Financial Institutions: Issues Regarding the Tax-Exempt Status of Credit Unions
Published: 2005-11-03T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Unlike other depository institutions, credit unions are exempt from federal corporate income taxes. Recent legislative and regulatory changes to credit union membership restrictions and allowable products and services have blurred some of the historical distinctions between credit unions and other depository institutions. As a result, some observers have raised questions about whether tax exemption provides credit unions with an advantage over other depository institutions and whether the original basis for tax exemption is still valid. As part of its continuing oversight of the tax-exempt sector, the House Committee on Ways and Means asked GAO to address (1) the historical basis for the tax-exempt status of credit unions; (2) the arguments for and against taxation, including estimates of potential revenue from eliminating the exemption; (3) the extent to which credit unions offer services distinct from those offered by banks of comparable size, and serve low-and moderate-income individuals; and (4) the extent to which credit unions are required to report information on executive compensation and assessments of their internal controls.
section_title: What GAO Found
paragraphs: Congress originally granted tax-exempt status to credit unions in 1937 because of their similarity to other mutually owned financial institutions that were tax-exempt at that time. While the other institutions lost their exemption in the Revenue Act of 1951, credit unions specifically remained exempted. The act's legislative history is silent regarding why the tax-exempt status of credit unions was not revoked. More recently, the Credit Union Membership Access Act of 1998 indicates that credit unions continue to be exempt because of their cooperative, not-for-profit structure, which is distinct from other depository institutions, and because credit unions historically have emphasized serving people of modest means. Arguments for taxing credit unions center on creating a "level playing field" since credit unions now compete more directly with banks. Proponents also point to associated potential revenues, with federal estimates ranging from $1.2 billion to $1.6 billion per year. Opponents of taxation argue that credit unions remain distinct--organizationally and operationally--from other financial institutions and taxation would impair their capital levels. Prior GAO work has found that relatively large credit unions offer many of the same services that same-sized banks offer, while smaller credit unions tend to provide more basic financial services. Limited comprehensive data exist on the income of credit union members. GAO's assessment of Federal Reserve data suggested that credit unions served a slightly lower proportion of low- and moderate-income households than banks, but the lack of comprehensive data prevents definitive conclusions. Most credit unions are not subject to reporting requirements that provide information on executive compensation or internal controls. Specifically, federal credit unions are not required to file the Internal Revenue Service form that most other tax-exempt entities must file and some states allow credit unions to file on a group basis. Further, credit unions are not subject to internal control reporting requirements applicable to banks and thrifts, an item we identified for Congressional action in 2003.

section_title: Letter
paragraphs: I am pleased to be here today to discuss issues regarding the tax-exempt  status of credit unions. Credit unions are the only type of financial  institution currently exempt from federal income taxes. As we have noted  in a prior testimony before this Committee, the size of the tax-exempt  sector has grown in recent years in both the number and assets of  institutions. Today’s hearing on issues related to the credit union tax- exempt sector is timely in light of current and projected fiscal imbalances  and renewed emphasis on accountability and governance in both the  corporate and nonprofit sectors. A comprehensive examination could help  determine whether exempt entities such as credit unions are providing  services that are commensurate with their favored tax status, and whether  an adequate framework exists for ensuring that these entities are meeting  the requirements for tax-exempt status. The information that I am  providing today is based primarily on prior work completed on the credit  union industry and on ongoing work underway for this Committee.
Based on your request, I will discuss:  the historical basis for the tax-exempt status of credit unions;   arguments for and against the taxation of credit unions, including  estimates of the potential tax revenues from eliminating the tax-exempt  status of credit unions; the extent to which credit unions offer services that are distinct from  those offered by banks of comparable size; the extent to which credit unions are serving low- and moderate-income  individuals, including relevant programs of the National Credit Union  Administration (NCUA) that target these individuals; and the extent to which credit unions are required to report or make public  certain information such as executive compensation and assessments of  their internal controls for financial reporting.
In summary, we found that:    The basis for continuing tax exemptions for credit unions, although not  often articulated in legislation over the years, appears to be related to the  perceived distinctness of credit unions and their service to people of  modest means. Congress originally granted tax-exempt status to credit  unions in 1937 because of their similarity to other mutually owned  financial institutions that were tax exempt at that time. While the other  institutions lost their exemption in the Revenue Act of 1951, credit unions  specifically retained the exemption. The legislative history on the 1951 act  did not articulate a rationale for the continued exemption of credit unions.  However, more recent legislation (the Credit Union Membership Access  Act of 1998 or CUMAA) states that credit unions are exempt from taxes  because “they are member-owned, democratically operated, not-for-profit  organizations generally managed by volunteer boards of directors, and  because they have the specified mission of meeting the credit and savings  needs of consumers, especially persons of modest means.”
