Credit Union's Capital Raise Should Make Bankers Nervous

A Louisiana credit union just reeled in what is believed to be a record amount of

outside capital.

Jefferson Financial Federal Credit Union in Metairie said on Nov. 13 that it had

received the first installment of a planned $12 million capital infusion. The

amount is so large that the firm that handled the injection believes it to be the

largest ever for a credit union.

At the very least, it represents roughly 7% of all secondary capital held by credit

unions, based on data from the National Credit Union Administration.

The $563 million-asset credit union’s groundbreaking deal —and the prospect of

more like it in the months ahead — is certain to further incense banking groups

that earlier this year pursued litigation in hopes of challenging moves by the

NCUA to loosen regulations governing fields of membership and member-

business lending.

“The ever-expanding list of permissible activities of credit unions is a continuing

source of frustration to community banks everywhere,” said Ron Samford, the

CEO of the $381 million-asset Metairie Bank, which competes against Jefferson.

“Not paying income taxes, making C&I loans, including anyone who breathes in

the membership ranks, and now, raising capital — how many perks does an

industry need to stay ahead of the competition from community banks?” Samford

added.

While the NCUA has been mulling ways over the past year to expand credit

unions’ access to outside capital, low-income designated credit unions such as

Jefferson have had the authority to raise secondary capital since 1996. Through

June, however, fewer than 100 low-income credit unions out of more than 2,000

had secondary capital on their books.

“There has always been an interest in secondary capital among low-income

designated credit unions,” said Mark Rosa, Jefferson’s CEO. “Knowing where to

start 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 secondary

capital. The firm, which brokered Jefferson’s deal, has arranged more than $100

million of secondary capital for credit unions.

Adding capital is a big deal for Jefferson, which has grown at a sizzling pace

since late 2015, adding assets at a clip that has eclipsed the increase in its net

worth. As a result, its net-worth ratio has plummeted by more than 100 basis

points, falling to 9.14% on Sept. 30. Absent the new capital, Jefferson would

almost certainly have been forced to hit the brakes on its expansion.

As with mutual banks, credit unions primary source of capital is retained

earnings. Credit unions must maintain a retained-earnings ratio of 7% or more to

be considered well-capitalized.

“The rationale for [secondary] capital was to provide asset growth to expand both

loan and deposit opportunities for my members, drive down my efficiency ratio

and accelerate earnings,” Rosa said. “Without it, my asset growth would have to

be much more measured.”

Unlike banks, which face few restrictions to raise capital, credit unions must draft

detailed plans demonstrating how they intend to use the funds and obtain NCUA

approval 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 very

comprehensive an intricate process requiring a thorough knowledge of the

institution and its needs, the regulations and how they all interconnect,” Colvin

said. “Every aspect of Jefferson’s model was evaluated and then developed over

a series of meetings.”

The daunting prospect of “navigating and applying all the regulations” has likely

deterred many credit unions from seeking secondary capital, Rosa said. That is

what makes Jefferson Financials’ deal so important for credit unions and

worrisome for banks. Just knowing an impactful transaction is possible is likely

serve as an eye-opener for credit unions straining to underwrite breakneck

growth trends, experts on both sides of the issue believe.

Even bigger changes could be just over the horizon. Earlier this year, the NCUA

issued a notice of proposed rule making on capital alternatives, which received

more than 750 comment letters. While there was broad support for increased

access to investor capital among credit unions, bank groups panned the idea.

CU Capital Market Solutions CEO Lew Lester downplayed criticism from banking

advocates, claiming that increased use of secondary capital could create an

investment opportunity for banks since credit unions can only seek funds from

institutional investors and other financial institutions. Banks could also receive

Community Reinvestment Act credit for investing, he added.

One bank seriously considered participating in Jefferson’s capital raise, citing the

income and CRA credit opportunities, before the proposal was scotched by its

board, 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 payments

only during the first five years, and 20% reductions in principal during each of the

final five years.

That structure could create problems for institutions that don’t manage their

capital carefully, said Keith Leggett, a retired American Bankers Association

economist 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 Reosti

November 17, 2017