Position Paper on New York Credit Unions Seeking Authority
to Become Depositories for Municipal Deposits
June 4, 2010
New York state and federally chartered credit unions have been seeking authorization for more than two decades to become depositories for municipal deposits. Credit unions assert that municipalities will have more choices for investment of their funds, thereby providing the municipalities with the possibility of obtaining higher return on their funds.
The Independent Bankers Association of New York (IBANYS) is strongly opposed to the granting of this authority to credit unions because it is not in the best interest of local municipalities, New York State, and community banks throughout New York and the credit unions themselves. This paper will address each of the points of IBANYS’ position.
1. Authorizing credit unions to become depositories of municipal deposits is not in the best interest of local municipalities.
Credit unions argue that if municipalities have more choices where they can invest their funds, the municipalities will earn more interest income annually, which will help alleviate budgetary pressures and minimize possible real estate tax increases.
IBANYS points out that municipalities already have multiple choices as to where they can invest their funds, thereby greatly minimizing any benefit from including credit unions. As an example, most municipalities “shop” their longer-term investible funds (certificates of deposits) as they realize the demand for these types of municipal funds is already intense. Often times, the difference between the successful bidder on these funds and the runner-up bidder is as small as 1 basis point (0.01%). Using an example of a $1 million certificate of deposit, the 1 basis point a credit union would pay a municipality equates to $100 per year. This increase is hardly an amount that would alleviate any municipality’s budget pressures.
It is highly likely that the types of municipal deposits credit unions will seek if granted this power are the checking, savings and money market deposits of municipalities. Historically, these accounts are “cheaper” sources of funds for financial institutions.
If this is true, in most cases, municipalities will not see any appreciable increase in interest income. In many cases, community banks do not require a minimum balance that the municipalities need to maintain to avoid monthly fees and still many more do not charge municipalities for an array of sundry banking services. Credit unions will generally not seek to provide services such as check clearing or cash management because membership limitations require credit unions to be comprised of individuals who share a common bond. Municipalities already have the benefit of investing most of their “excess” deposits in longer-term, higher yielding investments. Moreover, as evidenced by Rate Watch, an independent third party vendor that surveys financial institutions weekly, there is no evidence that credit unions consistently pay higher interest rates than community banks on savings or money market accounts. It is true, that on any given day, a credit union may elect to pay a higher rate, but this statement is also true for community banks.
However, in an attempt to present a fair and balanced paper, let’s assume that on a particular day a credit union chooses to pay a municipality a higher rate on a savings or money market account or even a certificate of deposit. Let’s also assume the credit union pays 0.25% higher than any community bank and that the municipality invests the full $1 million with the credit union. The 0.25% equates to an additional $2,500 in annual interest income for the municipality.
A municipality should also consider what the negative consequences are if it chooses to invest with a credit union rather than a community bank. Using the example above, for $2,500 the municipality will likely experience an increase in its cost of borrowing. Credit unions do not pay state and federal income or franchise taxes, nor do they pay local and state sales taxes. In addition, in the MTA region credit unions do not pay the MTA surcharge or the MLT mobility tax. Further, credit unions have litigation pending to obtain immunity from payment of the mortgage recording tax. Therefore, community banks have no economic incentive and are less likely to bid on a municipality’s borrowing request. It is well documented that for years, community banks have been the main source (in most cases, the sole source) of borrowings for non-secondary market municipal debt. If a municipality makes the decision to invest with a credit union rather than a local community bank, the community bank losses its economic incentive to offer the municipality the lowest interest possible for its borrowings. It would only take a 1% increase on $250,000 in the municipality’s borrowing to totally offset the $2,500 in increased interest income offered by the credit union.
Municipalities also need to consider the amount of monetary support local community banks contribute to the many requests for financial support municipalities make each year. The community bank loses its economic incentive to contribute, at least at the same level as previously, if it loses a portion of the relationship. It is well documented that because of their not-for-profit status, credit unions do not make the same level of monetary contributions to not-for-profit community groups. Banks are additionally motivated by Community Reinvestment Act requirements which do not apply to credit unions.
A municipality that is considering investing with
a credit union rather than a local community bank should also understand the
amount of various tax revenues that are at risk. As stated above, credit
unions do not pay state income tax or state and local sales taxes. Community
banks pay these taxes. If a municipality chooses to invest with a credit
union, no incremental business is being done that would not have been
otherwise had the municipality invested with a community bank. Each financial
entity would take the municipal money invested and re-invest the same amount
with others in the form of local loans. The difference between the two
financial entities is that the income from the loans is taxable income for the
community bank but non-taxable to the credit union because of their tax-exempt
status. An example: Let’s assume a municipality invests $1 million with a
local community bank. The bank re-invests this money back into the community
in the form of loans (this is exactly what happens today). Let’s also assume
the bank makes a 3.50% spread on what it pays the municipality for the
investment versus what interest rate it charges the customer for the loan.
