NCUA Board Member Todd M. Harper Statement on the Subordinated Debt Final Rule

As Prepared for Delivery on December 17, 2020

Myra, Tom, Rick and Justin, thank you for your presentation and for your very hard work over several years on this much-anticipated final rule. A well-structured regulatory system of subordinated debt will protect the credit union system from losses. It also has the potential to expand access to financial services for underserved communities.

When the NCUA Board considered the subordinated debt proposed rule at the start of the year, I said that “capital is king.” That is still true. Clarifying the ability of certain credit unions to issue subordinated debt will better protect federally insured credit unions, their members, and taxpayers from losses to the Share Insurance Fund by creating a buffer against the capital losses caused by economic downturns, fraud, and management errors. In turn, that capital will strengthen the resilience of the system.

In this final rule, we create an overarching framework to govern the subordinated debt issued by low-income credit unions, complex credit unions, new credit unions, and credit unions anticipating becoming complex or low-income within 24 months of issuing the subordinated debt. In developing this rule, staff have also constructed a workable and appropriate regulatory structure that will well serve the credit unions comprising 91 percent of the system’s assets.

Safeguard the Access of Low-Income Credit Unions

With appropriate guardrails in place, a number of low-income credit unions have prudently used secondary capital, a form of subordinated debt, for many years. This secondary capital has increased regulatory capital levels to protect against future losses and serve as a foundation for strategic initiatives and growth. These funds have also served as a valuable resource to some low-income credit unions, enabling them to provide much-needed lending and other member services to under-resourced communities.

According to Call Reports, we currently have 75 credit unions issuing $349 million in secondary capital. Because these issuances support efforts to advance economic equality and justice around our country, my first guiding principle in considering this rule was to ensure that we did no harm to those low-income credit unions that are intensely focused on serving communities of color and people in need. In other words, I want to preserve low-income credit unions’ access to secondary capital.

During this rulemaking, some stakeholders have expressed apprehensions that this regulation will hamper the efforts of smaller community development credit unions to obtain modest amounts of secondary capital. Inclusiv — a group dedicated to organizing, supporting and investing in community development credit unions — noted in its comment letter that it has supported efforts to originate secondary capital loans of as little as $7,500.

Before voting today, I want to ensure that this final rule will neither cut off that capital pipeline nor make it cost prohibitive to access small amounts of secondary capital. In that regard, Tom, will you explain for us how this final rule will not preclude a small, low-income credit union from proceeding with a small-scale, bilateral issuance as the current secondary capital rule permits?

Tom, I have also heard concerns from community development credit unions about incorporating secondary capital into a subordinated debt structure that must comply with applicable securities laws. Some have said a small, low-income credit union might forgo issuing secondary capital given the costs of hiring a securities lawyer to prepare disclosure documents. In that regard, what new compliance requirements are we actually imposing on credit unions related to securities law and is this necessary?

Following up and comparing the current process to the final rule, what do you believe will be the increased time and resources for low-income credit union applicants? And, could the industry develop standardized securities disclosures to facilitate access to secondary capital under this new rule?

That response gives me hope that while there will be short-term costs in adjusting to the new system, small, community development credit unions in the long term will still be able to access the secondary capital that they need to best serve their members. The agency needs to monitor this rule’s implementation to ensure that result.

Finally, it occurs to me that pooling subordinated debt may be a good way to help smaller credit unions with their issuances. Pooling could also create a diversified portfolio of assets that may be more attractive to investors. Tom, will this final rule allow for pooling?

Preserve the System’s Cooperative Structure

In considering this final rule, another principle guided my decision: the need to maintain the mutual, cooperative one-person, one-vote structure of the credit union system. The introduction of funds into complex credit unions from parties outside of the credit union system has the potential to undermine the basis for the federal tax exemption.

To preserve the cooperative structure of the credit union system, this final rule appropriately limits that outside funding to debt. In doing so, we are protecting against the erosion of the mutual structure of the credit union system. The purchasers of the debt will lack voting rights and ownership in the issuing credit union.

Moreover, the final rule’s provisions will prohibit negative covenants to ensure that the investors in subordinated debt cannot interfere in the operation of the credit union or impose conditions that will affect the safety and soundness of the credit union or the NCUA’s authority as a regulator and insurer. These are important guardrails.

Protect the Investors Purchasing Subordinated Debt

Investor protection was the final principle on my mind when reviewing this regulation. This rule expands who can purchase subordinated debt from certain institutions to a broader group of investors, including natural persons who meet certain tests.

Subordinated debt has real risk attached to it. In the best case, investors can expect a steady stream of income for a period of time. In the worst case, investors may lose their entire investment. We, therefore, need to provide the investors in subordinated debt with appropriate disclosures, so they can better understand the risks.

To address my concerns about investor protection, the final rule requires strong, clear disclosures. To protect elderly retirees, among others, staff have worked to ensure that the disclosures provided with any issued subordinated debt will be transparent, accurate, and verifiable. And, these disclosures will be absolutely clear that the subordinated debt product is not federally insured.

Other Important Aspects of the Rule

Finally, and briefly, three other aspects of this rule merit attention today. First, in preventing a credit union that issues subordinated debt from purchasing the subordinated debt of other credit unions, the final rule protects against loss transmission that could occur if one credit union fails. As we know far too well from the domino effect during the corporate credit union crisis, the downstream consequences of a failure at one institution have the potential to magnify and grow if not properly abated in advance through sound regulatory policy.

Second, in terms of the NCUA’s approval process, I like that this final rule preserves the ability of the agency to ask for additional information and documents, when needed, to assess the viability of the overall transaction. This reservation of authority is appropriate.

Finally, I appreciate the rule’s conflict-of-interest provisions. The regulation will prevent senior management, board members, and their immediate families from purchasing the subordinated debt of the credit union at which they work or volunteer. The rule will also codify a prohibition on the payment of direct or indirect compensation in the form of commissions, bonuses, or similar payments to any employee of the issuing credit union or a credit union service organization that assists in the marketing and sale of the issuing credit union’s subordinated debt.

In closing, this final rule is an important step forward for the credit union industry. In all, this rule maintains the cooperative structure of the system and minimizes issues related to state and federal tax exemptions. It also contains appropriate guardrails to protect credit unions, investors, and taxpayers. Ultimately, this well-considered final rule has the potential to positively transform the credit union industry over the long term. This final rule is a good one, and I will support it.