Recently, the economic environment has been turned on its head, and the effects present new challenges to credit unions. As a result, credit unions must proactively and strategically plan to navigate issues such as decreased deposits, dips in lending, and higher interest rates. During periods like this, “just-in-time” capital may provide the peace of mind credit unions need to pursue a necessary merger or acquisition, create organic growth, increase their net worth, or spend for other purposes. Credit unions can access this kind of capital in the subordinated debt (sub-debt) markets but is today’s higher interest rate environment the right time to issue sub-debt?

We introduced the benefits of credit unions issuing sub-debt on the podcast in 2021. Sub-debt is a borrowing alternative with a loan and term structure that gains favorable regulatory capital treatment. Podcast guest Jeff Cardone returns to the show to update Doug on the sub-debt capital markets and what credit unions should think about when planning around today’s issues. Jeff, a partner at Luse Gorman, specializes in helping credit unions with mergers and acquisitions, executive compensation, and employee benefits. 

In this episode, Jeff explains how sub-debt can continue to be an attractive borrowing solution for credit unions, even and maybe especially when interest rates surge. For example, Jeff shares how current conditions are driving more merger and acquisition activity for credit unions that want to broaden their fields of membership, add enhanced products and services, and provide more overall value to members. The ability to access secondary capital quickly and seize opportunities in these situations is one significant reason Jeff recommends credit unions should get the sub-debt pre-approval process, which takes up to six months, behind them as soon as possible. While credit unions do not have to issue sub-debt, raising capital when the need arises could be a difference of several months versus a few weeks if pre-approved.

Stream the episode to hear more updates from Jeff and learn:

  • The factors credit unions should consider when deciding to raise capital in the sub-debt market compared to securing another borrowing option
  • The cost versus value of credit unions issuing sub-debt
  • Why there’s currently an uptick in credit unions buying banks
  • Why Jeff recommends credit unions get a low-income designation
  • The market rate flexibility sub-debt offers

Listen to the conversation now. You may also learn more about sub-debt in the Luse Gorman white paper, which you can request at

Jeff Cardone and Luse Gorman are not affiliated with or endorsed by ACT Advisors, LLC. 

Audio Transcription (pulled from the podcast)

Doug English  (00:00)

Returning to the podcast today is Jeff Cardone. Jeff is a partner at Luse Gorman, where he specializes in helping credit unions with mergers and acquisitions, executive compensation, and employee benefits. In this episode, Jeff gives us an update on what the credit union movement needs to be thinking about in regard to subordinated debt in the current higher interest rate economic environment. Welcome back to “CU on the Show,” Jeff Cardone. I’m glad you’re back.

Jeff Cardone  (00:32)

Great to be here.

Doug English  (00:34)

So last time we recorded it was 2021. And the world was a completely different place. You helped us with a lot of great information to think about getting ready to issue subordinated debt, to get pre-approved to do that. And of course, since then we have had a massive interest rate surge, credit unions now being concerned with deposits, and lots and lots of merger and acquisition activity. So Jeff, we’re delighted you’re back again today and let’s talk about sub-debt. If you could remind our listeners, what happened back in January with the change? And then what sort of activity are you seeing in that area? And what do you think the credit union movement needs to be thinking about in regard to sub-debt?

Jeff Cardone  (01:24)

Yeah, it’s great to be back. Just to refresh the listeners’ memories, if you’re tuning in again, a lot of credit unions just think of sub-debt as secondary capital. In essence, it’s borrowing, you as a credit union are going out, you’re borrowing money. So it’s not any different than that; it’s going to be booked on your balance sheet as a loan. But the benefit to this is that it’s going to be accorded regulatory capital treatment, and if you’re low income designated, it’s going to be 100% accretive to your net worth. If you’re not low income designated, it’ll be accretive to your risk-based capital ratio. So it’s a real game changer, because it now allows credit unions to raise actual equity capital outside of retained earnings. I mean, that is the true benefit to
this. And there’s a whole regulatory approval process that you have to go through. So if you desire to issue—you have to go to your state regulator if your state charter requires that or you’re going to go to the NCUA—you have to get pre-approved, and then once you get pre- approved, you have two years to be an issuer, and you can go out and raise that capital. So that’s the nuance of the rule. I would just say we’ve seen, probably done about close to a dozen sub-debt raises and are in various phases with others. We have a lot of clients who’ve actually gone out and raised the capital. We have others who are not quite ready to raise capital but are sort of just in preparation, or for planning purposes they’ve gone out and gotten pre-approved. And I always recommend doing that. And we can talk more about this throughout the process but you can go out and get pre-approved and then you have two years to issue. Because from start to finish, it’s essentially a six-month process when you factor in the regulatory approval process. But if you get that behind you, and then you have gotten pre-approved, it’s now a matter of weeks where you can go out and get that capital. So that’s kind of been what’s going on from what we’re seeing right now with the sub-debt and kind of a refresher on that.

