Subordinated Debt
December 5, 2022
Melane Conyers-Ausbrooks
Secretary of the Board
National Credit Union Administration
1775 Duke Street
Alexandria, Virginia 22314
Re: Proposed Rule – Subordinated Debt (RIN: 3133-AF43)
Dear Secretary Conyers-Ausbrooks:
The National Association of State Credit Union Supervisors (NASCUS)[1] submits this letter in response to the National Credit Union Administration’s (NCUA) notice of proposed rulemaking and request for comment regarding Subordinated Debt.
NASCUS supports the NCUA Board’s efforts to amend the current subordinated debt rule. Unfortunately, the proposed rule does not go far enough, particularly for credit unions for which secondary capital authority was initially promulgated. Nor does the proposed rule fix some key issues within the 2020 final rule.
In December 2020, the NCUA passed a new subordinated debt rule (2020 final rule)[2] enabling large, complex credit unions to raise subordinated debt to count toward new risk-based capital standards that apply to federally insured credit unions with more than $500 million in assets. In that rulemaking, the NCUA subjected traditional secondary capital to many of the same provisions being promulgated for complex credit union risk-based capital. As predicted in comments submitted at the time, failing to distinguish between traditional secondary capital and complex credit union risk-based capital has impeded low-income credit union (LICU) use of secondary capital.
The proposed rule upon which we comment today would, if finalized, provide important updates to the subordinated debt rule that would effectively address several critical issues, including allowing Emergency Capital Investment Program investments to be considered Regulatory Capital for the full 30-year term; removing the 20-year cap on the maturity of subordinated debt notes, and clarifying the legal licensing and statement of cash flow requirements. While we support these changes, we urge the NCUA to further refine the 2020 final rule to recognize the differences between secondary capital and complex credit union risk-based capital.
Compliance with the rule is prohibitively expensive and burdensome for small credit unions. It is a mistake to require that institutions seeking to enter simple, bilateral loan agreements comply with rules that were designed for complex securities. Simple transactions with accredited investors are not subject to securities disclosures under the standard exceptions afforded by Congress under 3(a)(5) of the Securities Act of 1933. Despite this clear exemption, the NCUA rule requires expensive and complex securities disclosures. We remain concerned that retaining these disclosures, absent an accommodation for simple bilateral loan agreements, presents a substantial impediment on less-resourced credit unions seeking to issue subordinated debt.
Proposed Changes
Regulatory Capital Treatment for Grandfathered Secondary Capital (GSC)
Established by the Consolidated Appropriations Act of 2021[3], the Emergency Capital Investment Program (ECIP) was created to encourage low and moderate-income community financial institutions to augment their efforts to support small businesses and consumers in their community. The stated maturity of the ECIP subordinated debt note is 15 or 30 years.
The proposed rule would permit Grandfathered Secondary Capital (GSC) treatment for a period of 30 years. NCUA Rules and Regulations, prior to this change, would allow a maximum term of only 20 years. This adjustment will allow credit unions to treat their ECIP investments as Regulatory Capital for the full term of the investment, maximizing the benefit of the program and placing credit unions on par with other depository institutions participating in the program.
Maximum Maturity of Subordinated Debt Instruments
NASCUS supports eliminating the maximum maturity limit of 20 years. The NCUA’s existing 20-year maturity limit is inconsistent with other federal banking agencies’ treatment of subordinated debt issuance and disadvantages credit unions. However, we oppose requiring credit unions to provide an analysis or qualified legal opinion in order to issue any subordinated debt with a term of more than 20 years. Both the SEC and the IRS have found instruments with terms up to 50 years were debt instruments rather than equity.[4] The OCC has explicitly stated that instruments with a perpetual term may qualify as debt.[5] Indeed, there is no set term at which debt becomes equity, and the determination of whether an instrument is a debt or equity is generally a balancing test of several factors, which include term, though the term is often not a primary factor.
We recommend at a minimum that the NCUA accept subordinated debt issuances with terms up to 30 years without requiring a specific legal analysis to that point. Given that term alone is not dispositive on the debt/equity analysis, requiring a separate legal analysis on this point serves only to increase the cost of the transaction and further impede small credit union access to capital as envisioned by Congress.
Qualified Counsel
The NCUA is proposing to remove the phrase “in the relevant jurisdiction(s)” from the definition of “Qualified Counsel.” This change would provide necessary clarification that the rule does not require that attorney(s) be licensed to practice in every jurisdiction that may be relevant to the issuance. We support this change.
