Subordinated Debt for LID Credit Unions: Managing Capital and Unlocking Growth

Capital constraints are one of the most significant barriers preventing Low-Income Designated (LID) credit unions from growing their lending, expanding membership, and serving underserved communities at the scale they are capable of.

At CUCollaborate, our team works closely with credit unions to understand the regulatory tools available to them, including subordinated debt, one of the most powerful yet underutilized options available exclusively to LID institutions. When applied strategically, it can unlock meaningful growth that would otherwise be out of reach.

In this article, we will cover:

• Why the Low-Income Designation created a unique capital flexibility
• The relationship between growth, capital ratios, and return on assets
• How subordinated debt works mechanically and what it enables
• What the NCUA expects to see in an application
• When subordinated debt makes sense, and when it may not
• Why Subordinated Debt Exists in the Credit Union System

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Before 1998, credit unions were not constrained by capital-to-asset ratios in the way they are today. Instead, they were required to set aside 5% of gross income if their retained earnings fell below 6% of risk assets, largely loans. That meant credit unions could grow relatively quickly without a regulatory capital speed limit.

That all changed when Congress passed the Credit Union Membership Access Act (CUMAA), which introduced asset-based capital requirements. Credit unions now must maintain a minimum net worth ratio relative to total assets, with 7% representing the threshold for being considered "well capitalized." In practice, the NCUA often expects credit unions to maintain a ratio a couple of percentage points above that to avoid additional scrutiny.

Recognizing that LID credit unions often serve higher-risk or underserved markets, policymakers created additional flexibility for these institutions, including the ability to count subordinated debt toward regulatory capital. The goal was to balance safety and soundness with mission-driven growth.

The Core Constraint: Growth Requires Capital

Understanding the capital-growth tradeoff is essential before exploring subordinated debt as a solution. When assets grow faster than capital, the capital ratio declines. This is not a theoretical concern; it is a documented pattern across the entire credit union system.

CUCollaborate's analysis of more than 4,300 credit unions over a 10-year period found a clear inverse relationship between growth rates and net worth ratios. Credit unions with the highest net worth ratios, sometimes above 20%, actually experienced negative growth over that period. Meanwhile, those with the highest growth rates saw their net worth ratios decline to the 12-13% range.

A simple rule of thumb helps frame this dynamic:

Growth Rate ≈ ROA ÷ Capital Ratio

Growth strategies also tend to put downward pressure on profitability. To fund growth, credit unions may offer higher deposit rates, open new branches, invest in technology, or expand staff. Those investments are often necessary, but they can temporarily reduce return on assets (ROA), creating tension between growth goals and capital requirements.

What Is Subordinated Debt?

Subordinated debt is essentially a long-term loan from investors, such as charitable foundations, to the credit union. The key distinction from ordinary borrowing is that it counts as regulatory capital for LID institutions.

Investors receive interest payments, but they accept additional risk compared to traditional creditors. That is why the debt is called "subordinated": it is secondary to other borrowings in the event of a credit union failure or liquidation.

Typical characteristics include:

• Long maturity, often around 10 years
• Interest payments to investors
• Subordination to deposits and other obligations
• Recent market pricing in the range of 6% to 9%, depending on Treasury yields, credit union financial performance, and issuance structure

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One notable exception was the 2% rate charged by the Department of the Treasury for sub-debt issued under the Emergency Capital Investment Program (ECIP), a one-time pandemic relief program. That rate should not be treated as a baseline for future planning.

While subordinated debt is more expensive than deposit funding, it provides something deposits cannot: failure-absorbing capital.

Subordinated Debt Is Still Rare, but Growing

Despite its potential, subordinated debt remains uncommon across the credit union industry. According to NCUA call report data analyzed by CUCollaborate, only 3.7% of all credit unions had subordinated debt on their books as of 2024, up from just 1.3% in 2020.

In dollar terms, outstanding subordinated debt across the industry has grown from roughly $400 million before COVID to approximately $4 billion today. That sounds substantial, but it represents only about 18 basis points relative to the more than $2 trillion in total credit union assets.

