought by the state system, which would bring regulation of federally insured credit unions in line with regulations of some states that already allow their credit unions to issue secondary capital, including in the form of subordinated debt.

Thursday’s meeting was the first of two meetings for the board this week; it also meets today to consider its 2021 budget and the overhead transfer rate (OTR); see story below.

Key provisions of the final rule (137 pages long), approved unanimously by the board, include:

  • Permission for low-income-designated credit unions (LICUs), complex credit unions, and new credit unions to issue subordinated debt for purposes of regulatory capital treatment.
  • A maximum maturity of 20 years to be imposed on debt issued (with a minimum maturity of 5 years), and a minimum denomination of $100,000. The agency noted the maturity limit helps to clarify that the financial instruments issued are debt – and not equity in the credit unions (which are solely owned by the members; credit unions do not issue stock).
  • Prohibitions on a credit union from being both an issuer and investor unless the credit union meets certain conditions related to mergers.
  • A section addressing new rules and limits for making loans to other credit unions, including investing in subordinated debt at those credit unions.

The effective date for the final rule is Jan. 1, 2022 (which coincides with implementation of the new risk-based capital rule).

The final rule also grandfathers any secondary capital issued before the effective date of this final rule and preserves that capital’s Regulatory Capital treatment for 20 years after the effective date, the agency said. The “grandfathered secondary capital” generally, according to NCUA, remains subject to requirements in the agency’s current secondary capital rule.

The agency also noted a number of additions and amendments to other parts and sections of NCUA’s regulations through the new rule, including:

  • Cohering changes to part 741 of NCUA rules to account for the other changes proposed in the final rule that apply to federally insured, state-chartered credit unions (FISCUs);
  • A new section addressing limits on loans to other credit unions;
  • An expansion of the borrowing rule to clarify that federal credit unions (FCUs) can borrow from any source;
  • Revisions to the final RBC Rule and the payout priorities in an involuntary liquidation rule to account for subordinated debt and grandfathered secondary capital.

Several changes in the final from the proposal have also been made, the agency said, including:

  • Amendment of the definition of “accredited Investor;”
  • Provision of a longer timeframe in which to issue subordinated debt after approval;
  • Reduction in the required number of years of pro forma financial statements an issuing credit union must provide with its application (from five years to two years);
  • Clarification of the prohibition on subordinated debt issuances outside of the United States;
  • Clarification that the NCUA Board will publish a fee schedule only if it makes a determination to charge a fee.

In announcing the unanimous vote on the new rule, NCUA Board Chairman Rodney Hood said he was pleased with the balance struck with the final rule. “I support giving complex credit unions the authority to prudently use subordinated debt as an additional tool to comply with risk-based capital requirements, and newly chartered credit unions the ability to use this tool to get up and running,” he said.

Last summer, in a comment letter on the proposal, NASCUS wrote that the development of the rule is an essential complement to the implementation of a risk-based capital rule. “Including Subordinated Debt in risk-based capital ratio calculations is consistent with the statutory purposes of both state and federal credit unions and is sound public policy,” NASCUS wrote. “This rule will help credit unions and their members, protect the share insurance fund, and help place natural person credit unions in the United States on par with credit unions and other depository institutions worldwide.”

Reaction from the banking industry to the board’s action was negative, as illustrated by comments from two of the industry’s largest advocacy groups. The American Bankers Association (ABA), in an op-ed published the day before the board acted, said it “firmly opposed” the final rule, claiming it will undermine the “statutory principle that credit unions should serve consumers of small means.” The Independent Community Bankers of America (ICBA) said in press statement Thursday that the rule will “allow outside investors to exploit the credit union tax subsidy.”

Final rule: Subordinated debt (Parts 701, 702, 709, and 741)