Recently, arguments for taxing credit unions have centered on creating a  “level playing field” among financial institutions in terms of taxation,  referencing the notable recent growth of the credit union industry to  support the idea that credit unions compete more and more directly with  banks. Proponents of taxing credit unions also point to the potential  revenue associated with repealing the tax exemption. There is also some  debate regarding the extent to which credit unions are serving people of  modest means, especially in comparison with small banks. In response,  opponents of taxation have argued that credit unions remain distinct— both organizationally and operationally—from other financial institutions,  and that taxation would jeopardize the safety and soundness of credit  unions by adversely impacting their net worth or capital levels, which are  restricted to retained earnings. Opponents also note that other depository  institutions do have opportunities for tax relief as S-corporations. Federal  estimates of the potential tax revenues fall within a somewhat narrow  range—$1.2 billion to $1.6 billion annually—while nongovernmental  sources have produced higher estimates of up to $3.1 billion annually.
As the credit union industry has evolved, the historical distinction between  credit unions and other depository institutions has continued to blur. The  number of credit unions declined between 1992 and 2004, although the  total assets of the industry have grown. As of 2004, credit unions with  more than $100 million in assets represented about 13 percent of all credit  unions and 79 percent of total assets. The consolidation in numbers and  concentration of assets has resulted in two distinct groups of credit  unions: a few relatively large institutions providing a wide range of  services that resemble those offered by banks of the same size, and a  number of smaller credit unions that provide basic financial services. For  example, the loan portfolios of larger credit unions tend to hold more  mortgage and real estate loans, resembling those of similarly sized banks.  Smaller credit unions tend to carry smaller loans such as car loans.  Additionally, larger credit unions tend to offer a range of products and  services similar to those offered by banks.
As credit unions have become larger and begun offering a wider variety of  services, the issue of whether these institutions are serving households  with low and moderate incomes has become a matter for debate. Yet,  limited comprehensive data are available on the income of credit union  members. In prior work on the credit union industry, our assessment of  available data —the Federal Reserve’s 2001 Survey of Consumer Finances  and other studies—suggested that credit unions served a slightly lower  proportion of households with low and moderate incomes than banks. To  NCUA’s credit, it has established programs that are intended for low- income individuals and underserved areas. However, NCUA does not  collect comprehensive data such as the overall income of individuals  benefiting from these programs to allow definitive conclusions about the  membership served.
Most credit unions are not specifically subject to reporting requirements  that would disclose information on executive compensation or  assessments of internal controls for financial reporting—information that  can enhance public confidence in tax-exempt entities. Publicly available  financial reports reflect, and support, strong governance and  transparency—essential elements in assuring that tax-exempt entities  operate with integrity and effectiveness and maintain public trust. For  example, public disclosure of revenue and expenses, such as the  compensation of officers and directors, enhances transparency. However,  most credit unions do not individually file the Internal Revenue Service  (IRS) form that would provide such information—Form 990, Return of  Organization Exempt from Income Tax—because of exclusions and group  filings. Further, as we noted in a 2003 report, credit unions with assets  over $500 million are not subject to internal control reporting  requirements applicable to banks and thrifts under the Federal Deposit  Insurance Corporation Improvement Act (FDICIA), which are similar to  the reporting requirements of public companies affected by the Sarbanes- Oxley Act of 2002. As we suggested in 2003, making credit unions of $500  million or more subject to the FDICIA internal control reporting  requirements would provide a commensurate tool to NCUA and  appropriate state regulators to ensure that credit unions establish and  maintain internal control structure and procedures for financial reporting  purposes.
subsections: section_title: Background
paragraphs: Credit unions have historically occupied a unique niche among financial  institutions. Credit unions differ from other depository institutions  because they are (1) not-for-profit entities that build capital by retaining  earnings (they do not issue capital stock), (2) member-owned  cooperatives run by boards elected by the membership, and (3) tax- exempt. Like banks and thrifts, credit unions have either federal or state  charters. Federal charters have been available since 1934, when the  Federal Credit Union Act was passed. States have their own chartering  requirements. As of December 2004, the federal government chartered  about 62 percent of the slightly more than 9,000 credit unions and states  chartered the remainder. Both federally and state-chartered credit unions  are exempt from federal income taxes, with federally chartered and most  state-chartered credit unions also exempt from state income and franchise  taxes.
Another distinguishing feature of credit unions is that they may serve only  an identifiable group of people with a common bond. More specifically,  credit union membership may be based on one of three types of common  bond: single, multiple, or community. For example, a group of people that  share a single characteristic, such as a common profession, could  constitute the “field of membership” for a single-bond credit union. Field  of membership is used to describe all the individuals and groups, including  organizations, which a credit union is permitted to accept for  membership. More than one group having a common bond could  constitute the membership of a multiple-bond credit union. And, persons  or organizations within a well-defined community, neighborhood, or rural  district could form a community-bond credit union. Further, credit unions  can offer members additional services made available by third-party  vendors and by certain profit-making entities with which they are  associated, referred to as credit union service organizations (CUSO).
section_title: Rationale for the Historical Tax Exemption of Credit Unions
paragraphs: The tax-exempt status of credit unions originally was predicated on the  similarity of credit unions and mutual financial institutions; however,  while Congress did not always cite its reasons for continuing this  exemption, recent legislation mentions the cooperative structure and  service to persons of modest means as reasons for reaffirming their  exempt status. The Revenue Act of 1913 exempted domestic building and  loan associations (now called “savings and loans”), and mutual savings  banks not having a capital stock represented by shares, from federal  income tax. Further, the Revenue Act of 1916 exempted from taxation  cooperative banks without capital stock organized and operated for  mutual purposes and without profit. However, credit unions were not  specifically exempted in either of these acts. Their tax-exempt status was  addressed directly for the first time in 1917, when the U.S. Attorney  General determined that credit unions closely resembled cooperative  (mutual savings) banks and similar institutions that Congress had  expressly exempted from taxation in 1913 and 1916.