Statement of Cash Flows
NASCUS also supports the proposed removal of the “statement of cash flow” from the Pro Forma Financial Statements requirement and replacing it with a requirement for “cash flow projections.” This change better aligns the requirements of the current rule with the standard way credit unions develop their Pro Forma Financial Statements.
Securities Offering Status
The NCUA has determined that subordinated debt notes issued under the subordinated debt rule fit the definition of a security,[6] We urge the NCUA to reconsider.
Consideration should be given to the successful history of LICU issuances of secondary capital as well as the unique nature of the credit union system. Absent demonstrable material risk, the NCUA should avoid imposing burdens on LICU secondary capital, or complex credit union subordinated debt, issuances that disadvantage credit unions compared to their bank peers.
The current rule applies disclosure requirements to credit union issuances of subordinated debt that mimic the requirements of the federal securities laws, even if the credit unions’ issuances to accredited investors would not be subject to such requirements under the securities laws themselves.
Prepayment and Pre-approval Process
Section 702 was part of the NCUA’s 2022 one-third review of its rules and regulations. NASCUS took the opportunity to address a handful of areas for improvement in 702, including the prepayment and preapproval process. As part of the 2020 final rule, the NCUA has removed the criteria for “streamlined” prepayment approval that was previously part of the National Supervisory Policy Manual (NSPM).
With the absence of an automatic approval provision, credit unions are left immobile should a decision exceed 45 days. The state supervisory authorities, as the prudential regulator for federally insured state-chartered credit unions (FISCUs), should be granted deference in approving subordinated debt requests as well as requests for pre-payment of such transactions. With this rulemaking, the NCUA fails to acknowledge the role of states in approving such transactions.
As stated in our comments to the NCUA on the 2020 proposed rule, NASCUS is opposed to limiting FISCUs to instruments allowed for FCUs. The state system has a long history of leading the way in innovative products and services for credit unions and we oppose an overly preemptive approach to state authority.[7]
We encourage the NCUA to work with state regulators to evaluate whether additional flexibility in prepayment rules would enhance safety and soundness.[8] Furthermore, the NCUA, state regulators, and stakeholders should discuss what guidelines should be published to provide more certainty to institutions regarding the metrics for evaluating applications for prepayment.
Covenant Provisions
The ability of lenders to incorporate covenant provisions into financing agreements is standard commercial practice. It is our understanding in commercial debt transactions that default covenants are commonly negotiated and often expected. While we support limiting the ability of covenants to accelerate repayment, we want to ensure the rule provides for the inclusion of covenants that are commonly accepted in the marketplace. Furthermore, the inclusion of traditional elements of debt transactions supports the characterization of these issuances as Debt. Covenants are standard in bank debt obligations and allow parties to restructure deals in the event of material changes to the condition of the issuer.
Conclusion
We thank the NCUA for the opportunity to submit the above comments for consideration in the development of a final rule addressing necessary changes to Subordinated Debt. While NASCUS appreciates the NCUA’s efforts to amend the current rule and the changes proposed, we strongly encourage the agency to consider additional rulemaking addressing the comments above. We also encourage the NCUA to continue working with state supervisory authorities to avoid additional burdens on federally insured state-chartered credit unions.
Sincerely,
Sarah Stevenson
Vice President, Regulatory Affairs
[1] NASCUS is the professional association of the nation’s forty-five state credit union regulatory agencies that charter and supervise over 1900 state credit unions. NASCUS membership includes state regulatory agencies, state chartered and federally chartered credit unions, and other important stakeholders in the state system. State-chartered credit unions hold over half of the $2.2 trillion assets in the credit union system and are proud to represent nearly half of the 129 million members.
[2] 86 FR 11060
[3] Consolidated Appropriations Act, 2021, Pub. L. 116–260 (H.R. 133), Dec. 27, 2020
[4] SEC No-Action Ltr., National Rural Utilities Coop. Fin. Corp. (Feb. 7, 1972)
[5] OCC Interpretive Letter No. 1115 (Apr. 3, 2009).
[6] Fed. Reg. Vol. 86, No.34, p.11063
[7] See NASCUS Comments NCUA-2020-0016-002
[8] The regulatory structure for banks allows prepayment without OC approval of subordinated debt not included in Tier 2 Capital. Capitalized credit unions should have the same ability to prepay, without regulatory approval, the portion of subordinated debt not included in net worth.