Supplemental Capital Is No Panacea

Supplemental capital is a useful tool that is long overdue; however, it is not without risk and potential complications.


The NCUA can provide a list of low income-designated credit unions (LICUs) that have used secondary capital. These institutions typically get a long-term loan from the National Federation of Community Development Credit Unions, which has a web page full of success stories of its own.

We do the same thing ourselves this week on, with stories from credit unions in Virginia and Oregon. That’s all well and good, but it’s hardly the whole story.  Look a little deeper, and things are not quite as rosy. Worse, the whole discussion is threatening to become far more complicated. 

To this point, secondary capital for credit unions has been little more than a means of stretching the value of the charitable resources available to support LICUs. The NCUA’s first move to change this is to offer capital markets investors “greater clarity and confidence,” whatever that means. The regulator has also promised to include a new “supplemental capital rule” in the next iteration of its risk-based capital (RBC) proposal.

Before we go any further with any of this, it seems worthwhile to review some basic facts.



Primary capital is equity whether it is owned by stockholders, as in a bank, or it is the net worth of retained earnings, as in a credit union. The difference is that banks can issue, buy, and sell their equity. Credit unions cannot.

Secondary capital is subordinated debt. No matter what name it goes by — secondary, supplemental, Tier II — and no matter what its terms, it is all some form of subordinated debt. Various names indicate different regulatory structures, but fundamentally, they are distinctions without any real difference.

Capital itself is an indispensable foundation for the safe, sound, responsible management of every financial institution. It serves as a cushion for operations, a catastrophic loan-loss reserve, and a bulwark for the insurance fund. 

Capital is not a tool for active risk management. Even for banks, it is too inflexible, inefficient, and expensive to be effective in this role. This is a key reason why the Basel risk-based capital model has never worked well and why leading bank regulators are moving away from it.

Capital is even less-suited to a risk management role for credit unions because most can only raise capital slowly through retained earnings. Banks, at least, have myriad ways of raising money fast.

This means RBC is a bad idea for credit unions no matter how the NCUA revises its proposal, and regardless of whether it includes access to supplemental capital. 

Supplemental capital is a powerful potential tool, and if the NCUA continues to push for an RBC rule, universal access to supplemental capital for natural person credit unions is not only likely, it is necessary. But it won’t be without risk and difficulty.

On a practical basis, credit unions will never be able to compete with banks and private companies in the subordinated debt market, so supplemental capital will always be over-priced. To some extent, this is probably due to the NCUA’s arcane rules — which it promises to tweak — but for the most part it has more to do with the very nature of credit unions.

As member-owned cooperatives, credit unions don’t really play in the securities markets. In addition, they function and are governed differently than banks and use a different lexicon. Markets thrive on volume, homogeneity, and familiarity. Credit unions fail on all three counts, so it will be tough to interest traditional investors in credit union paper regardless of the other factors.

On a political basis, having the power to raise supplemental capital by issuing subordinated debt will just make credit unions “look” more like banks and increase pressure on Congress to terminate the tax exemption.

Credit unions are in this pickle because the political price for CUMAA was bank-type Prompt Corrective Action rules that subject cooperatives to an ill-fitting, stock-based regulatory structure. It is a damning legacy of political expediency triumphing over logic and rationality. And it is a perilous path to be contemplating again.


July 27, 2015


  • I agree with Chris 100%, the cost of supplemental capital will be expensive for CU's as compared to banks AND the more we start to look like a bank, the more likely Congress will want to treat us like a bank and start taxing us. We should be careful what we ask for! Second, look how well RBC worked for the banks in 2007, 2008 and beyond; I can't figure out why NCUA thinks it will prevent closures for CU's that are mismanaged.
  • You are correct in what you say about the covenants and therefore practical use of supplemental capital, but you don't explain why that makes RBC a bad idea. RBC is not being issued, to enable the issuance of supplemental capital. They're mutually exclusive considerations. Each has stand alone considerations.
  • You are right, of course, that supplemental capital and RBC are separate issues, but they are not unrelated. As an aggressive PCA rule, RBC2 threatens to force credit unions to increase their capital ratios very quickly. Without access to supplemental capital, that is possible only by rapidly shrinking the balance sheet. Doing that is invariably expensive and punitive to member-owner-borrowers. NCUA seems to have figured this out and has promised expanded access to supplemental capital as part of some future RBC3. As for the problems with RBC generally, I wrote on them extensively in March and April and thought it would be a little self-indulgent to repeat myself too much. Here is a link to my first blog post; links to others can be found within: Chris Howard
    Chris Howard