The Federal Credit Union Act of 1934 authorized the chartering of federal  credit unions. The stated purpose of the act was to “establish a further  market for securities of the United States and to make more available to  people of small means credit for provident purposes through a national  system of cooperative credit, thereby helping to stabilize the credit  structure of the United States.” The 1934 act did not specifically exempt  federal credit unions from taxation. In 1937, the act was amended to  exempt federal credit unions from federal tax and limit state taxation to  taxes on real and tangible personal property. Two reasons were given for  the exemption: (1) that credit unions are mutual or cooperative  organizations operated entirely by and for their members; and (2) that  taxing credit unions on their shares, much as banks are taxed on their  capital shares, places a disproportionate and excessive burden on the  credit unions because credit union shares function as deposits.
The Revenue Act of 1951 amended section 101(4) of the 1939 Internal  Revenue Code to repeal the tax-exempt status for cooperative banks,  savings and loan societies, and mutual savings banks, but it specifically  provided for the tax exemption of state-chartered credit unions. While  the act’s legislative history contains extensive discussion of the reasons  why the tax-exempt status of the other mutual institutions was revoked, it  is silent regarding why the tax exempt status of credit unions was not also  revoked.
The Senate report accompanying the Revenue Act of 1951 stated that the  exemption of mutual savings banks was repealed in order to establish  parity between competing financial institutions. According to the Senate  report, tax-exempt status gave mutual savings banks the advantage of  being able to finance growth out of untaxed retained earnings, while  competing corporations (commercial banks) paid tax on income retained  by the corporation. The report stated that the exempt status of savings and  loans was repealed on the same grounds. Moreover, it stated that savings  and loan associations were no longer self-contained mutual organizations,  for which membership implied significant investments over time, risk of  loss, heavy penalties for cancellation of membership or early withdrawal  of shares, and in which members invested in anticipation of becoming  borrowers at some time. Instead, investing members were simply  becoming depositors who received relatively fixed rates of return on  deposits that were protected by large surplus accounts, and borrowing  members dealt with savings and loans in the same way as other mortgage  lending institutions.
Credit unions, unlike many other participants in the financial services market, are exempt  from Federal and most State taxes because they are member-owned, democratically  operated, not-for-profit organizations generally managed by volunteer boards of directors  and because they have the specified mission of meeting the credit and savings needs of  consumers, especially persons of modest means.
section_title: Arguments for and against Taxation of Credit Unions
paragraphs: At various times, the executive branch has proposed taxing credit unions,  generally endorsing the creation of a “level playing field” among financial  institutions in which organizations engaged in similar activities would be  taxed similarly. Proponents of taxation contend that larger credit unions  compete with banks in terms of the services they provide. Proponents also  have questioned the extent that credit unions have remained true to their  historical mission of providing financial services to persons of modest  means. In response, opponents of the taxation of credit unions have  argued that credit unions remain distinct organizationally and  operationally from other financial institutions, providing their membership  with services they would not receive from other institutions. Opponents  also have argued that taxation would hinder the ability of credit unions to  build capital (which is restricted to retained earnings), jeopardizing their  safety and soundness. Finally, opponents have argued that other  depository institutions, particularly smaller banks, also have opportunities  for tax and regulatory relief such as S-corporation status. Some studies  have attempted to quantify potential tax revenue from repealing the tax  exemption, with estimates ranging from $1.2 billion to $3.1 billion,  depending on the fiscal year considered, tax rates used, and other  underlying assumptions.
subsections: section_title: Arguments for Taxation
paragraphs: Unlike income retained by most other financial institutions, income  retained by credit unions is not taxed until it is distributed to members.  Thus, tax exemption allows credit unions to utilize untaxed retained  earnings to finance expansion of services. Proponents of taxing credit  unions claim that this ability to use untaxed retained earnings provides  credit unions with a competitive advantage over banks and thrifts. In 1978,  the Carter administration proposed that the tax-exempt status of credit  unions be gradually eliminated to mitigate this advantage and establish  parity between credit unions and thrift institutions. The administration  also argued that the relaxation of rules regarding field of membership  criteria, the expansion of credit union powers, and the rising median  income of credit union members indicated that credit unions were no  longer true mutual institutions serving low-income workers excluded from  banking services elsewhere.
