GRAPH OF THE WEEK: Subordinated Debt Levels Surge

• In late 2021, the U.S. Treasury implemented the Emergency Capital Investment Program (ECIP) to help provide capital access to financial institution (including credit unions) that serve low-income populations (namely CDFIs and MDIs), available through an application process. The application window is now closed, but funds are still being distributed to approved credit unions. These grants combined with recent changes to regulations from the National Credit Union Administration to result in a surge in the number of credit unions with subordinated debt and the dollar amount being held.
• Low-income credit unions (LICUs) have at times issued subordinated debt to expand their operations, typically using the capital for lending expansion and servicing, or for the acquisition of newer and more efficient financial technology. The advantage of subordinated debt is that credit unions can make loans or provide other services to members with borrowed money that is counted as net worth and thus not counted against their capitalization.
• Though the Treasury ECIP grants are the primary driver of 2022’s record expansion in subordinated debt balances, it is important to note a corresponding recent change in NCUA capitalization regulations related to this secondary capital. As of the beginning of 2022, the NCUA expanded the number of credit unions eligible to issue subordinated debt to include complex credit unions (those with more than $500 million in total assets) and newly chartered credit unions – even those without LICU designations. This change was made in conjunction with the release of new regulatory capitalization ratios — risk-based capital and the Complex Credit Union Leverage Ratio — which are also designed for complex credit unions. Although only LICUs are permitted to include subordinated debt in net worth, complex and new credit unions can use it to bolster the new RBC value. By allowing these credit unions to issue subordinated debt, the NCUA is providing these institutions with a new route to adjust to the new regulatory thresholds.
• The Treasury ECIP investments spurred a 170.8% quarterly increase in the dollar value of subordinated debt at credit unions industrywide. As of the second quarter of 2022, 132 credit unions reported subordinated debt. This is up from 86 institutions in the first quarter of 2022 and 80 in the fourth quarter of 2021, before the ECIP program really took effect. Looking forward, ECIP is temporary, but the NCUA regulatory changes are ongoing. It remains to be seen if more complex credit unions will use subordinated debt to help finance growth while maintaining required capital balances.

Editor’s note: This story has been updated to include the impact of the U.S. Treasury’s Emergency Capital Investment Program (ECIP) on credit union industry subordinated debt balances.