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Introduce yourself

Thank you for allowing me to be here today.

I am here today on behalf of the South Dakota Bankers Association. In June, the SDBA Board decided that the timing was right for a full-court press to educate the general public about the tax exemptions enjoyed by credit unions and the Farm Credit System

I am here to provide you with the historical perspective on these public policy issues and to provide some perspective on the dollars involved. I will also explain why I believe that you have a significant stake in the upcoming tax reform debate in Congress.

1Tax Policy FundamentalsCredit Union and Farm Credit System Tax Exemptions date back 80 and 100 years

Tax Code should not create winners and losers like businesses should be treated the same

South Dakota Bank Franchise TaxThe Common Bond Credit Union Charter was created by Congress back in the 1930s and was specifically give an full tax exemption to ensure that people of modest means had access to basic banking services. The Farm Credit System tax exemptions date back almost a century ago, when this direct lending arm of the federal government was created because Congress was concerned that Young, Beginning and Small producers might have a difficult time accessing loans at banks.

I will show you how these two entities have been allowed to stray and in reality have nearly abandoned their original mission.

In Americas free-market economy, the nations tax code should not provide a competitive advantage to any one segment of the financial services industryor any other industry. Businesses that provide like products and services should be taxed equally. The tax code should not create winners and losers. Thats the role of the marketplace.

While South Dakota doesnt have a corporate income tax, our banks have been paying a tax based on net income called the bank franchise tax since 1939. Over the past 10 years this tax has brought in nearly $500 million with $174 million of that being distributed back to local county treasurers offices to be divided between each countys general fund, municipalities, local K-12 schools and local townships.

But as you will see in the next slide, not all financial service providers pay state and federal taxes.2Federal Law Protects Some ProvidersCredit Unions Pay No Tax Federal Income TaxSouth Dakota Bank Franchise TaxState or Local Sales Tax

Farm Credit Services pays only a nominal amount

Banks pay Federal Income, SD Bank Franchise and Sales Tax

As a matter of federal law, Credit Unions do not pay: Federal Income Tax, South Dakota Bank Franchise Tax or state or local sales tax.

Farm Credit System lenders only pay federal income tax and state bank franchise tax on income from loans which are not secured by real estate. To help quantify that, the Farm Credit System lender in our area, Omaha-based Farm Credit Services of America only paid about 1% of their earnings in state and federal income taxes last year.

Banks of course pay all of these taxes.

So what you see today in many communities is two financial service providers located across the street form one another, offering the same basket of banking products and services to anyone who wants to open an account. One institution pays federal income tax, state bank franchise tax and state and local sales taxes with the other does not. Does that make any sense?3Why should Congress Repeal the Exemptions?Credit Unions $1 trillion tax exempt industryNet Income of $9 billion in 2012Evolution of Credit Unions to a Community Charter - growth focus with limited interest in people of modest means

Farm Credit $250 billion arm of Federal GovernmentNet Income of $4.3 billion in 2012Return on Assets of 1.74%Limited interest in serving young, small, beginning producers

New Revenue Would Help Reduced Federal DeficitCredit Union Exemption = $2 billionFarm Credit System Exemption= $1.3 billion

So why do I think it is time that Congress repeal these long-standing tax exemptions?

The Credit Unions have evolved from the 1930s, single common bond charter, created specifically to ensure the availability of basic financial services for closely knit groups of people who were of modest means, to the 1980s when credit unions were allowed to provide nearly all of the same products and services as other financial institutions, sharing a common bond to the 1990 Community charter which allowed virtually anyone in a community to be a member. The Credit Unions have become a large trillion dollar industry which had net income of $9 billion dollar last year. Full taxation at the federal level would generate a minimum of $2 billion annually or $20 billion in 10 years.

The Farm Credit System is a large tax preferred entity at $250 Billion in size; who had net income in 2012 of $4.3 billion. This equates to a 1.74% return on assets. The FCSA out of Omaha had net income last year was 480 million, with an ROA of 2.75%. Compare these returns to the average commercial bank in our area with an ROA typically around 1%. Full taxation of their earnings would bring in an additional $1.3 billion to the federal treasury.

The financial stakes surrounding these exemptions are significant.

Perhaps if these tax exempt entities had stayed true to their original missions, tax exemptions may still be warranted, but that just isnt so.