In 1984, the Department of the Treasury (Treasury) report to the President  included a proposal to repeal the tax exemption of credit unions, which  also argued that the exemption gave credit unions a competitive advantage  over other financial institutions and its repeal would “eliminate the  incentive for credit unions to retain, rather than distribute, current  earnings.” In 1985, the Reagan administration proposed taxing credit  unions with more than $5 million in gross assets, but would have  maintained the exemption on credit unions with less than $5 million of  gross assets, since it was reasoned that taxing small credit unions would  significantly increase the administrative burden for a relatively small  revenue increase. Similarly, in the budget for fiscal year 1993 the first  Bush administration proposed taxing credit unions with assets of more  than $50 million.
More recent arguments for the taxation of credit unions note the strong  growth rates among large credit unions, which tend to offer a wider array  of services. As a result, taxation proponents argue that larger credit unions  compete with banks in terms of the services they provide and the  households to which they provide these services. They question both the  extent to which credit unions serve people of modest means and pass on  their tax subsidy to members. While limited data are available to evaluate  the income of credit union members—which precludes any definitive  conclusion— some studies, including one of our own, indicate that credit  unions serve a slightly lower proportion of households with low and  moderate incomes than banks. We discuss this issue in more detail later  in this statement.
section_title: Arguments against Taxation
paragraphs: Arguments against repealing the tax exemption for credit unions assert  that the exemption does not offer competitive advantages and that it is  justified by the unique services credit unions offer and by their capital  structure. As we reported in 1991, credit unions as organizations are  exempt from federal and state income taxes. However, the income that  their members receive is taxed. Members who receive dividends on share  accounts are taxed on that income, just as depositors at commercial banks  are taxed on interest income from savings or checking accounts. If credit  unions distribute all income to shareholders and do not retain earnings at  the entity level, all income will be taxed at the individual level. In this case,  credit unions would have little tax advantage relative to taxable mutual  financial institutions, whose income is taxed once at either the individual  or entity level.
In 2005 and in previous testimonies, trade and industry groups and private  individuals presented arguments supporting the tax-exempt status of  credit unions, maintaining that tax-exempt status is justified because  credit unions provide unique services, such as small loans, financial  counseling, and low-cost checking accounts that for-profit financial  institutions are unable or unwilling to provide. They stated that taxing  credit unions would lead credit unions away from their mutual, nonprofit  orientation and structure, leading to reductions in these types of services.  They also testified that taxation would hinder credit unions in building  reserves, and since credit unions do not have the ability to raise capital  through the sale of stock, their safety and soundness would be  jeopardized. They argued that while the number of large credit unions has  grown over the last 10 years, they hold a relatively small share of overall  depository institution assets. Opponents also argued that there is no clear  rationale for targeting larger credit unions because, regardless of asset  size, larger credit unions retain a distinct organizational structure and  must still adhere to limits on their field of membership as sanctioned by  Congress. Furthermore, they argued that larger credit unions, relative to  smaller credit unions, were more stable and efficient and therefore better  able to offer programs targeted to low- and moderate-income households.
Opponents of credit union taxation also have argued that other financial  institutions are not without tax privileges and tax relief. Specifically, credit  union trade organizations have pointed out that an increasing number of  banks have converted to S-corporation status and, thereby, have avoided  paying corporate income taxes. In general, U.S. tax law treats corporations  and their investors as separate taxable entities. Corporate earnings are  taxed first at the corporate level and again at the shareholder level, as  dividends if the corporation distributes earnings to shareholders, or as  capital gains from the sale of stock. In contrast, the earnings of S- corporations are taxed only once at the shareholder level, whether or not  the income is distributed. Corporations that elect Subchapter S status are  subject to certain restrictions on the number of shareholders and capital  structure. For example, an S-corporation may not have more than 75  shareholders, all of whom must be U.S. resident individuals (except for  certain trusts and estates) and may issue only one class of stock. Prior to  1996, banks and other depository institutions could not elect S-corporation  status. A provision of the Small Business Job Protection Act of 1996  repealed this prohibition.
Like credit unions, mutual thrifts are owned by their depositors and their  equity is derived from retained earnings. Mutual thrifts are permitted a tax  deduction for amounts paid or credited to their depositors as dividends on  their accounts if the amounts may be withdrawn on demand (subject only  to the customary notice of intention to withdraw). These dividends are  taxed only at the depositor level, whether they represent interest or a  return on equity, so that mutual thrifts are taxed only on retained earnings.  Further, some farmer’s cooperatives are allowed additional tax deductions  for dividends on capital stock and distributions to patrons. The earnings of  a cooperative generally flow through to the patron and are taxed once at  that level. Finally, some other similar entities, like rural electric  associations and telephone cooperatives are tax-exempt.
