Introduction
Over the last several years credit unions have sought to raise funds in the capital markets by issuing their Share Certificates through brokers or other intermediaries. Credit union shares have many of the same attributes of deposits at banks, including insurance by the National Credit Union Administration’s (“NCUA”) Share Insurance Fund (“SIF”) under terms similar to deposit insurance provided by the Federal Deposit Insurance Corporation (“FDIC”). For example, the SIF insures shares up to $250,000 for multiple different insurable capacities and “pass-through” insurance1 is available for shares held through intermediaries such as The Depository Trust Company.
However, as described below, there are significant differences between SIF insurance and FDIC insurance, including conditions for SIF insurance that do not apply to FDIC insurance.
If due diligence is performed by the underwriter, particularly on state-chartered credit unions, and appropriate disclosures are provided to investors, Share Certificates may be offered alongside bank CDs. However, there are a number of pitfalls for the unwary, including failure to review state laws, offering Share Certificates to ineligible investors and using CD documents that merely change “CD” to “Share Certificate.” This Client Alert highlights the relevant issues.
Credit Unions are Membership Organizations that Issue Shares
Credit unions are membership organizations. Eligible members are typically individuals within a defined field of membership, which must be defined by one or more “common bonds,” such as occupational (members work for the same employer or in the same line of work); associational (members belong to a particular church; professional, civic, or fraternal group, or labor union); or community (members live, work, worship, or attend school in the same geographic area). Eligible members may open a share account that is eligible for SIF insurance. Like bank deposits, share accounts can be for a specified term, or payable on demand. Share Certificates, like bank CDs, are term instruments with re-payment of principal on a specified date. Credit union shares typically provide members with certain voting rights.
Rather than accruing interest, share accounts accrue dividends at a stated rate. While the dividends are similar to interest in many respects, unlike interest on bank deposits, a credit union in certain cases is prohibited from paying dividends if it does not have sufficient undivided earnings to pay the dividends. Furthermore, unlike the FDIC, which insures accrued interest on deposit accounts at failed banks, the SIF is not obligated to insure accrued dividends at a failed credit union. It may, in its discretion, insure only the principal amount of a share. Purchasers of Share Certificates should be informed of this distinction in a disclosure specifically crafted for credit union shares rather than a re-purposed bank CD disclosure.
Federal and State Charters: Eligible Non-Members
Like banks, credit unions can be chartered by a federal agency, the NCUA, or a state regulatory agency. Shares at state-chartered credit unions can be insured by the SIF if the credit union meets the eligibility standards. With SIF insurance comes regulatory oversight by the NCUA. Some state-chartered credit unions have elected private insurance and are not subject to NCUA regulation.
NCUA regulations applicable to federally chartered credit unions provide exceptions to the requirement that a person must be in a credit union’s field of membership to open a share account and be eligible for SIF insurance. Federally chartered credit unions can offer shares to other credit unions and federal and state public units as if these entities were within field of membership (“Eligible Non-Members”), subject to a limit. Many states have adopted the federal exception for Eligible Non-Members, making Eligible Non-Members eligible for SIF insurance. However, some states have adopted an exception that differs from the federal exception either by being more limited or more expansive. For example, Georgia includes banks and other financial institutions as Eligible Non-Members – a more expansive exception than under federal law, while Connecticut limits public units to federal public units and public units of the State of Connecticut – a more limited exception.
The SIF will not insure shares of a state chartered credit union that are held pursuant an Eligible Non-Member exception that is broader than the standard federal Eligible Non-Member exception. Thus, for example, while banks may open share accounts at Georgia chartered credit unions, the shares will not be insured by the SIF.
Low Income Credit Unions
NCUA regulations permit federal and state-chartered credit unions to qualify for a low-income designation (such credits unions, “LICUs”) that permits a LICU to open share accounts for anyone, subject to limits, and for the share accounts to be eligible for SIF insurance. A credit union can qualify for LICU designation if a majority of the credit union’s membership meets specified low-income thresholds. Federally chartered credit unions need to apply to the NCUA and receive approval.
Many, but not all, states authorize the LICU designation. Like the Eligible Non-Member exception, a state can follow the requirements set by the NCUA or it can establish a standard that deviates from the federal standard. Some states have not adopted a LICU designation or the regulator has not implemented the designation by adopting regulations.
A credit union chartered in a state that authorizes the LICU designation must first obtain approval of its state regulator and then approval of the NCUA. Where there is no procedure for state approval, the state regulator is required to coordinate with the NCUA’s Regional Office.
When it grants an approval of a low-income designation, the NCUA relies on a representation from the state-chartered credit union that the state has approved its status. It does not independently confirm that the credit union complies with state requirements. Therefore, the fact that a state-chartered credit union is listed on the NCUA’s website as having a LICU approval is not dispositive of whether the credit union has actually been approved by its state regulator.
Failure of a credit union to obtain the appropriate approvals would cause the share accounts opened by a non-member to be ineligible for SIF insurance.
Underwriting Documents
Seward & Kissel has developed documents for underwriting Share Certificates that reflect the unique regulatory scheme governing credit unions and the limitations on Share Certificate ownership and insurance eligibility. This includes obtaining appropriate representations from the issuing credit unions and disclosing to investors material features of the Share Certificates, including exceptions to membership requirements, the prohibition on paying dividends under certain circumstances and the possibility that the SIF will not insure accrued dividends at a failed credit union.
While the documents we have drafted can be used with both federal and state-chartered credit unions, the documents can only be used with state-chartered credit unions that have membership exceptions (i.e., Eligible Non-Member and LICU) that parallel the exceptions for federally chartered credit unions. Attempting to offer Share Certificates with unique membership exceptions is simply not feasible in this market.
Due Diligence Check List
If you are underwriting Share Certificates, either directly for a credit union or as a member of a selling group, or purchasing Share Certificates in the open market, you should ask the following questions:
- What exemption is the credit union relying on to issue shares to non-members?
- If the credit union is state chartered, has the state authorized that exemption in a manner that parallels NCUA requirements such that the shares will be insured by the SIF?
- If the LICU exemption is being relied upon has the credit union obtained NCUA approval and, if applicable, state regulatory approval?
- Are you providing investors with adequate disclosure concerning the available exemption, the possible non-payment of dividends and the possible lack of insurance of accrued dividends, as well as other material features of the Share Certificate?
1 For additional information on FDIC pass-through insurance, see Paul T. Clark, Just Passing Through: A History of Critical Analysis of FDIC Insurance of Deposits Held by Brokers and Other Custodians, https://www.sewkis.com/wp-content/uploads/Paul-Clark-Article-FDIC-PASS-THROUGH-INSURANCEJust-Passing-Through.pdf.