Before operating expenses, the bank earns $35,000 annually. If we assume
operating expenses of 1.50%, the bank’s before tax income is $20,000. The New
York State franchise tax for community banks is 7.1%. Therefore, $1,420 of
the $20,000 is paid to New York State in taxes. While nominal in itself,
multiplied thousands of times over, this money is significant to the State and
is used by the State to re-invest into municipalities in the form of
State Aid. If the municipality invests with the community bank, the State
generates these taxes. If the municipality chooses a credit union it is NOT
generated – again because of the tax-exempt status of credit unions.
Other taxes used by the State and counties to benefit local municipalities are sale tax receipts. In generating the investment with the municipality and the loan with the customer both the community bank and the credit union use various forms and services. The difference between the two financial entities is that the community bank pays sales taxes on the forms or services needed to complete the transactions. Credits unions again do NOT pay these taxes. Individually, these taxes are nominal; but multiplied millions of times annually and they are significant for the State of New York, the individual counties and the municipality itself.
In conclusion, when viewed from a public policy perspective, municipalities on all levels have more to lose than gain if credit unions are granted the power to become depositories for municipal funds. A taxable entity will be replaced by a tax-exempt entity.
2. Authorizing credit unions to become depositories of municipal deposits is not in the best interest of the State of New York.
The illustration used above points out that if credit unions are granted the power to become depositories for municipals deposits, the State of New York will lose tax revenues in the form of State income, sales taxes, MTA surcharge, MLT mobility tax, and mortgage recording taxes (in litigation). The loss of municipal deposits results in a loss of tax revenue generated through the loans and investments generated by community banks. The state receives no tax benefit on loans or investments made by credit unions. This only results in an outflow of tax revenues for the state.
The overall economic climate of the state will be adversely impacted because community banks will not be able to fund the same level of loan activity. Community banks are critical loan conduits because they are exclusively focused on making loans in their communities.
3. Authorizing credit unions to become depositories of municipal deposits is not in the best interest of the Federal Government.
The principles outlined above regarding the reduction in taxable income generated because a fully taxable entity is supplanted by a non-taxed entity not only remain for the federal government, but are greatly enhanced because of tax rates. Using the example above, if a fully taxable community bank is supplanted, at its 34% income tax rate, the federal government would lose $6,800 in tax receipts on a $1 million transaction annually. Again, after being multiplied by tens-of-thousands of times this becomes very significant money and the “trickle down” multiplier is enormous.
4. Authorizing credit unions to become depositories of municipal deposits is not in the best interest of the community banks.
Municipal deposits constitute from 10% to 30% of the funds of community banks. Loss of municipal funds would negatively impact community banks’ balance sheets and ability to make loans for economic development. Further, the loss in revenue would result in a loss in the growth of capital. The loss of capital would reduce growth prospects that would mean less employment opportunities being created and the ability to increase the amount of small business loans. As is widely known and respected, small businesses make up 60% to 70% of all jobs created in the United States. Community banks have always been at the genesis of the creation of these jobs.
5. Authorizing credit unions to become depositories of municipal deposits is not in the best interest of the credit unions themselves.
The old adage “be careful what you wish for…” is something credit unions should ponder before they continue down this path of asking for the power to accept municipal deposits. They need to realize that along with the opportunity to expand their businesses come certain costs and responsibilities. Costs and responsibilities that could outweigh their benefits – not only for the credit unions themselves but their members, the National Credit Union Administration which insures them, and possibly US taxpayers.
A few of these costs include the necessary collateral for the municipal deposit (which could drastically reduce the net interest spread realized on these transactions); the third party costs associated with collateral safekeeping and the in-house operational costs associated with these transactions.
A major responsibility (and cost) credit unions will have to address is adequately addressing interest sensitivity and liquidity modeling to ensure their own safety and soundness. Community banks have long run these in-depth models, to the satisfaction of regulators, ensuring the regulators, and their depositors, that they understand and carryout their fiduciary responsibilities to each of these constituents. There is a wide variation of sophistication and size among credit unions which would make execution a matter of concern.
In conclusion, it is the position of the Independent Bankers Association of New York that granting credit unions the power to become depositories for municipal deposits is not in the best interest of the taxpaying public. By granting the power, no additional business will be conducted that is not already being conducted; any possible economic benefit to local municipalities will be minimal at best and vastly offset by the loss of other forms of income; charitable entities will face the loss of contributions from community banks that will not be offset by credit union giving; the State of New York and federal government will lose tax receipts; the engine of economic growth, small business loans by community banks, will be jeopardized; and many small credit unions are not able to discharge the fiduciary responsibilities which flow from handling public funds.