section_title: Estimates of the Potential Tax Revenues from Taxing Corporations Vary Widely Based on the Source and Underlying Assumptions
paragraphs: Governmental entities have attempted to estimate the potential revenue to  the federal government from repealing the tax exemption that ranged from  $1.2 billion to $1.6 billion on an annualized basis. In a 2001 report, the  Department of the Treasury estimated potential revenue between $1.2  billion and $1.4 billion annualized over the five year period from 2000-2004,  and $1.4 and $1.6 billion over the ten-year period from 2000 to 2009, if all  credit unions were taxed. More recently, in Analytical Perspectives,  Budget of the United States Government Fiscal Year 2005, Treasury  estimated the potential tax revenue from repealing the credit union tax  exemption at $7.88 billion from fiscal years 2005 through 2009, or $1.58  billion on average annually. However, according to Treasury officials, the  2005 Analytical Perspectives estimate did not account for any behavioral  changes in response to taxation by credit unions in contrast with estimates  from their earlier 2001 study. The Joint Committee on Taxation in a  February 2005 Congressional Budget Office report estimated that taxing  credit unions with assets greater than $10 million dollars would potentially  raise $6.5 billion from fiscal years 2006 through 2010, or $1.3 billion on  average annually over that five year period.
Nongovernmental entities have produced estimates that tend to be higher  than the estimates generated by government agencies. A study issued by  the Tax Foundation, which was funded by the Independent Community  Bankers of America, estimated the potential revenue from taxing all  insured credit unions to be as high as $3.1 billion per year when averaged  over the 10-year period from 2004 to 2013. Another private study  conducted by Chmura Economics & Analytics for the Jefferson Institute  for Public Policy estimated the revenue from taxing all credit unions to be  $1.89 billion in 2002, when the same corporate tax rate as banks paid was  applied to credit unions (in categories differentiated by asset size). In  reviewing these studies, we note that assumptions vary on the tax rates  imposed and the response of credit unions to the imposition of taxes (such  as distributing higher dividends, lowering loan rates, or increasing deposit  rates, which would reduce taxable income and therefore potential tax  revenue). However, large credit unions, though small in numbers, are  responsible for a disproportionate amount of the potential tax revenue as  compared with small credit unions.
section_title: Historical Distinctions between Credit Unions and Other Depository Institutions Have Continued to Blur
paragraphs: Since 1992, credit unions have become less distinct from other depository  institutions of similar size, particularly in terms of the products and  services offered by larger credit unions. Between 1992 and 2004, the total  assets held by federally insured credit unions more than doubled, while  the total number of federally insured credit unions declined. As a result of  the increase in total assets and the decline in the number of federally  insured credit unions, the credit union industry has seen an increase in the  average size of its institutions and a slight increase in the concentration of  assets. Total assets in federally insured credit unions grew from $258  billion in 1992 to $647 billion in 2004, an increase of 150 percent. During  this same period the number of federally insured credit unions fell from  12,595 to 9,014. As of the end of 1992, credit unions with more than $100  million in assets represented 4 percent of all credit unions and 52 percent  of total assets; as of the end of 2004, credit unions with more than $100  million in assets represented about 13 percent of all credit unions and 79  percent of total assets. From 1992 to 2004, the 50 largest credit unions (by  asset size) went from holding around 18 percent of industry assets to  around 24 percent of industry assets.
This industry consolidation contributed to a widening gap between two  distinct groups of federally insured credit unions—larger credit unions,  which are relatively few in number and provide a wider range of services,  and smaller credit unions, which are greater in number and provide more  basic banking services. Figure 1 illustrates institution size and asset  distribution in the credit union industry, with institutions classified by  asset ranges. As of December 31, 2004, the 2,873 smallest credit unions— those with $5 million or less in total assets—constituted almost one-third  of all credit unions but slightly less than one percent of the industry’s total  assets. Conversely, the 98 credit unions with assets over $1 billion (up to  just under $23 billion) held 33 percent of total industry assets but  represented just 1 percent of all credit unions. In our 2003 report, we  noted that as of December 31, 2002, 71 credit unions with assets over $1  billion held 27 percent of total industry assets.
As credit unions’ assets have grown in recent years, credit unions have  generally shifted to larger loans such as mortgages. Between 1992 and  2004, the amount of first mortgage loans held grew from $29 billion to $130  billion, while that of new vehicle loans increased from $29 billion to $71  billion and that of used vehicle loans increased from $17 billion to $85  billion. In terms of the relative importance of different loan types, we  compared the growth in the amounts of various loan types relative to  credit unions’ assets over the same period. Amounts held in first mortgage  loans grew from around 11 percent of assets in 1992 to around 20 percent  of assets in 2004, while amounts held in used vehicle loans grew from just  under 7 percent to slightly more than 13 percent.
As shown in figure 2, larger credit unions generally held relatively larger  loans (e.g., first mortgage loans) than smaller credit unions, which  generally held relatively more small loans (e.g., used vehicle loans). Since  1992, the amount of first mortgage loans held relative to assets has more  than doubled for credit unions with over $1 billion in assets, from around  12 percent to over 25 percent of assets, while it has grown less than 40  percent for credit unions with less than $100 million in assets, from around  9 percent to slightly more than 12 percent of assets.
The discrepancy between smaller and larger credit unions is more  apparent through an analysis of more recently collected data on more  sophisticated product and service offerings, such as the availability of  automatic teller machines (ATM) and electronic banking (see table 1).  While less than half of the smallest credit unions offered ATMs and one- third offered transactional websites, nearly all larger credit unions offered  these services.