Doug English  (03:20)

Yeah, the pre-approval is an interesting idea. It’s sort of like a bit of an insurance policy and in personal finances, I think of it like a home equity line of credit. You see, a lot of people do that, they just have a loan home equity line of credit; they have no balance on it, they just have their money there in case they need to get access to capital. It’s a no-cost way to have that access to capital. Of course, a credit union is a much more complex financial system but the idea that they can get access to the sort of capital markets pricing on subordinated debt is one I think would be particularly compelling in this time, but it takes six months to go through the process, right?

Jeff Cardone  (04:06)

That’s a great way to think of it as a home equity line. Back when we talked last time, deposits and liquidity were not an issue. Now that pendulum with the rising interest rate environment has swung completely the other way, so a lot more credit unions are coming back from a strategic standpoint and even if they aren’t necessarily ready to issue, because we are in a higher rate environment they are ready to at the very least get the pre-approval process behind them. Yeah, I would say it’s a little less than six months really to get the capital. So basically, if you go planning, filing your application, getting pre-approved, that’s about a three- to four-month process and then when you decide okay, let’s issue and go out and raise the capital—tack on another three weeks out thereafter. You get that behind you, you have that “home equity.” I think that’s a great analogy. And then when you need it, now you have much quicker access to it than going through the whole process. Because I always tell clients, look, at the end of the day you want to avoid what I call just-in-time capital. Because it happens all the time, whether you’re trying to be defensive or you’re trying to be strategic and be a purchaser. I’ve had a client, for example, want to buy a bank, and they went out and they’re looking at their pro forma capital levels. It’s like, oh my goodness, I’d love to have access to capital. And I was like, gosh, I wish she got pre-approved, because you can get that capital in a matter of weeks. And now you’re going to tack on another, again, it’s about a six-month process. So it’s all about being proactive in planning, particularly in this environment.

Doug English  (05:28)

How does the cost of capital compare from sub-debt versus the other options credit unions might consider if they had a situation where they needed a capital raise quickly?

Jeff Cardone  (05:42)

No, that’s a good point. I mean, you could always go out and borrow. Borrowing is probably a little bit cheaper. But again, the real true value-add to doing the sub-debt is it’s accretive to your net worth, it’s treated as regulatory capital. If you do a straight up borrowing you’re not going to get the benefit of that. So that’s the true value proposition to sub-debt—to not only get the liquidity, your regulatory capital, your net worth, your risk-based capital ratios increase and it’s more accretive.

Doug English  (06:11)

So obviously having the sub-debt as part of your regulatory capital is a strength over going and borrowing that money. How would you suggest credit unions think about when to do one versus the other?

Jeff Cardone  (06:24)

What happens from a regulatory perspective when you’re going to do sub-debt, part of the application process is you the credit union would have to put together a business plan pro forma analysis, and you have to show the regulators one, what are you going to use the proceeds for? And secondly, what’s the pro forma effect on your balance sheet, your capital, how you’re going to service the debt. So I think you balance that certainly. If you can go get an alternative source that may be less, you kind of look at the delta between the sub-debt rate you may be paying, let’s say, the sub-debt rate is 6%. But you can go out and borrow at 4%. The real value proposition to the credit union is going to be when looking at what a better source is. Yes, we’re going to pay more for sub-debt, but we get the benefit of adding that sub-debt amount or proceeds to our capital or regulatory capital, whereas a traditional borrowing you would not. And where this really comes into play, take a merger transaction, a credit union goes out, they’re going to buy a bank. Unlike credit union mergers, you actually have to pay for that equity you’re going to be getting, and it’s going to be a hit to your pro forma capital. So credit unions will go out and raise sub-debt to bring back their capital levels to a level that the board and C-Suite management teams are comfortable with. Whereas if you did that and you try to recoup that capital with a non sub-debt or another alternative borrowing source, you’ll get that liquidity back but your pro forma capital will not change as a result of that. So that’s the real value proposition. Now look, if the sub-debt markets, if the rates get too high, then you’d look at and say look, the cost of servicing the debt is just too much. And we’re not going to do that. But to me personally, I think the value or the fact that it’s accretive to your regulatory capital, to me, outweighs paying a little bit less on a more traditional borrowing such as federal from Federal Home Loan Bank or any other source or line of credit.

Doug English  (08:15)

Yeah, and I imagine you could unwind it right? Have you seen a credit union issue sub-debt and then have a different capital option that is more desirable? 

