Feature Stories - December 2008

Credit Unions

Unfair or necessary financial entities?

by Jessica Santina

A financial storm is brewing on both Wall Street and Main Street. A gaping lack of confidence has halted institution-to-institution and institution-to-consumer lending and current expectations indicate that lending will remain paralyzed through the coming quarters.

Economic turmoil is impacting every facet of business in this country, and an interesting story is taking place between banks and credit unions. Their battle is not new, as there is a well-documented history of banks versus credit unions, but the current economic conditions warrant an update on how the present climate has influenced their respective domains and potentially heightened their rift.

Historic Differences

A quick glance at the services offered by banks and credit unions may at first cause them to appear indistinguishable. Although, historically they are very different, the two have come to resemble each other more so now than ever before – a point which has caused increasing tensions between these entities.

According to the Credit Union National Association (CUNA), credit unions date back to 1844, when a group of weavers in Rochdale, England established the Rochdale Society of Equitable Pioneers, a cooperative that enabled members to raise capital in order to buy goods in quantity, at lower prices than retail, and then sell those goods at a savings to members. The idea caught on quickly and reached the U.S. in 1908, making this year the 100th anniversary of American credit unions.

Henry Kertman, vice president of public affairs for the Nevada Credit Union League (NCUL), a trade and advocacy association, explains, “[When credit unions appeared] it was at a time when people did not have credit and it made more sense for credit unions to form around an employer group. A good historical example of this is the railroad industry. Over the years, those employer groups shrank and small businesses saw the greatest employment growth, but in order for a financial institution such as a credit union to provide the greatest combination of services, it needs more than the usual eight to 10 employees of a small business.” To address this challenge, credit unions successfully lobbied to extend their memberships to different employer groups. As the membership base grew in size, it was determined by the National Credit Union Administration (NCUA) that in the interest of consumers, credit unions should be allowed to serve defined geographic regions, in addition to multiple employer groups,” said Kertman. This is how credit unions are able to service such a board base of members today.

“Credit unions were originally founded for people of modest means with the same employers. When they shared that common bond, it made sense,” said Bill Uffelman, president and CEO of the Nevada Bankers Association (NBA). “The problem now is you have credit unions that have entered the arena of commercial lending and stepped outside their original purpose. Today, just being a resident of Clark County affords you the right to belong to Nevada Federal Credit Union.” Lax membership standards have long been one of the largest points of contention between banks and credit unions.

Much to the chagrin of some bankers, the membership flexibility of credit unions appears to be growing. In fact, according to Brad Beal, president and CEO of Nevada Federal Credit Union (NFCU), his institution’s 82,000 members are “residents of Clark County, as well as Pahrump and certain areas of Reno.” These liberal residence standards are where banks cry foul and charge credit unions with departing entirely from their first generation, employer-based cooperatives.

Tax Disputes

According to those at the helm of credit unions, the fair market ideal is their argument against credit union naysayers. In Beal’s opinion, “A fair marketplace means that everyone should have the right to enjoy the benefits of credit union membership.” Credit unions are not-for-profit cooperatives, owned by depositors. On the other hand, banks are for-profit entities that have the goal of making money for their stockholders. These structural differences imply there is a place for both financial institutions in the marketplace. According to Beal, credit unions offer unique opportunities for consumers and he cites their tradition of being democratically controlled and governed by an all-volunteer board of directors who are elected by the credit union members as evidence. Their not-for-profit status means they are exempt from federal and state income taxes, as well as sales, gasoline and branch taxes, which were levied in 2003 as a seven percent quarterly tax, per bank branch in Nevada. Additionally, credit unions pay only 0.7 percent payroll taxes, whereas banks have paid two percent payroll taxes since 2003. This disparity in taxes owed is at the very core of this long standing dispute between banks and credit unions.

“What we have are two financial systems – one that pays taxes, and one that doesn’t,” said Bill Martin, vice chairman and CEO of Service 1st Bank. Martin, a Nevada banker for 25 years, has long been an outspoken opponent of the “unfair privileges” granted to credit unions.

While Kertman (NCUL) and others insist that credit unions are not completely exempt from taxes – they continue to pay payroll and property taxes and their members pay taxes on interest earned – Martin called such refutations “ridiculous.”

“Are you telling me that by complying with federal law and paying FICA and social security that you are paying taxes?” asked Martin. “Credit unions do not pay taxes on income or sales tax. For example, if they buy a roomful of desks to outfit a branch, they pay no sales tax on that purchase. If they have a conference out of town, they are exempt from paying hotel taxes. The ‘taxes’ they pay have nothing to do with funding schools, roads or mental health facilities.”

Indeed, a 2005 academic study by The Tax Foundation estimated that between 2004 and 2008, the country suffered a $12.6 billion tax loss resulting from credit unions’ tax exemption status.

However, as many in the credit union business point out, the federal government has maintained their tax-exempt status for decades. “In 1973, Congress elected to exempt credit unions from federal income taxes because they are nonprofit, mutually-owned, democratically controlled institutions that have no capital stock, rely heavily on volunteers and in many cases the support of sponsoring companies,” Kertman said. “The tax exemption was deliberated, reviewed and reaffirmed by Congress again in 1998. The reasons to maintain the tax exemption remain true today.”

Commercial Lending

The current financial environment means that neither banks nor credit unions are achieving the profits of a few years ago, making credit unions’ perceived advantages acutely frustrating to banks.

“Commercial lending is very specialized in the banking industry,” said Uffelman. “One of the things we’ve found is that credit unions do not have the expertise. It’s [the Nevada Bankers Association’s] assertion that allowing credit unions to do commercial loans is not good public policy.”

