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Now may be best time for bankers to push for credit union taxation

Community bankers have long called on credit unions to comply with the Community Reinvestment Act, and now a wellknown Chicago-based non-profit group is doing the same. The Woodstock Institute, a 29-year-old organization that promotes economic development and community reinvestment for lower-income and minority communities, says the CRA should be amended to include credit unions.

After surveying some 3,000 people in the Chicago area, the Woodstock Institute concludes credit unions "serve much lower percentages of lower-income households than they do middle- and upper-income households." The Woodstock Institute's findings are published in a report released earlier this year. (Copy available at www.woodstockinst.org.)

"We were surprised by the degree to which credit unions under-serve lower-income people," said Malcolm Bush, Woodstock' Institute president.

The organization notes the credit union industry, with 10,365 institutions across the country, enjoys a federal income tax exemption worth about $6 billion per year. In a press release, Bush reminds people that credit unions receive tax benefits partly because they are supposed to serve people of modest means.

The Woodstock Institute's research is consistent with banking industry research that shows the typical credit union customer is wealthier than the typical bank customer.

Bush contends that if the Community Reinvestment Act - the 1977 law that requires banks to serve all groups of people in their market area - applied to credit unions, they would do a better job living up to their charter. "If credit unions were being examined on a regular basis for community reinvestment, that data would be very useful," Bush said. By collecting such data from banks, Bush said groups such as his have worked with banks over the years to expand the availability of credit. The credit union industry's regulator, the National Credit Union Administration, recently pulled the plug on an effort that would have required credit unions to comply with a CRA-like law.

Credit Unions: All Grown Up

The credit union industry has matured into a robust component of the financial services arena since Congress passed the Federal Credit Union Act in 1934. The Credit Union National Association, the industry's top trade group, reports that almost twothirds of all credit unions seek to be their customers' primary financial institution, with about 30 percent of them offering full retail banking services. Most credit unions remain small, but 37 of them have more than $1 billion in assets.

As credit unions grow to look increasingly like banks, their tax-exempt status becomes more difficult to justify. Lawmakers in some states, such as Texas, are considering taxing the income of credit unions and four states, including Indiana and Nebraska, already do.

Congress created the credit union charter in part to encourage thrift, and the industry's mainstay product for years was the share account. Keith Legget, an economist with the American Bankers' Association, points out, however, that in 1980 credit unions gained the power to offer share drafts, the equivalent of checking accounts. The shift away from savings accounts toward transaction accounts inherently made credit unions more like banks, Legget says. The increased customer contact that transaction accounts afford, give credit unions more cross-selling opportunities and facilitate the development of full-service financial institutions.

In the early 1990s, credit unions also gained the opportunity to join the Federal Home Loan Bank System, an opportunity that 546 credit unions are capitalizing on. Traditionally, credit unions have relied on the savings of their customers to fund loans but with Home Loan Bank membership, credit unions join banks and thrifts which use the wholesale funds to make loans to customers. Home Loan Bank membership generally includes larger credit unions, which currently have advances totaling more than $3.5 billion.

Furthermore, the NCUA has laid out aggressive growth goals for the credit union industry, including an annual increase in credit union membership by 2.5 million people. The NCUA encourages the formation of more community-based credit unions, and encourages credit unions to offer more online, interactive services.

Sen. Paul Sarbanes, (D-Md.) Chairman of the Senate Banking Committee, recently chided the credit union industry for seeking powers that would make credit unions indistinguishable from banks. "The more credit unions seek to be like other financial institutions in their powers of membership, they undercut the argument they are deserving of different treatment on taxation and regulations," he said at a committee meeting.

On the state level, credit unions continue to gain power. In Wisconsin, the NCUA approved the state's "member business lending" regulation in February. The rule would make it easier for state-chartered credit unions in Wisconsin to make real estate development loans and construction loans. It would also eliminate the requirement that borrowers give personal guarantees for all such loans. The regulation will become final if the state's legislature approves it.

In Minnesota, the legislature recently passed the Credit Union Protection Act, which brings the state charter into near-parity with the federal charter. When the credit union industry proposed the bill, it originally sought several new powers in the areas of trust, insurance, real estate and leasing. It wanted fewer regulatory examinations and it wanted additional ability to compensate directors. Those provisions were dropped from the bill before it was passed in April.

The Tax-exempt advantage

Bankers who compete against credit unions have long decried the unfair competition. Joe Hardy, president of Prairie State Bank in Springfield, Ill., notes that many credit unions in his state have converted to community charters, which makes their field of membership indistinguishable from community banks that serve a defined geographic marketplace. "They don't pay income taxes," Hardy said. "It makes a big difference."

Hardy also took issue with many of the common stereotypes associated with credit unions. "In central Illinois, their loan and deposit rates aren't any different from what banks offer," he noted. "They tend to have nicer buildings and they pay their employees on the high end."

Hardy said giants like the Peoriabased Citizens Equity First Credit Union, with assets of $22 billion, have a significant advantage over his $148 million bank.

Most of the banking industry's complaints are leveled against only the largest credit unions. "I have sympathy for the small credit union," commented Roger Bense, president of Lake Country State Bank in Long Prairie, Minn. "I have no problem with the credit unions that are doing what they are supposed to be doing."

Congress granted credit unions an exemption from income tax partly because of their cooperative corporate structure, in which each customer is considered an owner with a voice in the credit union's governance. At the largest credit unions, however, there are so many customers that most do not participate in the credit union's annual meeting nor governing activities. They are no different than bank customers, Bense noted.

The credit union industry is maturing at a time when many state governments are struggling to balance their budgets. In Texas, for example, the state's comptroller's office noted that the state loses $3.6 million by exempting credit unions from a state franchise tax. As pressures grow on state budgets, experts predict more lawmakers will begin to consider taxing credit unions.

"The downturn in the economy has resulted in budget shortfalls across the country," noted Colleen Kelly on CUNA's web site. "The poor economy has resulted in lower sales tax and income tax collection, and at the same time, corporate layoffs raise the demand for state government services." Kelly is CUNA's vice president of state government affairs.

Lawmakers in Minnesota considered the tax consequences associated with its credit union law. The Minnesota Credit Union Network noted that in recent years 54 state-chartered credit unions have switched to a federal charter, under which they avoid paying state sales tax. It represents a loss to the state of $1.7 million per year. Minnesota's 123 state-chartered credit unions pay approximately $3.1 million in sales tax per year, the trade group says. The credit unions would pay much more in income taxes if the state taxed credit union income in the same fashion it taxes income at banks and thrifts.