Subordinated debt rule gives big credit unions new path to growth

After six years of discussion and debate, the National Credit Union Administration’s board voted Thursday to approve a rule clearing the way for large credit unions that don’t possess a low-income designation to issue subordinated debt.

Board member Todd Harper expressed concern about the rule’s impact on small, low-income credit unions but ultimately voted yes. However, he voted against issuing proposed rules addressing shared facility requirements, mortgage servicing rights and overdraft policy.

Chairman Rodney Hood and Kyle Hauptman, who joined NCUA’s board Monday, also voted for the subordinated debt rule.

“It was a long time coming,” Harper said of the subordinated debt rule.

Hood characterized it as “reasonable and responsible regulatory relief.”

The new rule’s roots stretch back to December 2014, when then-Chairwoman Debbie Matz assembled a working group to study the issue.

The subordinated debt rule will not take effect until Jan. 1, 2022. After that date, hundreds of credit unions with at least $500 million of assets and that don’t have a low-income designation will be permitted to sell debt to investors and use the proceeds to satisfy risk-based capital requirements.

At least one large credit union, the $14.4 billion-asset First Technology Federal Credit Union in San Jose, Calif., has identified itself as a potential test case, offering to “blaze the trail” with ratings agencies, law firms and other groups to test whether a market for private placements of investment-grade credit union debt can be nursed into existence.

First Technology President and CEO Greg Mitchell said he foresees an outcome where large credit unions pool debt issuances to raise hundreds of millions of dollars from institutional investors. Rick Mayfield, an NCUA capital markets specialist, said Thursday that nothing in the rule prevents pooling.

Unsurprisingly, banks, who already compete with tax-exempt credit unions for loans and other business, aren’t keen on competing for investor capital. American Bankers Association President and CEO Rob Nichols blasted the rule Wednesday in an op-ed where he raised the specter of investors influencing the management of member-owned credit unions with outstanding debt.

“Congress should be concerned about this latest step by NCUA to further blur the lines between large credit unions and taxpaying banks,” Nichols added Thursday in a statement. “NCUA’s disappointing decision to allow large credit unions that already benefit from a tax exemption to issue subordinated debt to sophisticated, for-profit investors will only fuel their increasing market share, crowding out smaller credit unions and community banks.”

Independent Community Bankers of America President and CEO Rebeca Romero Rainey sounded a similar note, claiming the rule would “fuel runaway growth of an industry that has abandoned its founding mission to serve people of modest means,” in a statement Thursday.

Under regulations in place now, low-income-designated credit unions are permitted to issue subordinated debt and include the proceeds to calculate their net worth.

However, these credit unions have made sparing use of the dispensation. According to NCUA, 75 institutions currently have outstanding debt totaling $345 million. Historically, low-income credit unions have accessed debt in small quantities, with some issuances as small as $7,500, according to Harper.

In other actions Thursday, the board approved proposed rules that would update its definition of permissible shared service facilities, allow federal credit unions to purchase mortgage servicing rights and amend overdraft procedures to give individual credit unions more leeway in handling insufficient funds transactions.

Harper said he does not object in principle to allowing credit unions to purchase mortgage servicing rights. He argued the proposed rule lacks “important guardrails” to protect against liquidity risk and ensure consumer protection safeguards.

“Mortgage servicing is a complex and risk-laden business that not only impacts safety and soundness, but also consumers,” Harper said.

On overdraft, Harper claimed the rule unveiled Thursday prioritized the needs of credit unions over members, adding policies at many federal credit unions “are fundamentally detrimental to members and inconsistent with the very definition of ‘federal credit union.'”

The rule eliminates a requirement that federal credit union members repay overdrafts within 45 days or obtain a loan from their institution to satisfy the debt. Instead, it permits individual credit unions to establish a time limit for covering overdrafts “that is both reasonable and applicable to all members.”

Harper, however, cited the absence of measures to protect members from excessive fees. Indeed, by potentially extending the timeframe for negative balance resolution beyond 45 days, the proposed rule actually lengthens the period during which a credit union can maintain lien position over its members, Harper said.

Harper also criticized the proposed rule on shared services, which permits any automatic teller machine or shared branch to count as a service facility for multiple-common-bond credit unions.

The Federal Credit Union Act requires institutions to maintain a service facility in reasonable proximity to members. The current rule requires institutions to hold an ownership stake in a branch or ATM for them to qualify.

According to Harper, credit union members, especially those in underserved neighborhoods “prefer and need personalized service… A leased ATM would not serve the needs of an under-resourced community well.”

For his part, Hood called the proposed shared services rule “good public policy that will allow individuals greater access to affordable products and services — especially in underserved and low-income areas.”

“These are changes that really should have happened a long time ago,” Hood added.

As part of the proposed rule, NCUA is asking commenters to advise whether it should amend the service facility definition even further to include websites and mobile banking applications. The comment period for all three proposed rules is 30 days from their publication in the Federal Register.


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