Jeff Cardone  (08:25)

Yeah, because the other piece of this sub-debt too, the reason it gets regulatory capital treatment although it’s going to feel like a borrowing legally, it’s a security. So to get regulatory capital treatment, it can’t be callable for at least five years. So you’re really committed to this because that’s how the regulators would view this as true capital. If you could just redeem it right away, let’s say a very short-term borrowing, you’re not going to get accorded regulatory capital treatment. So it’s a little bit less flexible in that regard. But again, that’s one of the requirements to get accorded regulatory capital treatment, net worth or risk-based capital.

Doug English  (09:02)

You mentioned M&A just a moment ago, and we did obviously a couple of episodes before about when you are the acquirer in an M&A transaction or when you’re being acquired or being merged. That was in our 2021 episodes you and I did together. These days, I imagine that activity has changed. What have you seen change in M&A activity for 2022? 

Jeff Cardone  (09:29)

I would say what we’re seeing right now, at least, on the credit union side, I think what’s keeping boards up at night right now is the deposit issue. I think with rates going up, cost of funds going up, there’s true concerns about membership runoffs, particularly for smaller credit unions. And I think that’s certainly driving some M&A activity, particularly for smaller credit unions that are looking to partner up, whether it’s a merger of equals with a comparable-sized credit union or partnering up with a larger credit union. The other end of the pendulum in the credit space, we’ve seen a tremendous uptick this year in credit unions looking to acquire banks. Now the real value proposition of that is, again, to expand the products and services these inquisitive credit units are offering to their members. So take a credit union, they’ll find a bank and a lot of these banks have some sort of retail component, they’re generally more on the commercial lending side, wonderful family, not so much very active with the consumer. And that’s the real value proposition is the credit union can come in and augment what the bank’s doing with the retail, the consumer lending piece, and then that hopefully will attract more members and create more value. So that’s been the true value proposition. That’s why you’re seeing a lot of credit unions looking at banks, sort of an alternative growth strategy to just traditional credit union acquisitions and mergers.

Doug English  (10:51)

I know, I follow the press. And I’ve seen, I think, a couple recently where the regulators have turned those down, right?

Jeff Cardone  (10:58)

Yeah, it depends on the state. Some states are more political than others, for example, Minnesota, Iowa, Nebraska. So that’s part of the due diligence process. If you’re going into a state if you’re a credit union and you acquire a state-chartered bank, that’s something to look at. Now, conversely, if you’re in a state like Illinois, Wisconsin, Michigan, Florida, all these states we’ve done deals in, it’s a much more favorable regulatory environment. But I think what’s paramount if you’re going to undertake bank acquisition strategies, you find the right partner first. And then secondly, you need to obviously be engaging with your regulators both on the credit union side and certainly on the bank side, just to make sure you’re on firm footing from a regulatory standpoint and getting the deal done.

Doug English  (11:43)

You just mentioned buying banks because sometimes they have stronger commercial operations. In one of the episodes we did we talked to Tru Treasury, a credit union CUSO organization that helps credit unions pursue commercial deposits. And in that episode, one of my takeaways is how that can be quite an inexpensive source of deposits for credit unions. I would imagine that if you’re a more deposit heavy or low cost of deposits institution, you might be finding a lot of suitors these days. Are you seeing that? Are you saying deposits drive M&A activity? 

Jeff Cardone  (12:23)

Absolutely. That’s a great point. Because now, with the commercial relationships, not only are you doing the lending, you’re also doing all the deposit, you’re gonna get their deposit/share accounts. So that is the other true value proposition sort of beyond just a commercial lending piece. I think the credit unions we’re working with that are being inquisitive are also evaluating the core deposit base, sticky deposits, and area growth field of membership expansions in these new market areas. So that is certainly a big or key component to credit unions in terms of evaluating a bank acquisition.

Doug English  (12:57)

As we head toward the end of 2022 and into the great unknown of the economic backdrop of dramatic interest rate hikes and potential slow down in borrowing activity and deposits being hard to come by, the idea I’m hearing is that more credit unions might want to look at getting pre-approved for sub-debt so they have that as one of the choices in case it becomes a necessary option, as you said, in offense because you’re going to buy somebody. Is there any other reason you could come up with why they would want to have that capital offensively?

Jeff Cardone  (13:41)

Yeah, I mean, certainly buying banks, I think, whether it’s buying branches, funding organic growth opportunities, certain reimagining or enhancing your balance sheet if you have other problematic loans or risks of charge-offs. And that’s kind of more than the defensive reasons for doing it. I’ll just tell you, Doug, and I say this all the time when I give presentations, my big takeaway, if you don’t listen, anything else I’ve said, if you’re a credit union out there, I don’t see any downside to getting pre-approved for sub-debt, even if you’re kind of on the fence of actually being issued. You always want to maximize the tools in your toolbox. And capital’s always king. Regulators are going to be particularly tough in this environment. With higher interest rates and risk of deposit runoff, you’re probably going to see a little bit of downswing in loan demand given where we are in the economy. And regulators want to make sure credit unions have robust capital plans. Getting pre-approved, I think, makes a lot of sense for those reasons.

