Using Subordinated Debt to Support Credit Union Mergers and Acquisitions
By Justin Anderson
September 16, 2026
Subordinated Debt can help an eligible credit union complete a merger or acquisition by supplying transaction liquidity and, more importantly, by supporting the institution’s regulatory-capital position after the transaction. Its precise benefit depends on the issuer’s status:
- For a low-income designated credit union (“LICU”), qualifying Subordinated Debt can be included in the net worth ratio and, if the credit union is “complex” (over $500 million in assets), also its risk-based capital ratio.
- For a complex credit union that is not a LICU, Subordinated Debt can support the risk-based capital ratio, but does not increase the credit union’s statutory net worth ratio.
The Capital Challenge in Credit Union M&A
Why Mergers and Acquisitions Can Strain Capital
As credit unions are aware, M&A activity, while beneficial in the long term, can be expensive in the short term. Traditional costs include integration, conversion, severance, and branch-consolidation expenses, as well as the professional services employed to get to transaction close.
In addition to the monetary cost of M&A activity, this type of activity can place immediate pressure on the surviving or acquiring credit union’s capital measures because it can:
- Increase total assets, thereby enlarging the denominator of the net worth ratio.
- Add risk-weighted assets, increasing the denominator of the risk-based capital ratio.
- Produce goodwill, core-deposit intangibles, or other intangible assets.
- Add acquired loans that require credit-loss provisioning.
- Concentrate the combined institution in higher-risk asset categories.
- Require cash to purchase bank assets, deposits, branches, or another financial business.
- Reduce earnings during the integration period, slowing the organic replenishment of retained earnings.
Credit unions, unlike their bank siblings, must generally rely on retained earnings for the principal source of net worth. While the M&A activity may, over the long term, tend to generate organic growth, this growth can be too slow to address immediate regulatory capital pressures created by the M&A. This paradoxical loop can sometimes dissuade credit unions from pursuing otherwise beneficial opportunities or keep CEOs and CFOs up at night worrying about the impact of a transaction on the credit union’s balance sheet. Luckily, in 2022, NCUA expanded the once little-known secondary capital rule into the Subordinated Debt Rule that we know today. The issuance of Subordinated Debt may be the key to bridging the gap between immediate impact of M&A and slow supporting growth.
So, what is Subordinated Debt and how can it help in an M&A context? By regulation, NCUA permits certain federally insured credit unions to issue Subordinated Debt, provided the credit union meets the requirements of the rule. Subordinated Debt, as defined by NCUA, is a borrowing that counts towards a credit unions total borrowing limit, but it also a security and subject to certain aspects of federal and state securities laws. To count as Regulatory Capital, a Subordinated Debt Note must meet specific requirements under the rule.
Credit unions must also be preapproved to issue Subordinated Debt by NCUA and, if applicable, the state regulatory authority. This approval process requires the credit union to submit an application that meets the requirements of the regulation, prepare a compliant note, an Offering Document, and develop Subordinated Debt policies in consultation with qualified counsel.
Why Subordinated Debt is Different from Ordinary Borrowing
- Ordinary borrowings provide liquidity but normally do not count as Regulatory Capital.
- Qualifying Subordinated Debt is designed to absorb losses before more senior creditors and the National Credit Union Share Insurance Fund.
- That loss-absorbing capacity—not merely the availability of cash—supports Regulatory-Capital recognition.
- It is nevertheless a liability, not equity, for GAAP purposes.
Which Credit Unions May Issue Subordinated Debt?
Eligible Issuers
Subject to regulatory approval, the following may issue Subordinated Debt:
- A complex credit union, as defined by NCUA with a capital classification of at least “undercapitalized”
- A LICU
- A credit union that can demonstrate it reasonably expects to become an eligible complex credit union or LICU within 24 months
- A new credit union with retained earnings of at least 1% of assets
It’s important to point out that a credit union that is not yet complex or a LICU but anticipates becoming complex or a LICU within 24 months may apply to issue Subordinated Debt to prepare for when it reaches either of these thresholds. This becomes increasingly important for some credit unions that may be just shy of $500 million in assets but are contemplating an M&A transaction that will bring them above the “complex” threshold, or it will otherwise be becoming complex.