4Banks Serve More People of Modest Means

Credit Unions, especially the largest, fastest growing ones dont want people to understand how they have changed the focus of their business model. But studies have show that credit unions generally no longer focus on servicing closely knit groups of people of modest means.

A 2006 study by the Governmental Accountability Office showed that banks provide services to a higher percentage of customers with low-to-moderate income than credit unions (40% to 31%)

AND credit unions serve a higher percentage of upper income customers than banks (49% vs 41%)

5Farm Credit Mission Challenged!80 to 90 % of loans are to older, well-established larger farmers1,714 South Dakota Farm Service Guaranteed loans - 99% were underwritten by Banks (as of 7/31/13)FCS financed luxurious vacation home for Hollywood producer in Black Hills.

In the case of the Farm Credit System, their own facts dont support their mission of focusing on serving young, small and beginning ag producers. According to their own latest annual report, 80 to 90 percent of what this direct lending arm of the federal government does is make taxpayer subsidized loans to older, well-established, large farmers and ranchers.

(If anyone wants to know how this number is derived, as of 12/31/12 11% of system loans were made to young producers, 18% to beginning producers and 22% to small producers. Given double and triple counting in those numbers, then 80 to 90 percent of loans are to older, well established, larger producers).

Here is another interesting fact. As of July 31, 2013 Federal Farm Service Agency records show that there were 1,714 active FSA guaranteed loans in South Dakota. These are loans made to some of agricultures most at-risk borrowers. Banks underwrote 99% of those loans.

A few years ago, FCSA financed this luxurious 6500 sq ft home with a 2100 square foot guest home and state of the art equestrian center for a Hollywood producer in the Black Hills. Does sound like something a tax favored government sponsored ag lender should finance? Should the earnings from this real estate secured loan be exempt from federal and state taxation?

6FARM CREDIT: Mission Challenged.

This advertisement was placed on the back cover of an issue of East Carolina Farm Credits quarterly magazine that was sent to all of its borrower-shareholders. The message was quite clear: Forget ag lending! Want a new toy? - Farm Credit will loan you the money.

Farm Credit, a creature of the federal government seems more than willing to thumb its nose at the spirit and intent to the enabling laws passed by Congress.

Should it continue to grow and ignore its mission at the expense of the American taxpayer?

When the mission of a tax-exempt organization changes, then the tax-exemption should be ripe for change as well.7Why is this important to you?National StakeholderYou pay income taxes, Credit Unions dont Farm Credit Pays a minimal amount

Local StakeholderSouth Dakotas Bank Franchise Tax benefits important programs - state and localSo Why is this important to you?

At a national level, you and I and the business we own or work for pay federal income taxes. The 6,000 plus community banks that compete with credit unions pay $4 billion in corporate income taxes every year to support their communities. But the credit unions pay nothing at all. ZERO. Farm Credit, a 250 billion dollar arm of the federal government itself, pays a minimal percentage 5% or less.

But Congress not only decided to exempt these two lending industries from federal income tax, but it also decided to preempt the rights of states to apply state or local taxes to them as well. So credit unions are totally exempt from SDs bank franchise tax and sales tax. And again, Farm Credit pays almost nothing.

Every dollar of income earned by credit unions and Farm Credit on loans that would otherwise be made by a tax-paying bank means lost tax revenue for state and local governments in South Dakota. Lets take a look at what the SD Bank Franchise means to our state and local governments.

8SD Bank Franchise TaxSD Bank Franchise Tax is assessed on entities providing financial services to South Dakota citizens.

This income tax, which is paid at a rate of 6% by South Dakotas traditional community banks and credit card banks, totaled nearly half a billion dollars between 2004 and 2013.$489 million to be exact.

The State treasury kept $315 million, most of which came from banks solely in the credit card business because 95% of the tax paid by those banks stays in the state treasury. The other 5% is returned to local government.

Local Governments (counties, cities and towns, school districts, townships and rural fire districts) received bank franchise taxes totaling $174 million. Over 90 percent of that tax came from traditional community banks like mine. That is because 73 and 1/3 percent of taxes paid by community banks and commercial banks benefits local government programs while the remaining 26 and 2/3 percent stays in the state treasury to fund state government programs.

Tax receipts go up and down as the net income of banks fluctuate. It is easy to see the effects of the recent recession on bank income and tax collections, especially those of banks concentrated in the credit card business.

People opposed to repealing these outdated exemptions might have you believe that this is all about banks complaining about their competition.

