It is a relatively unused commodity within the credit union, certainly from a lenders position. This blog looks at how subordinated debt can be an issue and the advantages from a lenders and borrowers point of view.
CREDS 5.2 deals with SD and it is quite clear on how the loan is structured.
The subordinated loan is essentially to help give time for a credit union to get back into an adequate capital position as it can be counted towards capital.
From the 4th year the loan is reduced by 20% per annum from the capital calculation. This doesn’t mean the loan is repaid by 20% per annum it can remain unpaid until the redemption date. The borrower needs to plan adequately to ensure the capital remains within the criteria once the reductions come into force.
The criteria that must be met for the SD to be counted towards capital is:
(a) the maturity of the loan must be more than five years and one day from the date on which the loan is made
(b) the subordinated creditors rank behind those of all unsubordinated creditors including the credit union's shareholders;
(c) creditors waive their rights to set off amounts they owe the credit union against subordinated amounts owed to them by the credit union;
(d) the only events of default are non-payment of any interest or principal under the debt agreement or the winding-up of the credit union;
(e) the remedies available to the subordinated creditor in the event of default in respect of the subordinated debt are limited to petitioning for the winding up of the credit union or proving for and claiming in the liquidation of the credit union;
(f) the subordinated debt must not become due and payable before its stated final maturity date except on an event of default complying with (d);
(g) the terms of the subordinated debt must be set out in a written agreement or instrument that contains terms that provide for the above conditions;
(h) the debt must be unsecured and fully paid up.
The risk for the lender can be perceived to be high. In a liquidation situation the lender falls last in the queue for repayment therefore if a credit union is the lender it is highly likely that the debt will not be repaid should the borrowing credit union fail, especially if the borrowing credit union is close to its capital adequacy level. Only when the borrower misses payments can the lender exercise some power by winding up the credit union. Due to the unsecured nature of SD this leaves the lender in a vulnerable position.
- Take a commercial view on making a SD loan
- Review financial and any non-financial information before issuing the loan
- Review alternatives that secure the debt
- Ask for regular information to monitor progress once the SD loan has been made
- Seek professional advice
If you require guidance as to the best course of action please call:
Philip Jones, Hallidays on 0161 476 8276