How can this help a credit union contemplating an M&A transaction? The more obvious benefit is the immediate infusion of cash that may be needed to absorb the costs associated with the M&A transaction. Less obvious, but more importantly, Subordinated Debt can count towards a credit union’s net worth ratio, risk-based capital ratio, or both. Below, we explain how Subordinated Debt applies based on the classification of the issuing credit union.
Treatment for a LICU
For a LICU, qualifying Subordinated Debt treated as regulatory capital is included in “net worth.” This has important impacts:
- It increases the numerator of the net worth ratio.
- Because the net worth ratio equals net worth divided by total assets, it can offset transaction-related denominator growth.
- If the LICU is also complex and uses the RBC framework, the qualifying amount is also included in the RBC numerator.
- A complex LICU therefore may obtain both leverage-capital and risk-based-capital benefits from the same issuance.
Treatment for a Complex Credit Union That is Not a LICU
For a complex non-LICU:
- Qualifying Subordinated Debt is included in the RBC numerator.
- It is not included in the statutory definition of net worth merely because the issuer is not a LICU.
- The institution must still maintain adequate retained earnings and net worth after the transaction.
NCUA’s RBC numerator expressly includes qualifying Subordinated Debt as a capital element.
It is important to note that all Subordinated Debt is subject to discounting in the last five years before maturity. Per regulation, the amount of Subordinated Debt that counts as Regulatory Capital is reduced by 20% of the original issued amount each of the last five years before maturity. As such, a credit union that uses Subordinated Debt will need to plan appropriately for the discounting and eventual complete repayment of the Subordinated Debt and the impacts on its Regulatory Capital.
How Subordinated Debt Can Facilitate a Credit Union Merger
Cushioning Post-Merger Asset Growth
In a credit union merger, the surviving institution acquires the merging credit union’s assets and assumes its liabilities. As a result of the merger, the larger asset base may dilute the surviving institution’s net worth ratio and/or RBC ratio. Depending on the surviving credit union’s designation, Subordinated Debt can help restore the deterioration to one or both of the credit union’s key ratios.
Since LICU issued Subordinated Debt counts as net worth, Subordinated Debt for a LICU can help restore the decreased net worth ratio and help preserve net worth headroom.
Conversely, if the surviving credit union is complex, but not a LICU, the credit union can use Subordinated Debt to support its RBC ratio. An institution that is both a LICU and complex, can count the debt towards both its net worth and RBC ratios.
Supporting the Merger of a Weaker Credit Union
At times, a healthier credit union may wish to acquire a credit union with limited capital, asset-quality issues, or expected integration losses. The acquisition of a weaker credit union can present additional risks to the balance sheet such as potential losses or downside scenarios. Pre-closing or transaction-contingent Subordinated Debt can improve the survivor’s ability to absorb these risks and help temporarily improve balance sheet projections. Subordinated Debt can be a tool but is not a silver bullet as Subordinated Debt should supplement, not substitute for, thorough due diligence and realistic valuation of the target.
How Subordinated Debt Can Facilitate Bank and Branch Acquisitions
Why a Bank Acquisition Presents a Different Capital Problem
In a bank acquisition, the credit union typically purchases assets and assumes deposits or other liabilities of the target bank. As this type of transaction is not a merger of two credit unions under the Federal Credit Union Act the target bank’s equity does not automatically become credit union net worth. In addition, the transaction may generate goodwill or other identifiable intangible assets. The acquiring credit union may, therefore, add a substantial volume of assets without a corresponding addition to retained earnings. So, how can Subordinated Debt help.
