John Heasley

John Heasley
TBA General Counsel

Credit unions get aggressive in push for sub debt

Credit unions get aggressive in push for sub debt In late January, the NCUA, the federal credit union regulator, issued a proposed rule to allow credit unions with more than $500 million in assets to issue subordinated debt. Those 285 credit unions represent more than $730 billion in assets; 34 Texas credit unions are over $500 million.

Basically, you have a proposal where large non-profit, non-taxpaying entities could go to for-profit hedge funds and institutional investors to get funds to grow or to even purchase banks.

We have come a long way from when credit unions were established over a century ago to meet the needs of underserved communities. Teachers, factory workers and government workers were encouraged to establish credit unions to obtain consumer credit and deposit services at a time when they were not available to the working man. Single common bond credit unions still exist but they have been eclipsed in profitability and influence by their larger, more diverse and more profitable compatriots.

The Texas Bankers Association has been in an ongoing battle with credit unions since 1990. TBA bankers funded a lawsuit against a Houston credit union, and the ABA joined with other state bankers associations to assert that credit unions were violating the single common bond requirement that dates back to a federal law passed in 1934.

The TBA suit was prevailing in the lower courts and was eventually joined with a North Carolina case challenging multiple common bonds, NCUA v. First National Bank and Trust, that had reached the U.S. Supreme Court.

In February 1998, the Supreme Court ruled that federal credit unions may not consist of more than one occupational group having a single common bond. The ruling caused the credit union industry to sound the alarm bells and tell Congress that millions of their members would be forced to leave their credit unions.

The House Speaker at that time, Newt Gingrich, had a bill ready that would allow for multiple common bonds. In April 1998, he obtained passage of the bill in the House. Observers at that time believed he was influenced to act because of waning Republican fortunes and the desire to help middle-income and more affluent suburbanites, many of whom were credit union members, a core Republican constituency.

The Senate was slow to act until 6,000 angry credit union advocates showed up at the capitol. The Senate passed the Gingrich bill in July and President Clinton quickly signed it. Credit unions continued to grow organically and with the inclusion of other groups.

Since that time, credit unions have continued to act, with a very compliant regulator, to expand their geographic reach. They have also pushed to greatly increase their ability to make business loans, even to borrowers that are not credit union members.

Up until a few years ago, many credit unions converted to mutual thrift charters subjecting them to federal taxation, something that puts them on a level playing field with banks. Thirty-five credit unions either converted to thrifts or merged with FDIC-insured institutions. Many of those subsequently converted to stock ownership.

Two of the largest conversions involved billion-dollar credit unions in the DFW area in 2006. House committee chair and Texan Chairman Jeb Hensarling had to prod the NCUA to permit the conversions. The NCUA subsequently changed the rules to make it punitive and costly for a credit union to become a mutual thrift. There have only been a few transactions as a result of the rule change.

The NCUA was probably motivated by two things: antipathy toward banks by the credit union “movement,” and the desire to protect the National Credit Union Share Insurance Fund, the industry’s equivalent of the FDIC.

The latest gambit by credit unions to grow is by purchasing banks. The NCUA has authorized credit union purchases of more than 30 banks according to CU Today, an industry magazine. In Florida alone, 12 banks were acquired. Because of this unusually high number, the Florida Bankers Association’s CEO temporarily relocated to Washington, D.C., last fall to educate legislators on these developments.

So, you have acquirors, advantaged by their tax status, acquiring tax-paying banks. There is also some speculation that the NCUA allows for more liberal accounting rules on items such as goodwill to enhance the balance sheets of the purchasers.

January’s NCUA proposal allowing credit unions to issue subordinated debt is ostensibly to allow additional “flexibility” to deal with coming risk-based capital requirements, according to the NCUA chairman. The proposal raises a number of issues: Will the issuance of sub debt change the mission of credit unions, charged with meeting the needs of “underserved” communities, to prioritize payments to hedge funds? Is this just another way to allow large credit unions to accelerate their growth? What will keep them from using these funds to continue purchasing banks?