Despite the growth in credit union assets over recent years, the credit  union industry remains much smaller than the banking industry, with  credit unions representing around 6 percent of total assets of both  industries. For example, at the end of 2004, the largest credit union had  nearly $23 billion in assets, while the largest bank, with $967 billion in  assets, was larger than the entire credit union industry combined.
Although credit unions are on average much smaller than banks, larger  credit unions and banks of comparable size tend to offer the same  products and services (see fig. 3). In particular, nearly all banks and  larger credit unions reported holding first mortgage loans, while a majority  of the smaller credit unions did not.
section_title: The Extent to Which Credit Unions Serve Persons of Modest Means Is Not Definitively Known because of Limited Data and Lack of Indicators
paragraphs: While credit union fields of membership have expanded, the extent to  which they serve people or communities of low or moderate incomes is  not definitively known. In 1998, CUMAA affirmed preexisting NCUA  policies that had allowed credit unions to expand their field of  membership and include underserved areas. After the legislation was  passed, NCUA revised its regulations to enable credit unions to serve  larger communities or geographic areas. As they have become larger and  begun offering a wider variety of services, questions have been raised  about whether credit unions are more likely than banks to serve  households with low and moderate incomes. However, limited  comprehensive data are available to evaluate the income of credit union  members. Our assessment of available data —the Federal Reserve’s 2001  Survey of Consumer Finances (SCF) and other studies—provided some  indication that, compared with banks, credit unions served a slightly lower  proportion of households with low and moderate incomes. Although  NCUA has undertaken initiatives to enhance the availability of financial  services to individuals of modest means, as of October 15, 2005, it had not  implemented our 2003 recommendation to develop indicators to evaluate  the progress credit unions made in reaching the underserved.
subsections: section_title: Credit Unions Can Serve More People and Larger Areas because CUMAA Permitted NCUA to Continue Preexisting Policies That Expanded Field of Membership
paragraphs: In 1998, the Supreme Court ruled against NCUA’s practice of permitting  federally chartered credit unions based on multiple bonds. Subsequently,  Congress passed CUMAA, which specifically permits multiple-bond credit  unions. The act permits these credit unions to retain their current  membership and authorizes their future formation. Figure 4 provides  additional information on the percent and assets of federally chartered  credit unions by bond type. While multiple-bond credit unions have  constituted on average slightly under 50 percent of all credit unions since  2000, they tend to be larger than the other two types of credit union bonds  in terms of asset size. For example, at year-end 2004, multiple bond credit  unions made up 45 percent of the total number of federal credit unions but  represented 57 percent of federal credit union assets.
In addition to permitting multiple-bond credit unions, CUMAA further  qualifies the definition of community bond. The act adds the word “local”  to the preexisting requirement that community-based credit unions serve a  “well-defined community, neighborhood or rural district,” but provides no  guidance on how “local” or any other part of this requirement should be  defined. However, after the passage of CUMAA, NCUA revised its  regulations to make it easier for credit unions to serve increasingly larger  areas (e.g., entire cities or counties). As a result, NCUA approved a  community-based charter application in July 2005 covering Los Angeles  County with a potential membership of 9.6 million.
section_title: Limited Comprehensive Data Are Available to Evaluate Income of Credit Union Members
paragraphs: While it has been generally accepted that credit unions historically have  emphasized service to people with modest means; currently, there are no  comprehensive data on the income characteristics of credit union  members, particularly those who actually receive loans and other services.  Industry groups and consumer advocates have debated which economic  groups benefit from credit union services, especially in light of the credit  unions’ exemption from federal income taxes. As stated in our 1991 report,  and still true, none of the common-bond criteria available to federally  chartered credit unions refer to the economic status of their members or  potential members.
Information on the extent to which credit unions are lending and providing  services to households with various incomes is scarce because NCUA,  industry trade groups, and most states (with the exception of  Massachusetts and Connecticut) have not collected specific information  describing the income of credit union members who obtain loans or  benefit from other credit union services. Credit unions—even those  serving geographic areas—are not subject to the federal Community  Reinvestment Act (CRA), which requires banking regulators to examine  and rate banks and thrifts on lending and service to low- and moderate- income neighborhoods in their assessment area. Consequently, NCUA  and most state regulators do not require credit unions to maintain data on  the extent to which loans and other services are being provided to  households with various incomes.
section_title: Federal Reserve Board Data Suggest That Credit Unions Serve a Slightly Lower Proportion of Low- and Moderate-Income Households Than Do Banks
paragraphs: Our prior work, which included an analysis of data from the Federal  Reserve Board’s 2001 SCF, suggested that credit unions overall served a  lower percentage of households of modest means (low- and moderate- income households combined) than banks. More specifically, while credit  unions served a slightly higher percentage of moderate-income households  than banks, they served a much lower percentage of low-income  households. We combined the SCF data into two main groups— households that primarily and only used credit unions versus households  that primarily and only used banks. As shown in figure 5, this analysis  indicated that about 36 percent of households that primarily and only used  credit unions had low or moderate incomes, compared to 42 percent of  households that used banks. Moreover, our analysis suggested that a  greater percentage of households that primarily and only used credit  unions were in the middle and upper income grouping than the proportion  of households that primarily and only used banks.