Credit unions using subordinated debt also tend to be larger institutions. Among credit unions with assets between $10 billion and $100 billion, roughly 23.8% have issued subordinated debt. That adoption rate drops significantly for smaller institutions. On average, credit unions with subordinated debt have 2.6% less in retained earnings as a percentage of assets compared to those without it, which is a key driver behind their decision to seek additional capital sources.

What Subordinated Debt Can Do

When a credit union issues subordinated debt, its regulatory capital increases immediately. This creates a larger cushion to either support growth or absorb losses.

Scenario 1: Supporting Growth

Consider a credit union with $100 million in assets and a 10% capital ratio. By issuing $5 million in subordinated debt, its capital rises to $15 million and its capital ratio climbs to 15%. That cushion then allows the credit union to grow to $150 million in total assets before the ratio returns to 10%.

Result: $5 million of sub-debt supports $50 million of additional asset growth.

Scenario 2: Absorbing losses

For a credit union already under capital pressure, say, one with a 6% net worth ratio facing NCUA scrutiny, issuing $9 million in subordinated debt can raise the capital ratio to 15% and create the same $50 million in growth capacity.

A credit union with $100 million in assets and $7 million in retained earnings, but no subordinated debt, would be rendered insolvent by $8 million in loan losses.

Result: With $7 million in subordinated debt added to its capital stack, the same institution survives those losses with $6 million in remaining capital, gaining time to recover.

CUCollaborate research tracking 113 credit unions that issued subordinated debt between 1996 and 2024 found that they grew by 94% over the subsequent 10 years, compared to just 39% growth for a matched group of similar credit unions that did not issue subordinated debt. Furthermore, since 2016, credit unions with subordinated debt on their books have reported zero failures across all asset size ranges.

What the NCUA Looks for in an Application

Applying for NCUA approval to issue subordinated debt requires preparation and rigor. The NCUA evaluates three core elements:

• A plan to raise the debt: Details on how much capital will be raised, who the investors are, and what interest rate will be paid
• A clear use of proceeds: A defined explanation of what the funds will support, whether that is new branch expansion, technology investment, or growth into underserved markets
• Financial projections: A 10-year forward-looking model demonstrating performance with and without the subordinated debt issuance

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Applications also typically include stress testing scenarios, such as unusually large loan losses (benchmarked against peak loss years like 2008), sudden large deposit inflows or outflows, and long-term slow or fast growth scenarios. The goal is to demonstrate that the credit union is better positioned with subordinated debt than without it, across a range of plausible futures.

When Subordinated Debt Makes Sense, and When It May Not

Subordinated debt is a powerful but specialized tool. Before pursuing it, leadership teams and boards should ask themselves:

• Is capital truly the constraint limiting growth, or is the underlying challenge one of profitability, pricing, or lending strategy?
• Are other levers of profitability being used before turning to debt?
• Is this a temporary bridge to support a growth initiative, or is it intended as a long-term structural element?

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Subordinated debt is not a substitute for return on assets. It can raise the capital ratio and provide breathing room, but credit unions must still grow into their capital structure over time. The debt will eventually need to be repaid, and at 6% to 9%, it carries a meaningfully higher cost of funds than deposit funding.

Final Thoughts: A Strategic Tool for Mission-Driven Growth

Subordinated debt temporarily increases the capital cushion, can support growth and resilience, and should be used strategically rather than as a default response to capital pressure.

For LID credit unions committed to expanding lending, deepening membership, and serving communities that traditional financial institutions have left behind, subordinated debt represents a legitimate path forward. When paired with sound financial projections, a clear use of proceeds, and a realistic growth strategy, it can make a meaningful difference.

At CUCollaborate, we help credit unions assess whether subordinated debt is the right fit for their situation, prepare rigorous NCUA applications, and build the financial models regulators expect to see. If your credit union is weighing this option, let's start the conversation.