I believe that the issue is much larger than that. Failure to repeal these tax exemptions means 2 things will happen:

(1) Tax payers like you and I get to pay more, and

(2) Funding for state and local government programs will get shortchanged.

Every dollar of income shifted from a tax-paying financial institutions to a credit union or farm credit means lost tax revenue federal, state and local.

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8 year avg. - $485,800As nearly three fourths of the taxes paid by community banks are returned to the county treasurer office proportion to a banks footings in that county, we have a unique opportunity to drive the effects of this taxation inequity vary close to home. Once the local treasurer receives the countys share of bank franchise tax, those monies are divvied out among the various units of local government based on a laws and formulas dating back to the 1970s.

The following information is all available at the local auditors office and is presented to you to give you a feel of the significance of the revenue coming back to our local governments.

Here you can see a 8 year history of the total amount of the bank franchise tax received by Brookings County from the state Department of Revenue. You will note that there are some ups and downs in franchise tax revenues, and frankly that is what happens when a tax is based on net income. Over the last 8 years $3,886,204 has been returned; averaging $485,775/year; in 2013 Brookings County received $451,00010

In this chart, I picked the most recent year and show how the total amount of tax received in 2013 was divided between the local governments in Brookings County. Schools located in the county received $313,000; Cities and towns were next at $70,000; the county general fund received $55,000; and Townships got $12,000

I think it is also relevant and important to note that South Dakota Community Banks support their communities in many ways beyond just safe-keeping their customers money and making loans to individuals and small businesses and by paying taxes.

We invest back into our communities. Take a look around town, which organization supports philanthropic, charitable and civic causes in your town..your local bank, the local credit union or the farm credit system?

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This chart breaks down the total school district share of $313,000 by individual school district:

Brookings $189,000Sioux Valley $ 49,300Elkton$ 26,800Deubrook, Hendricks, Astoria$ 22,900Arlington$ 19,400Estelline$ 5,900

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8 year avg. - $203,300This slide shows the bank franchise tax received by the Brookings School District over the last 8 years, totaling $1,626,658; averaging $203,332 annually.13

This slide breaks down the City and Towns share of franchise tax allocated to Brookings County.

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8 year avg. - $64,400This slide shoes the bank franchise tax received by the Brookings municipality over the last 8 years, totaling $515,368; averaging $64,421 annually.15

8 year avg. - $59,500The Brookings County portion of the bank franchise tax over the last 8 years totaled $476,462 and averaged $59,557 per year.16Cost of Protecting Status Quo - South DakotaAnnual Cost of Tax Exemptions for South DakotaCredit Unions $1 MillionFarm Credit $4 MillionTOTAL$5 million*Local Government Share = $3.7 million(*Doesnt include lost sales and use tax revenue on products and services purchased by federal credit unions)

So just how many tax dollars are being missed based on these outdated exemptions?

The net income for South Dakotas Credit Unions totaled $21 million last year. With a 6% Bank Franchise Tax, that equates to $1 million. That doesnt however account for lost revenue from non payment of state and local sales taxes.

Those are todays numbers, but credit unions are leveraging their tax exemption to grow at twice the rate of banks. The longer that federal law stays the same, the larger the credit union tax subsidy will get as more business flows away from tax paying banks.

Because agriculture is such a significant part of South Dakotas economy, the estimated loss of franchise tax to the SD treasury from the Farm Credit System exemption is significantly larger than that of the credit union industry. Even though Farm Credit pays some tax on income from non-real estate secured loans, rolled together, the combined effective federal and state tax rate for Farm Credit Services of America was about 1 percent last year. We estimate that full assessment of South Dakotas bank franchise tax on a loan-based allocation of FCSAs income to South Dakota could yield around $4 million in new revenue.

The primary beneficiaries of this new income, under current law, would be counties, cities, towns, schools and other units of local government that would realize a net gain of around $3.7 million, a sizable jump over their 5-year average annual share of bank franchise tax of about $15 million. 17Tax ReformBipartisan Congressional Focus on writing a simpler, more efficient, fairer tax code.

Blank Slate Approach replace current policies that benefit special interest groups

Eliminate exemptions & increase taxable income

Lower rates across the board

This summer, leaders of the Congressional tax writing committees, including the Senate Finance committee where Senator John Thune is a member, decided it was time to initiate a bipartisan effort to reform the U.S. tax code, making it simpler, more efficient & fairer.