We also looked at each of the four income categories separately. As shown  in figure 6, this analysis suggested that the percentage of households in the  low-income category that used credit unions only and primarily (16  percent) was lower than the percentage of these households that used  banks (26 percent). In contrast, more moderate- and middle-income  households were likely to use credit unions only and primarily (41  percent) than banks (33 percent). Given that credit union membership  traditionally has been tied to occupational- or employer-based fields of  membership, that higher percentages of moderate- and middle-income  households using credit unions is not surprising.
We also attempted to further explore the income distribution of credit  unions members by separately analyzing households that only used credit  unions or banks from those that primarily used credit unions or banks.  However, the results were ambiguous and difficult to interpret, due to the  characteristics of the households in the SCF database. For example,  because such a high percent of the U.S. population only uses banks (62  percent), the data obtained from the SCF is particularly useful for  describing characteristics of bank users but much less precise for  describing smaller population groups, such as those that only used credit  unions (8 percent).
Other relatively recent studies—notably, by the Credit Union National  Association and the Woodstock Institute—generally concluded that credit  unions served a somewhat higher-income population. The studies also  noted that the higher income levels could be due to the full-time  employment status of credit union members. Officials from NCUA and  the Federal Reserve Board also noted that credit union members were  likely to have higher incomes than nonmembers because credit unions are  occupationally based. A National Federation of Community Development  Credit Unions representative noted that because credit union membership  is largely based on employment, relatively few credit unions are located in  low-income communities. However, without additional research,  especially on the extent to which credit unions with a community base  serve all their potential members, it is difficult to know whether the  relative importance of full-time employment is the primary explanatory  factor.
section_title: NCUA Has Established Initiatives That Target Low-Income Individuals and Underserved Areas
paragraphs: NCUA recently has established two initiatives to further enhance the  availability of financial services to individuals of modest means: the low- income credit union program and expansion into underserved areas.  According to NCUA, its Low Income Credit Unions (LICU) program is  designed to assist credit unions whose members are of modest means in  obtaining technical and financial services. LICUs grew in number from  more than 600 in 2000 to nearly 1,000 by the end of 2004. To obtain a low- income designation from NCUA, an existing credit union must establish  that a majority of its members meet the low-income definition. According  to NCUA, credit unions that meet this criterion are presumed to be serving  predominantly low-income members. Also, newly chartered credit unions  can receive low-income designation based on the income characteristics  of potential members.
Credit unions that receive a low-income designation from NCUA are  measured against the same standards of safety and soundness as other  credit unions. However, NCUA grants benefits that other credit unions do  not have, including:    greater authority to accept deposits from nonmembers such as voluntary  health and welfare organizations;   access to low-interest loans, deposits, and technical assistance through  participation in NCUA’s Community Development Revolving Loan Fund;   ability to offer uninsured secondary capital accounts and include these  accounts in the credit union’s net worth for the purposes of meeting its  regulatory capital requirements; and   a waiver of the aggregate loan limit for member business loans.
NCUA has stated that one of its goals is to encourage the expansion of  membership and make quality credit union services available to all eligible  persons. It has done so in part by allowing credit unions to expand into  underserved areas in recent years, from 40 in 2000 to 564 in 2004 (see fig.  7).
CUMAA and NCUA’s Interpretive Ruling and Policy Statement (IRPS) 03-1,  the Chartering and Field of Membership Manual, allows credit unions to  include in their fields of membership, without regard to location,  communities in underserved areas. The Federal Credit Union Act defines  an underserved area as a local community, neighborhood, or rural district  that is an “investment area” as defined by the Community Development  Banking and Financial Institutions Act of 1994—that is, experiencing  poverty, low income, or unemployment. In order to expand into an  underserved area, credit unions must receive approval from NCUA by  demonstrating that a community qualifies as an investment area. Credit  unions must also provide a business plan describing how the underserved  community will be served. Finally, although the underserved and LICU  initiatives are intended to help serve the underserved, NCUA does not  collect data such as overall income levels of individuals using specific  credit union products.
section_title: NCUA Has Not Fully Implemented Our Recommendation to Develop Indicators to Evaluate Credit Union Progress in Reaching the Underserved
paragraphs: Although NCUA has targeted underserved individuals and areas, in our  2003 report on credit unions we found that NCUA had data on potential— but not actual—membership of low- and moderate-income individuals in  underserved areas adopted by credit unions. We recommended that NCUA  use tangible indicators, other than potential membership, to determine  whether credit unions have provided greater access to credit union  services in underserved areas.