Subordinated Debt proceeds may potentially be used to:
- Fund a cash purchase price
- Replace liquidity deployed at closing
- Support the assumption of deposits
- Finance conversion and integration expenses
- Preserve ordinary liquidity sources for member lending and operations
Regulatory Capital
In addition to supplying a credit union with needed liquidity, as shown in the examples below, the Subordinated Debt can act as a shield or buffer against regulatory capital ratio decreases caused by the acquisition. A well-timed Subordinated Debt issuance can help ensure the credit union regulatory capital ratios stay stable immediately following an acquisition. Over time, as the debt begins to pay down, the acquisition and normal operations of the credit union will, generally, supply enough organic growth to replace the debt with retained earnings. This cushion not only makes regulators more comfortable but helps CEOs and CFOs feel confident that post acquisition their credit union maintains strong capital ratios needed to address the day-to-day operations of the credit union and any unforeseen economic uncertainties.
Illustrative Transaction Examples
Example 1: Complex LICU Acquiring a Community Bank – Net Worth Component
- Acquirer has $1 billion in assets and a total net worth of $100 million, which equates to a net worth ratio of 10%.
- It acquires $250 million of bank assets, bringing its total assets to $1.25 billion and it drops its net worth ratio to 8%.
- The transaction increases total assets, which increases the denominator of the net worth calculation, thereby lowering the acquiring credit union’s net worth ratio.
- If this credit union also issues $40 million of Subordinated Debt, the net worth ratio at the conclusion of the acquisition would actually be higher at 11.2%.
Example 2: Complex LICU Acquiring a Community Bank – RBC Component
- Taking the same facts as above, except for also assuming that before the transaction this credit union had an RBC numerator of $107 million and total risk weighted assets of $900 million, which equates to an RBC ratio of 11.88%.
- As part of the acquisition, the credit union acquires $175 million of risk weighted assets. This would decrease its RBC ratio to 9.9%.
- With the inclusion of the $40 million Subordinated Debt, this credit union’s RBC ratio at the close of the acquisition would be 13.6%.
- The institution gains greater protection against both total-asset growth and risk-weighted asset growth.
Example 3: Non-complex LICU Acquiring a Community Bank Branch
- Acquirer has $400 million in assets and a total net worth of $40 million, which equates to a net worth ratio of 10%.
- It acquires $50 million of bank assets, bringing its total assets to $450 million and it drops its net worth ratio to 8.8%.
- The transaction increases total assets, which increases the denominator of the net worth calculation, thereby lowering the acquiring credit union’s net worth ratio.
- If this credit union also issues $15 million of Subordinated Debt, the net worth ratio at the conclusion of the acquisition would actually be higher at 12.2%.
In these examples, you can see how Subordinated Debt not only cushions the impact of the acquisition but actually increases the credit union’s ratios at the closing of the transactions. As the Subordinated Debt begins to paydown, organic growth or additional issuances can replace that capital and keep the credit union in a similar position.
Subordinated Debt works best when it is structured as temporary loss-absorbing capital supporting a well-underwritten transaction and a credible retained-earnings plan. It cannot turn a weak acquisition into a safe one, but it can give a sound transaction the capital runway needed to reach its projected long-term value.
With the 2022 rule, the NCUA not only greatly expanded the universe of credit unions eligible to issue Subordinated Debt, but also created an instrument that is more widely accepted and sought after in the marketplace. Unfortunately, education on the benefits and uses of this tool have lagged behind, leaving many eligible credit unions unaware of the benefits of using Subordinated Debt. Our goal is to bridge that education gap and provide real world insight into the multitude of uses of a well-timed and well-planned Subordinated Debt issuance.
If your credit union is interested in exploring Subordinated Debt, our team can help evaluate how and where it may fit within your broader strategy.
About the Author
Justin Anderson
Justin Anderson, Of Counsel at SW&M, is a seasoned regulatory attorney with over 17 years of experience advising the National Credit Union Administration (NCUA) and credit unions on complex legal, financial, and administrative matters. He brings deep expertise in subordinated […]
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