In the ever-present competition for market share between banks and credit unions, the misfortunes of one side are usually viewed as the fortunes of the other: More restrictive membership rules for credit unions are good for banks; tougher capital requirements for banks are good for credit unions.

But the current turmoil in the credit union world—where multiple corporate credit unions are on life support and the retail credit unions that own them are anxiously watching their capital ratios—may turn out to be bad for both banks and credit unions.

An estimated 2,300 credit unions will need fresh capital in the next few years and they lack options for raising it. The expectation is that scores of weak credit unions will be compelled by the National Credit Union Administration to merge with healthier ones, thus creating larger—and more formidable—competitors. Community bankers often say they have no qualms with small credit unions that stick with serving specific member groups; their anger is with the large credit unions that advertise aggressively, while enjoying a tax advantage over banks.

Already, consolidation is underway. Last year, the NCUA arranged mergers for 56 weak credit unions, including Eastern Financial Florida Credit Union's takeover by Space Coast Credit Union, which doubled Space Coast's assets to $3.2 billion. NCUA data also shows credit unions are adding heft organically. Their total assets rose 4.4 percent from February 2009 to February 2010, even though the number of credit unions fell 3.2 percent in that time. Over roughly the same period, the banking industry's total assets shrank 5.3 percent, Federal Deposit Insurance Corp. data indicates.

Douglas L. McClure, president and chief executive of Rocky Mountain Bank & Trust in Florence, Colo., says competition with credit unions is fierce; in El Paso County, where his bank is based, credit unions have 40 percent of the deposits. "As they get bigger," McClure says, "they have bigger marketing budgets and they are pushing to increase the amount of business loans they can have, which further eats into bank market share."

Like banks, credit unions have been hurt by the financial meltdown and the increase in mortgage defaults. Their troubles also include a capital crisis at the major corporate credit unions. Last spring, the NCUA placed the two largest corporates, U.S. Central Credit Union and Western Corporate Federal Credit Union, into receivership after the value of their mortgage-backed securities plunged. The corporates, which provide long- and short-term investments, clearing, electronic funds transfer and other services to retail credit unions, are estimated to have incurred systemic losses of between $15 billion and $50 billion.

Retail credit unions already in tenuous capital positions could take a significant—if not fatal—hit when the losses on their investments in corporates are realized. The NCUA is "going to try to merge as many of these guys together as they can get away with," says Alan D. Theriault, president of Credit Union Financial Services in Portland, Maine.

Credit union advocates say the claims of capital problems are overblown. "Credit unions have less capital than they did but they are in pretty good shape overall," says Credit Union National Association spokesman Patrick Keefe. He attributes their trouble to a surge of deposits from customers fleeing banks during the financial crisis. On credit union books, deposits translate into assets, he says, and because it's hard finding quality loans these days, that increase has triggered changes in credit union capital levels.

Bankers, though, just fret about credit unions getting larger. "We see the credit unions we are competing against already being very competitive across all the products we offer as a community bank," says Robert R. Jones 3rd, president of United Bank in Mobile, Ala. "If they are going to get to a certain size, the viability of the credit union charter needs to be reconsidered."

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