As of October 15, 2005, NCUA had not adopted any indicators. According  to NCUA, it has established a working group to study credit union success  in reaching people of modest means. NCUA indicated that the working  group was exploring meaningful measures of success for this objective,  determining how to best quantify the measures with available or readily  obtainable data. The working group has also been evaluating the impact of  other regulations, such as the Privacy of Consumer Financial Information,  on the collection and use of such data. According to NCUA officials, as of  October 15, 2005, the working group had not issued its report or  recommendations.
section_title: Credit Unions Lack Transparency on Executive Compensation and Larger Credit Unions Do Not Have to Report on Effectiveness of Internal Controls
paragraphs: Most credit unions are not subject to IRS and other federal reporting  requirements that would disclose information such as executive  compensation and assessments of internal controls for financial  reporting—information that can enhance public confidence in tax-exempt  entities. Public availability of key financial information (that is,  transparency) can provide incentives for ethical and effective operations  as well as support oversight of the tax-exempt entities. At the same time,  the disclosure of such information helps to achieve and maintain public  trust.
Recognizing the importance of transparency for tax-exempt entities,  Congress made returns of the IRS Form 990 (Return of Organizations  Exempt from Income Tax) into publicly available documents. Since tax  exemptions are granted to entities so that they can carry out particular  missions or activities that Congress judges to be of special value, the  public availability of Form 990 promotes public oversight. Most tax- exempt organizations, other than private foundations with gross receipts  of $25,000 or more, are required to file Form 990 annually. The form  contains information on an organization’s income, expenditures, and  “activities” including compensation information for officers, directors,  trustees, and key employees. IRS also uses these forms to select  organizations for examination.
However, most credit unions do not individually file Form 990. In 2002 and  2003, credit unions filed 1,435 and 1,389 Form 990s, respectively. On  August 23, 1988, IRS issued a determination that annually filing Form 990  was not required for federal credit unions because of their status as tax- exempt organizations under section 501(c)(1) of the Internal Revenue  Code. Depending on the state, some state-chartered credit unions file  through a group filing process. For these states, IRS receives only the  names and addresses of individual credit unions. As a result, scrutiny of  the compensation of credit union executives and other key personnel is  difficult. As you are aware, we have ongoing work in this and other areas,  and we hope to provide you with additional information on the  compensation of credit union executives and officials as part of this  follow-up work.
As noted in our 2003 report, the Federal Credit Union Act, as amended,  requires credit unions with assets over $500 million to obtain an annual  independent audit of financial statements by an independent certified  public accountant. But, unlike banks and thrifts, these credit unions are  not required to report on the effectiveness of their internal controls for  financial reporting. Under FDICIA and its implementing regulations, banks  and thrifts with assets over $500 million are required to prepare an annual  management report that contains:    a statement of management’s responsibility for preparing the institution’s  annual financial statements, for establishing and maintaining an adequate  internal control structure and procedures for financial reporting, and for  complying with designated laws and regulations relating to safety and  soundness; and   management’s assessment of the effectiveness of the institution’s internal  control structure and procedures for financial reporting as of the end of  the fiscal year and the institution’s compliance with the designated safety  and soundness laws and regulations during the fiscal year.
Additionally, the institution’s independent accountants are required to  attest to management’s assertions concerning the effectiveness of the  institution’s internal control structure and procedures for financial  reporting. The institution’s management report and the accountant’s  attestation report must be filed with the institution’s primary federal  regulator and any appropriate state depository institution supervisor, and  must be available for public inspection.
The reports, with their assessments and attestations on internal controls,  allow depository institution regulators to gain increased assurance about  the reliability of financial reporting. Also as we stated in our 2003 report,  the extension of the internal control reporting requirement to credit  unions with assets over $500 million could provide NCUA with an  additional tool to assess the reliability of internal controls over financial  reporting.
Moreover, bank and thrift reporting requirements under FDICIA are  similar to the public company reporting requirements in the Sarbanes- Oxley Act of 2002. Under Sarbanes-Oxley, public companies are required  to establish and maintain adequate internal control structures and  procedures for financial reporting; the company’s auditor is also required  to attest to, and report on, the assessment made by company management  on the effectiveness of internal controls. As a result of FDICIA and the  Sarbanes-Oxley Act, reports on management’s assessment of the  effectiveness of internal controls over financial reporting and the  independent auditor’s attestation on management’s assessment have  become normal business practice for financial institutions and businesses.
In a letter dated October 2003, NCUA’s Chairman stated that while the  Sarbanes-Oxley Act does not apply specifically to federal credit unions,  certain provisions may be appropriate to consider for some federal credit  unions. Federal credit unions are encouraged (but not required) to  consider the guidance provided and are urged to periodically review their  policies and procedures as they relate to matters of corporate governance  and auditing.
Mr. Chairman, this concludes my prepared statement. I would be pleased  to respond to any questions you or other Members of the committee may  have.
section_title: Contact and Acknowledgments
paragraphs: For further information regarding this testimony, please contact Richard  Hillman at (202 512-8678) or hillmanr@gao.gov. Individuals making key  contributions to this testimony include Janet Fong, May Lee, John Lord,  Harry Medina, Jasminee Persaud, Barbara Roesmann, and Richard  Vagnoni.
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