Secondary capital said to be crucial for credit union balance sheets

Frank Gargano

Credit union leaders and investment experts are recommending subordinated debt offerings and asset-backed securities as key tools for stockpiling capital and fueling loan growth in the unstable months ahead.

During a capital markets symposium at the New York Stock Exchange on Tuesday, speakers offered credit unions advice on managing their balance sheets amid the banking crisis caused by the failures of Signature Bank and Silicon Valley Bank in early March.

"Although credit unions have posted solid operating results and are clearly positioned to provide another century of service to our members, there has lamentably been turmoil in the financial services markets that require our industry to remain hyper-focused on the tenets of sound enterprise risk management," said Rodney Hood, board member and immediate past chairman of the National Credit Union Administration, which hosted the event.

The issuance of subordinated debt — which are higher-risk notes that are paid out last in the event that the organization issuing them declares bankruptcy — has been a valuable tool for ensuring institutions have adequate capital for deepening underwriting programs and expanding access to financial services. The NCUA recently approved amendments to its 2020 rule which raised maturity limits on notes among other changes to make the subordinated debt market more accessible for federal credit unions.

NCUA amends its rules to expand access to subordinated debt

For Olden Lane, a Bridgewater, New Jersey-based financial services firm that specializes in helping credit unions during the issuance process, subordinated debt and asset-backed securities have helped clients stabilize balance sheets and weather sudden market shifts.

"[In this] recent period where we've seen the market whipsaw from extreme conditions during the pandemic to an entirely different set of conditions today, our clients are recognizing the utility in these tools to help them navigate these conditions and in fact make the most of them," said Dan Prezioso, partner at Olden Lane.

One such institution is the $4.1 billion-asset Truliant Federal Credit Union in Winston-Salem, North Carolina, which enlisted the help of the St. Louis-based investment bank Stifel Nicolaus to serve as the placement agent for its $50 million offering in December 2021. The added capital was used to help fuel organic loan growth, according to Truliant FCU President and Chief Executive Todd Hall.

Even for smaller, low-income designated credit unions, subordinated debt provides a critical opportunity to capture member deposits held in other financial institutions by offering competitive loan and dividend rates, said Frank Santucci, managing director of Stifel Investment Services.  

For other larger institutions like Pentagon Federal Credit Union in McLean, Virginia, asset-backed securities supported by home equity loans and other income-generating holdings are instrumental for expansion efforts.

James Schenck, president and CEO of the $36 billion-asset PenFed, explained how pricing was a key measure for managing balance sheets, and held that asset-backed securities were a more equitable option for all involved when helping the credit union grow.

"The great thing about securitizations versus participations is there's amazing depth and breadth in the [asset-backed securities] market where you have pricing transparency that is good for the issuer and for the investor. … For us, securitization was the natural growth process in order to control the balance sheet to stay right about 100% percent loaned out," Schenck said. The credit union closed its first-ever auto loan securitization in August 2022 after issuing more than $460 million in notes. 

As executives at credit unions and other financial institutions continue to weather the fallout from the banking crisis, secondary capital pools of funding remain valuable sources of funding for community development financial institutions.

Cathie Mahon, president and CEO of Inclusiv, which is an association of credit unions serving economically disenfranchised communities, said her organization sees these sources as "the vehicle by which CDFI credit unions and so many other lenders really have been able to grow their business and their balance sheets," she said.