Credit unions were originally intended to help “the little guy,” but that is not the case anymore, elaborated Martin (Service 1st Bank). He points specifically to a Nevada Title Company report of commercial transactions in Clark County in July 2008, which shows a loan made by Community One Federal Credit Union in Las Vegas in the amount of $4 million and another industrial loan of $3.65 million made by Nevada Federal Credit Union in August. “If they want to use the argument that they’re serving the community better than banks, they have to defend these multi-million dollar loans, and they can’t,” said Martin.

Interestingly, while credit unions suggest that their intent is to serve more moderate or low income consumers than banks, a November 2006 report on credit unions by the U.S. Government Accounting Office suggests otherwise. The report shows 31 percent of households “of low or modest means” use credit unions exclusively, compared to 41 percent of such households who use banks. Additionally, the report states that the two institutions varied little with regard to mortgage rates.

However, credit union members did tend to pay lower fees, according to the report. Car loans at credit unions were offered for an average of 1 to 2 percentage points less than at similarly sized banks, and credit union members enjoyed an average of 0.4 percentage points higher interest for their regular savings accounts. “Credit unions offer one of the last opportunities for most consumers to be involved in a not-for-profit cooperative,” said Beal (NFCU). “I think that’s an important value to be preserved, and with all due respect, I don’t think it’s something [banks] should try to deny customers who need every break they can get right now.”

The present economy makes credit unions more appealing due to their lower interest rates, but their membership surges in the last few years can be attributed more so to the expansion of membership criteria and less so to the present economy.

Economic Conditions

The financial crisis is not limited to the banking industry. Both banks and credit unions are addressing the economic fallout. George Burns, commissioner of financial institutions with the Nevada Department of Business and Industry, said, “The impact of the current financial crisis is affecting both banks and credit unions to similar degrees. If an institution’s lending was concentrated in residential real estate, commercial real estate, loans to consumers dependent on incomes from either of these sectors – and loan underwriting standards were less than conservative – loan delinquency and charge-off rates will have increased significantly.” Burns added that surviving the current economic storm will involve leaner operating philosophies. “The institutions that managed their exposure to risk well in the past, and continue to do so, will survive the current economic crisis. Those that did not, or do not, may be at risk. A general consolidation of the financial industry can be expected as stronger institutions survive and absorb those institutions that do not.”

Uffelman (NBA) believes that Nevada’s banks will survive the storm due to the fact that, in general, they are well capitalized. He also expects that banks with good credit ratings will continue to have the ability to borrow money, but it is going to be more difficult, especially since the FDIC recently increased the required amount for insured deposits from $100,000 to $250,000.

Credit unions, on the whole, may be a little better off, said Kertman (NCUL), explaining that the cause of the crisis – risky lending practices – never applied to credit unions because of their policy of only lending within their membership base. “However, they are suffering collateral damage. You may have a home loan with a lender that has provided a high risk subprime loan and you’re struggling to make the payment. The first thing you’ll do is try to keep your house, but it may cause you to default on a loan with a credit union. So we’re suffering, too.” Kertman added that the NCUA, which oversees credit unions, has also increased its requirements in response to the economic crisis, now insuring up to $250,000 worth of assets, in sync with the FDIC’s new requirements.

“Most credit unions, Nevada Federal included, did not get involved in the subprime mortgage lending practices that caused much of this crisis. So all of those ills associated with subprimes, we’ve escaped almost entirely. However, the general economic downturn is affecting us all. Members have struggled with losing jobs or reductions in their hours, and that affects their ability to make loan payments, so in that way, we’re being affected, but we’re managing those losses,” said Beal (NFCU).

Dennis Flannigan, CEO of Great Basin Federal Credit Union, said his institution’s loan portfolio is comprised of 83 percent consumer loans, which indicates they are seeing a high proportion of defaults and charge-offs. “The last numbers I saw were that unemployment in Washoe County was at 7.1 percent, which is higher than the national average. So that’s really impacting our ability to collect what is owed to us right now.”

Oddly enough, credit unions have not restricted or changed their lending practices in light of the current credit milieu. How is that possible? Credit unions, as a rule, do not typically engage in what is considered “risky” lending or relaxation of lending standards. Coupled with their peripheral participation in subprime mortgages, credit unions are still able to offer a full range of loans to their members.

2009 Legislature

Flannigan, who sits on the government relations committee of the Nevada Credit Union League, said he is not expecting any relief for the Nevada economy – by way of a bailout or new taxes – from the 2009 legislative session. “There may be attempts to tax mining and gaming, but other than that, the Legislature recognizes that the Nevada consumer is strained already, so they will be reticent to increase taxes,” said Flannigan, recalling the 2003 Legislature’s decision to levy new branch taxes and higher payroll taxes against banks. Additionally, he is unaware of any bank or credit union sponsored legislation being advanced for the next session.

Uffelman (NBA) concurs with Flannigan and has said that while his organization has not put forward any specific legislation to increase regulation or taxes for credit unions, it has worked with the Interim Finance Committee to draft several bills pertaining to foreclosures, mortgage lending and fraudulent renting practices.

The frustrations brewing between banks and credit unions will likely not be resolved in the near future, but currently, Nevada’s banks and credit unions are banding together on one front: shoring up depositor confidence and assuring the public that they are safe places for consumers to keep their money. “There’s no fight between us now, if we know what’s good for us,” said Martin (Service 1st Bank). “Furthering uncertainty and a lack of confidence is just about the worst thing a financial institution could do right now.”

Jessica Santina
Jessica Santina is a freelance writer based in Reno.