For years, community banks and credit unions have been duking it out for market share. And now the gloves have come off. Just ask James A. Hughes.
“Credit unions are doing the exact same things that banks are doing — collecting deposits and making loans — and they are competing head to head with us,” said Hughes, chief executive officer and president of Unity Bank in Clinton. “But they have the advantage that they have no shareholders to be accountable to and they don’t have to pay taxes. It is a disgrace that Congress has allowed this to continue.”
Hughes penned the first of several contentious letters between leaders in the community bank and credit union sectors that were published by NJBIZ this summer. Naturally, executives such as John Fenton, CEO and president of Affinity Federal Credit Union, came out in defense of his industry’s tax exemption.
“The tax treatment conveyed on credit unions roughly 100 years ago continues to serve the purpose for which it was created, and is one of the best investments that the government makes in its citizens,” Fenton wrote July 10, later adding: “Credit unions provide substantial benefits to their members, and the dollar amount of those benefits greatly exceeds the loss in federal revenue that would result from taxing not-for-profit credit unions.”
The local banking industry’s frustration has hit a boiling point recently, but credit unions have operated in the state for nearly a hundred years. Why is the issue coming to a head now?
In June, the National Credit Union Association, the industry’s regulatory body, proposed a regulatory change that would allow credit unions to expand their commercial lending portfolios.
Small business lending is a particular bone of contention between the two groups.
John E. McWeeney Jr., CEO and president of the New Jersey Bankers Association, said community banks account for 40 percent of loans to small business — an increasingly competitive market.
“The changes the NCUA is considering are very real and could have a significant impact on the banking industry,” McWeeney said.
McWeeney added that the proposed credit union regulatory changes are coming at a time when revenue growth is a challenge for independent banks. These community banks make their money on loans, and while loan demand has improved since the recession, interest rates are low.
And when interest rates are low, so are banks’ profits.
Credit unions have grown increasingly aggressive about commercial lending over the last 15 years. The nationwide credit union system’s total business lending portfolio has grown from $4 billion in 2000 to $51 billion in 2015, a 12-fold increase.
“During the recession, many credit unions saw a growth in the business lending,” said Linda McFadden, CEO and president of Xcel Federal Credit Union and chair of the New Jersey Credit Union League. “The mom-and-pop businesses were struggling through the economy and the banks weren’t interested in making $50,000 to $25,000 loans, so those businesses came to us. There was a need in the market for people who didn’t have an alternative.”
Many community banks say this growth has come at their expense. Credit unions are structured as nonprofits and do not pay income taxes, which bankers believe gives credit unions a greater opportunity for growth.
“Credit unions are not paying income tax and they are not following CRA guidelines, and that seems like unfair competition,” said Peter A. Michelotti, CEO and president of Community Bank of Bergen County and an officer of The Community Bankers Association of New Jersey. “If I didn’t have to pay taxes every year, I could reinvent that money into technology, bigger and better locations, and other benefits for my customers as well.”
The proposed regulatory changes will loosen restrictions on credit unions by allowing credit union loan officers to waive borrowers’ personal guarantees, remove explicit loan-to-value limits and lift limits on construction and development loans.
Industry executives believe regulatory changes are a step in the right direction, but say real legislation reform is necessary. There is a bill currently in Congress that would lift that credit union business lending cap from 12.25 percent to 27.5 percent of total assets.
“Right now, there are 500 or so credit unions in this country that are at that cap or actively managing the cap because there are nearing it,” said Greg Michlig, CEO and president of the New Jersey Credit Union League. “It’s a big issue. Credit unions could be lending much more to small business.”
One credit union at its cap is First Financial Credit Union, which operates in Monmouth and Ocean counties and has a $24 million portfolio.
“Commercial lending for small businesses is much needed, but we are unable to help those businesses who come to us,” said Issa E. Stephan, CEO and president of First Financial Credit Union.
Michlig added that the cap prevents many smaller credit unions from getting involved with business lending at all. Because the cap would keep the number of loans low, it would be impossible for the small credit union to generate the returns necessary to support the staffing required to handle the data processing and member service associated with business lending.
As community banks around the state engage in grassroots efforts to influence public opinion about allowing credit unions to increase lending, the credit unions are firing back by defending their income tax-exempt status.
Michlig described credit unions as not-for-profit, cooperative financial intuitions that are member-owned and have no outside shareholders earning profits. Credit unions are governed by volunteer boards of directors who are voted in by the membership.
And, historically, credit unions were created to provide financial services to underserved or disenfranchised comminutes. Today, there are three types of credit union charters: community-based, employer-based and industry-based.
“The banks like to talk about tax structure as a tremendous competitive advantage that credit unions have; but if you look at this in terms of market share, credit unions in New Jersey hold 3.8 percent of the deposits,” Michlig said.
Many other executives in the credit union industry also take issue with bankers’ claims of tax structure as a competitive advantage.
“The banks portray us like we’re churches and we don’t pay any taxes,” Stephan said. “The only tax we don’t pay is the federal income tax, which would be the tax paid on the profit distributed to shareholders. But, we don’t have shareholders. We pay every other tax — property tax, municipal tax, payroll tax, unemployment tax and everything else.”
Any profits made by credit unions are to be passed on to its member owners or used for the required capital reserve.
“Credit unions pass along our profits to members in the form of lower rates on services,” said Candice Nigro, vice president of marketing at First Atlantic Credit Union. “In extremely good years, credit unions will pay dividends to members.”
While community bankers describe the credit union’s structure as lawmakers’ favored child, the credit unions argue those privileged appearances may be deceiving.
“If any for-profit financial institution would like to convert to a credit union, that is an opportunity that is available to them,” Michlig said. “They would just have to change their governance to a volunteer board and reinvest all their profits back to their customers instead of paying shareholders.”
Stephan added, “If we have such a golden opportunity, then come get some of this gold.”
New Jersey credit unions are experiencing rapid growth. Since 2008, the industry has seen a 37 percent increase in savings, a 12 percent increase in loans and a 30 percent increase in assets.
Yet credit unions have not only remained static, but actually saw a decline in membership.
According to the Credit Union National Association, there are about 1.04 million people in the state who belong to credit unions, which is down from about 1.08 million in 2008.
While credit unions struggle to market themselves, they have successfully increased the amount of engagement they have with existing members.
“The growth of credit unions has not been a phenomena, but rather a steady plod through our history,” said Linda McFadden, CEO and president of Xcel Federal Credit Union and chair of the New Jersey Credit Union League.
For credit unions, cooperation, not competition with other credit unions has been essential to their success.
“Credit unions notoriously band together to solve problems,” McFadden said. “We band together to overcome our shortcomings as small intuitions.”
According to McFadden, credit unions across the state leverage each other’s technology, ATMs and branch locations to provide seamless service to their members.
“We don’t have branches on every corner like the banks do,” McFadden said. “We don’t have that convenience factor. I have two branches and a lot of technology. Some credit unions have several branches, but not much access to technology.
“So, we help each other out. We have a co-op network of ATMs, so members don’t incur fees for using another credit union’s machine.”
While credit unions do have overlap in the market, banks are their biggest competition.
“If someone chooses to join another credit union in my area, it might mean I’m not doing a good enough job and I need to look at my operations,” said Bob Steeves, CEO of Essex County Teachers Federal Credit Union. “But, I feel good that they went to another credit union. I don’t compete with other credit unions. I compete with Bank of America and Valley National Bank.
“I compete successfully because we can give the best service to our members because of the cooperation I get from the other credit unions.”
Besides cooperating on customer service, credit unions are currently working together on improve another shortcoming — advertising.