Doug English  (14:40)

Yeah. And it sounds like you really haven’t seen the pickup in volume you would expect in this environment. Maybe it’s just credit unions getting more comfortable with this. And you mentioned in the presentations you do, is there any place you can tell our listeners where they can hear more from Jeff Cardone about this issue? Besides on this podcast? This is our fourth episode together. So we got a lot of Jeff right here.

Jeff Cardone  (15:07)

We put together a white paper that kind of takes a deep dive into the nuances of the NCUA’s rules, the regulatory framework, kind of like a high-level timeline. I always think that’s a great starting point. I always recommend to boards—typically boards meet at least annually to talk about strategic planning—I think capital should be a part of that, subordinated debt. So I think the very good first step is just the educational piece, understanding what sub-debt is, how it works, how much we can realistically raise, looking at kind of like the market, the interest rate environment. And I always think that’s a great starting point. And then usually from that, when I’ve had a chance to speak to boards and talk with them about that, we’ve generally moved to the logical next step, which is to go ahead and get pre-approved, file the application, figure out how much we’re going to raise. And then the one misconception I think and just want to emphasize to the audience is if you go get pre-approved, you absolutely do not have to issue. The NCUA rules allow you to wait or have two years to decide to do it without having to go to the regulators. But if your credit union decides, look, we don’t want to do it, the timing is not right, rates are a little bit too high, you don’t have to do it. And the other thing I would emphasize to the audience too is that if you decide to issue and do it, just like any business terms of a loan, you can set the market rate. So I think right now the interest rate market is generally in the fives to sixes. But if a board said, look, we’ll issue but we are not going to go out or pay more than five and a half percent, you have the flexibility to do that. There’s no regulation that says what has to be six percent or six and a half percent, or it’s tied to the Fed funds rate or some objective interest rate; you as the credit union can set that market. It’s just really a question of can you raise the requisite capital at your desired rate? And that’s where you’re working with your placement agent, your investment banker, going out into your network and seeing if that’s the case.

Doug English  (17:12)

You get pre-approved and you have up to two years to issue. Once that time frame is expired, is the process of getting reapproved simpler, shorter, cheaper? 

Jeff Cardone  (17:24)

Yeah, it probably will be cheaper because you could just roll forward your business plan and you kind of have the framework you built the application. But yeah, you’d have to go back to the regulators and you know, and under the NCUA rules, they take up to 60 days to get back to you. So you’re just kind of resetting the process. After that two-year period expires, which kind of makes sense because in two years there could be a fundamental change to your business. And the regulators want to kind of come back in and reevaluate what you’re doing, I’m sure, but two years is a good window, I think. I mean, it gives you plenty of time; you never know, you may have a potential acquisition opportunity on the offensive side, something may happen defensively, you may have membership runoff or some massive charge-off issue with loans gone bad. Or you may just want some liquidity, just an abundance of caution. But again, you’ve shrunk that period of time to get that capital once you get pre-approved to now a matter of weeks versus a matter of months. I think that’s the true value proposition in going in and getting pre-approved.

Doug English  (18:36)

Well, Jeff, I know from talking to you before, that our listeners will reach out to get this white paper. So tell us how should listeners go about getting the white paper so they can learn more about the process of issuing.

Jeff Cardone  (18:45)

I would just say listeners out there, feel free to email me. My email is I think, Doug, you have it posted with but if not, you can go on our website at And if you click on my link, my email address is on there; just shoot me an email and I’ll happily send you a sub-debt white paper.

Doug English  (19:05)

So that’s Luse Law, L U S E 

Jeff Cardone  (19:10)

Correct, and go to my name, Jeff Cardone, you’ll see under the attorneys list, my email is on there. And just shoot me an email and I’ll happily send the white paper.

Doug English  (19:20)

Awesome. Great, Jeff. Well, thank you for that update on the sub-debt market and M&A activity. We very much appreciate your continued service to the credit union movement. Any final thoughts for our listeners today?

Jeff Cardone  (19:35) 

I’ll just repeat what I said before. If you’re not low income designated, become low income designated and get pre-approved for sub-debt. Whether you want to be an acquirer and you are in your growth mode or even for defensive purposes, I think having access to extra liquidity and capital makes a lot of sense in either scenario.

Doug English  (19:54)

Excellent. Thanks, Jeff.

Jeff Cardone  (19:55) 

Thank you, Doug. Great to be here. Appreciate it.

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