The blank slate approach to tax reform being supported by Finance Committee Chairman Baucus, Senator Hatch and Senator Thune is to replace current policies that benefit special interest groups with new ones that benefit all taxpayers.

Exemptions would be eliminated thus increasing taxable income. Rates would be lowered across the board.

18Its time to take actionSign petition of support

Contact Senator Thune, Johnson and Representative Noem

Support tax reform, including repeal of tax exemptions for Farm Credit & Credit Unions.

Contact our your local LegislatorsSupport 2014 SD Legislature Resolution of support

THE TIME TO ACT IS NOWWe are here today to ask for your help. We believe that when missions of a tax-exempt organizations change, then the tax-exemption should be ripe for change as well.

If we are going to get Congress to take the brave step forward to remove these outdated exemptions from the tax code, we need to broaden the awareness and concern about these outdated inequities in the tax code well beyond bankers.

I am here to ask for your support in this taxation equality campaign. If you agree that now is the time to change these archaic tax exemptions, I would ask that you sign the petition which I will send around, which will help us quantify our level of support for this issue.

Then I would ask you to contact Senator Thune, Senator Johnson and Representative Noem to support the repeal the Credit Union and Farm Credit tax exemptions AND to repeal the prohibition on state taxation.

I would also ask that you contact State Senator _____________, State Representatives _____________and _________________. Ask them to support a resolution next year in the state legislature telling Congress that now is the time to act.

This exercise is all about showing our elected members of Congress that it is OK politically to repeal these illogical relics in the federal tax code.

In the game of politics, its all about who has the votes. The only way to get those votes is to provide political cover at a level high enough to offset the pressure from those who will do whatever it takes to maintain the status quo.

Additional items to cover during discussion following formal presentation:

Group of bankers met with Senator Thune, a member of the Senate Finance Committee, on Sept 3. We asked him to take a lead role in making sure that those exemptions are on the table during future discussions or hearings on federal income tax reform in his committee. His response confirmed that the Board made a good decision.

Discuss size and scope of South Dakota Credit Unions (next slide); including the growth of Black Hills Federal Credit (Billion in assets) and Dakota Land Federal Credit Union ($220 million) Only 4 of SD 44 CU still single bond credit unions representing 2% of the assets. $2.6 Billion total assets.19South Dakotas Credit Unions44 South Dakota Credit UnionsAssets = $2.6 billion Income = $21 million (2012)Black Hills Federal Credit Union nearing $1 billionSDs Community Chartered Credit Unions 28 Charters (63%) and $2.4 billion assets (93%)SDs Multiple Bond Credit Unions12 Charters (28%) and $118 million assets (5%)SDs Original Single Bond CUs 4 Charters (9%) and $55 million assets (2%)

In order to better understand the level of mission change that has occurred in South Dakotas credit union industry, lets look at some examples of recent growth in this tax-exempt industry.

South Dakotas largest credit union, Black Hills Federal Credit Union operates under a full blown community charter. In Rapid City, Black Hills is second in size only to Wells Fargo. It is larger than every community bank operating in South Dakotas second largest city. Its community footprint now covers 7 counties, starting in the Black Hills and running east over 150 miles through Philip, Midland and Hayes all the way to Pierre / Ft. Pierre. Black Hills Federal is closing in on $1 billion assets, where it will join over 200 others throughout the U.S. above the billion dollar mark. Right now they are constructing a new branch in Pierre- 7000 sq. ft. 5 drive thru lanes on about 6 acres of ground. The land alone cost $1.5 million. I guess thats is what you have available to spend on expansion if you dont pay taxes!

Dakotaland Federal Credit Union has nearly $220 million in assets, more than double where it was five years ago. In 2010, Dakotalands federal regulator granted it the authority to expand its community from 3 to 25 counties in eastern South Dakota, stretching east and west from Pierre to the Minnesota border. From north to south its territory extends from I-90 to just south of Aberdeen.

Even a community chartered credit union like Sioux Falls Federal that operates in a single county, at $207 million in assets is larger than two thirds of South Dakotas banks.

These 3 along with 25 other community chartered credit unions account for 93% of all credit union assets in SD and 85% of credit union income. Add in the 12 with multiple bond charters and you account for 98% of assets and 93% of the income.

That leaves only 2 of percent of the market for the single, common bond credit union envisioned back in the 1930s when Congress granted the tax exemption.

They look, feel and act just like community banks. They ought to be taxed the same way!

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