Credit Union's Capital Raise Should Make Bankers NervousCredit Union JournalNov 17, 20173 min readA Louisiana credit union just reeled in what is believed to be a record amount ofoutside capital.Jefferson Financial Federal Credit Union in Metairie said on Nov. 13 that it hadreceived the first installment of a planned $12 million capital infusion. Theamount is so large that the firm that handled the injection believes it to be thelargest ever for a credit union.At the very least, it represents roughly 7% of all secondary capital held by creditunions, based on data from the National Credit Union Administration.The $563 million-asset credit union’s groundbreaking deal —and the prospect ofmore like it in the months ahead — is certain to further incense banking groupsthat earlier this year pursued litigation in hopes of challenging moves by theNCUA to loosen regulations governing fields of membership and member-business lending.“The ever-expanding list of permissible activities of credit unions is a continuingsource of frustration to community banks everywhere,” said Ron Samford, theCEO of the $381 million-asset Metairie Bank, which competes against Jefferson.“Not paying income taxes, making C&I loans, including anyone who breathes inthe membership ranks, and now, raising capital — how many perks does anindustry need to stay ahead of the competition from community banks?” Samfordadded.While the NCUA has been mulling ways over the past year to expand creditunions’ access to outside capital, low-income designated credit unions such asJefferson have had the authority to raise secondary capital since 1996. ThroughJune, however, fewer than 100 low-income credit unions out of more than 2,000had secondary capital on their books.“There has always been an interest in secondary capital among low-incomedesignated credit unions,” said Mark Rosa, Jefferson’s CEO. “Knowing where tostart may have kept credit unions from proceeding.”Rosa credits an effort by CU Capital Market Solutions, an Overland Park, Kan.,credit union service organization, for spurring credit unions to seek secondarycapital. The firm, which brokered Jefferson’s deal, has arranged more than $100million of secondary capital for credit unions.Adding capital is a big deal for Jefferson, which has grown at a sizzling pacesince late 2015, adding assets at a clip that has eclipsed the increase in its networth. As a result, its net-worth ratio has plummeted by more than 100 basispoints, falling to 9.14% on Sept. 30. Absent the new capital, Jefferson wouldalmost certainly have been forced to hit the brakes on its expansion.As with mutual banks, credit unions primary source of capital is retainedearnings. Credit unions must maintain a retained-earnings ratio of 7% or more tobe considered well-capitalized.“The rationale for [secondary] capital was to provide asset growth to expand bothloan and deposit opportunities for my members, drive down my efficiency ratioand accelerate earnings,” Rosa said. “Without it, my asset growth would have tobe much more measured.”Unlike banks, which face few restrictions to raise capital, credit unions must draftdetailed plans demonstrating how they intend to use the funds and obtain NCUAapproval every time they want to approach investors. In Jefferson’s case, the process took about three months, said Ron Colvin, CU Capital Market Solutions’ chief strategist.“The development of a capital plan and the submission of an application is a verycomprehensive an intricate process requiring a thorough knowledge of theinstitution and its needs, the regulations and how they all interconnect,” Colvinsaid. “Every aspect of Jefferson’s model was evaluated and then developed overa series of meetings.”The daunting prospect of “navigating and applying all the regulations” has likelydeterred many credit unions from seeking secondary capital, Rosa said. That iswhat makes Jefferson Financials’ deal so important for credit unions andworrisome for banks. Just knowing an impactful transaction is possible is likelyserve as an eye-opener for credit unions straining to underwrite breakneckgrowth trends, experts on both sides of the issue believe.Even bigger changes could be just over the horizon. Earlier this year, the NCUAissued a notice of proposed rule making on capital alternatives, which receivedmore than 750 comment letters. While there was broad support for increasedaccess to investor capital among credit unions, bank groups panned the idea.CU Capital Market Solutions CEO Lew Lester downplayed criticism from bankingadvocates, claiming that increased use of secondary capital could create aninvestment opportunity for banks since credit unions can only seek funds frominstitutional investors and other financial institutions. Banks could also receiveCommunity Reinvestment Act credit for investing, he added.One bank seriously considered participating in Jefferson’s capital raise, citing theincome and CRA credit opportunities, before the proposal was scotched by itsboard, Rosa said. He declined to name the bank.“I suspect the idea ... caused anxiety to some” directors, Rosa added.Jefferson’s new capital takes the form of a 10-year note, with interest paymentsonly during the first five years, and 20% reductions in principal during each of thefinal five years.That structure could create problems for institutions that don’t manage theircapital carefully, said Keith Leggett, a retired American Bankers Associationeconomist who writes frequently about credit unions.“Secondary capital is not high-quality capital,” Leggett said. “It has a maturity.Retained earnings are still credit unions’ only source of permanent capital.”By John ReostiNovember 17, 2017
