Plan Proposes to Convert CUs to Commercial Banks and to Eliminate CU Tax Exemption

The following editorial by Benjamin C. Bishop, Jr., Chairman of Allen C. Ewing & Co -- an investment bank with office in Jacksonville (FL) and Charlotte (NC) -- proposes a plan to convert credit unions to commercial banks and to eliminate the credit union tax exemption. The editorial first appeared in the Second Quarter 2015 Florida Banking Industry Update. The portion of the editorial dealing with the proposed plan is reprinted with the permission of Allen C. Ewing & Co.

The Proposed Plan

The “Credit Union Conversion Legislation” that this Plan proposes must be passed by Congress as legislation will be necessary not only to repeal the current income tax exemption of the credit union industry but also to enact enabling legislation to facilitate the steps discussed below. The legislation would require a mandatory conversion of the existing credit union charters to state or national banking charters as of January 1, 2017. At that date, the converted credit unions would become subject to a federal tax of 33% of the calculated income taxes in 2017, 66% in 2018, and 100% beginning January 1, 2019.

In discussing the phases of the proposed conversion, we have used as an example, a credit union with assets of $250 million, tangible capital of $25 million, pre-tax income of $2.5 million, 1,000,000 shares outstanding, and 1,000 qualified members.

 Phase I: Each member of the credit union would receive equally shares in 50% of the equity capital of the converted bank (500,000 shares) which would be distributed at no cost and tax-free to each member. The shares would have a tangible book value of $25.00 per share, and each member would receive 500 shares. The shares would have a value of $12,500 if they were valued at book value. Qualified members will be those who were members as of a selected date several months prior to the conversion date of January 1, 2017.

 Phase II: Depending on the size of the credit union and its business plan, the directors can offer any part of the remaining 50% of the authorized shares at any time to the public to raise capital. The shares would be offered at a price to be determined, and the members would have the right to purchase shares in the offering, i.e., a Rights Offering.

 Phase III: The existing management, directors, and staff of the credit unions will become the management, directors, and staff of the bank. The bank can continue to offer the same products and services but at rates and prices that
reflect the cost of income taxes.

 Phase IV: The credit union regulatory authority, NCUA, would be merged into a comparable state or federal bank regulatory authority. The NCUA Share Insurance Fund (“NCUSIF”) would be merged into the FDIC’s Deposit Insurance Fund (“DIF”). If the reserves/asset ratio of the NCUSIF is less than that of the DIF’s requirement, the premiums paid to DIF by the converted credit unions would be increased to fund any shortfall.

 Phase V: Existing rates and terms on the credit union’s loans and deposits as of December 31, 2016, would be grandfathered in.

The reluctance in the past by politicians to address the unfairness of the present tax exemption for credit unions is attributable primarily to the perception that the credit union industry is too small to be of concern, and that credit unions provide a unique service to small affiliated groups that’s banks do not provide. The perception has also been that the elimination of the income tax exemption from the credit union industry would be injurious and would turn members against those members of Congress sponsoring this legislation. The Plan addresses these perceptions.

The Plan should have the following positive effects on the credit union industry and Congress:

 Credit Union Members: The Plan will provide the credit union’s members with the same products and services that they currently have, but at bank rates. They would become shareholders of the succeeding commercial bank, as they would receive shares of the bank representing their implied interest in the credit union. Unlike the member’s interest in the credit union, the shares of the bank will have tangible value.

Existing CDs and loans will have their terms and rates grandfathered as of December 31, 2016, and they will be dealing with the same management and staff that they currently have.

 Credit Union Management and Directors: There should be no change in management and/or the directors when the charter of the credit union is terminated and a bank charter becomes effective. The bank will have access to new capital to support future growth, and trading markets for the bank’s shares may result for the larger banks.

 Credit Union Staff: There should be no changes.

 NCUA Regulators: They will be merged into a federal or state bank regulatory organization.

 Government: The conversion will result in increased tax revenues of $2.5 billion per year. The Plan will also result in greater regulatory efficiency as the existing credit union regulatory staff and insurance fund will be merged into existing, larger banking regulatory entities.

Recommendations

In order to obtain the support of some members of Congress, it may be necessary to broaden the benefits of this Plan. As veterans represent a significant percentage of the credit union membership, a portion of the projected new tax revenues could be allocated to improve VA hospitals.

The challenge is to obtain the attention of key members of Congress to support this Plan, and when a member of Congress understands the purpose and benefits of this Plan, the sponsorship should become achievable. Banking industry leadership needs to be more aggressive by joining forces in seeking the elimination of the credit union tax exemption and, in doing so, creating a level playing field for depository institutions.

This Plan needs to be implemented as soon as possible because of the rapid growth of credit unions facilitated by their tax advantage and their departure from their initial tax-exempt purpose, i.e. catering to small affiliated groups. The prior conversion of mutual savings banks and mutual savings & loans years ago was very successful, and there is no reason why the same success should not be the result of this long-needed Plan.