Seizing the Subordinated Debt Market Opportunity
The NCUA Low-Income Designation Program provides a number of regulatory benefits to eligible credit unions and the members they serve, including the power to obtain additional capital. As the number of Designated Low-Income Credit Unions (LICUs) has grown and the NCUA’s Final Rule on Subordinated Debt has come into effect expanding issuer eligibility, the industry has more opportunity than ever to realizing the potential benefits of the subordinated debt market. .
What is subordinated debt?
Subordinated debt is an unsecured loan and is treated as regulatory capital due to its subordination to all other creditors. Additionally, subordinated debt is seen as another “layer of protection” subordinated to NCUSIF. As shown below, subordinated debt is unsecured and is only included in statutory net worth for LICUs. Subordinated debt issued by a non-LICU will not be included in the net worth or net worth ratio. Regardless of designation, all credit unions that qualify to issue subordinated debt may include subordinated debt in their risk-based capital ratio (RBC).
Regulatory net worth
How is subordinated debt structured?
Over the years, the broader subordinated debt market has grown and evolved. A total of $33.8 billion was issued from 2014 to mid-2021, with a significant peak in issuance in 2020. The most common structure, accounting for around 95% of this volume, is the 5 non-call structure. at 10 years (10NC5). Its features include:
- Maturity 10 years with redemption at par after 5 years, fixed-variable coupon
- Fixed for first five years, becomes floating last five years if not called
NCUA regulations require subordinated debt issued by credit unions to have a maturity of at least five years, but no longer than 20 years. In addition, subordinated debt cannot be repaid for five years from the date of issue. Once subordinated debt ages within five years of stated maturity, its regulatory capital value decreases by 20% each year, as shown in the table below.
Regulatory capital weighting
Why issue subordinated debt?
Qualifying credit unions may choose to issue subordinated debt for a number of reasons, including to:
1. Develop products/services and loans
2. Support growth
- In-store purchases
- Mergers and Acquisitions
3. Diversify sources of capital
- Increase statutory capital
As credit unions evaluate their unique use case, it is important to understand that subordinated debt is not perpetual capital. When developing a strategic plan for the deployment of subordinated debt, the institution must ensure that the application of subordinated debt can sufficiently cover the cost of carrying the debt, the additional leverage expenses and the repayment deadlines.
How to prepare to issue subordinated debt
The new NCUA rule on subordinated debt went into effect on January 1, 2022, although LICUs can issue before that. In addition to developing a clear use case including a detailed strategy for deploying subordinated debt, institutions interested in becoming issuers should take the time to adequately prepare for internal and external audiences. Part of this process includes preparing investor presentations, which typically include detailed information such as the following:
- Offer conditions sheet
- Management biographies
- Balance sheet and income statement highlights
- Pro forma finance and strategic plan
Whether a qualifying credit union is looking to drive balance sheet growth, merge, or increase regulatory capital levels, the opportunity in the subordinated debt market is worth considering as part of the long-term strategy. of an avant-garde cooperative. Partnering with an experienced investment professional and balance sheet strategy consultant to thoroughly evaluate your options is a solid starting point in the subordinated debt market, or any other market.
Brittany Rollek is Managing Director of Client Experience for Dallas-based ALM First Financial Advisors.