These and other factors were expected to lead to an increase in credit union consolidation, but it has not materialized. The number of credit union mergers has actually declined every year since 2004, despite the fact that more than one-third of the industry generated a negative ROA last year and the combined number of CAMEL 3, 4 and 5 credit unions has increased.

Although the recent pace of bank mergers is slower than in previous years, meaningful consolidation had already begun. What's more, the recent pace does not threaten the well-being of top performing banks the way the lack of merger threatens top credit unions.

Banks can grow two ways, credit unions just one. Strong credit unions are at a competitive disadvantage to their bank counterparts because they cannot equally grow through merger. This reality is becoming more obvious to the large credit unions. Consider that 52% of the credit union industry assets reside in institutions with less than $1 billion in assets, while only 10% of banking industry assets are in banks smaller than $1 billion. Over the years, numerous players in the banking industry imposed more accountability on average and weak performers. These players included customers, shareholders, directors and regulators of weak banks as well as stronger competitors. Top performing credit unions believe the CU system of accountability is not functioning as efficiently as evidenced by fewer mergers and subpar ROI on capital spent on branches and marketing among other things.

Over time, the impact on income and competitiveness will be felt as stronger banks merge  meaningful assets and improve their efficiency ratios, while stronger credit unions cannot. Stronger banks of all sizes acquire weaker banks, sometimes with FDIC assistance, which has led to only 10% of the industry's assets residing in banks smaller than $1 billion. Further compounding the issue is the relative size of the merged institutions. Sandler O'Neill research derived from NCUA and FDIC data reveal the average credit union merged since 2004 has $19 million in assets, compared to $749 million for banks.

Average and weak credit unions are not merging. To maintain market relevance, many are pricing their products and fees in a manner that not only produces a negative ROA, it erodes their capital. In addition, such loss-leader pricing harms healthier institutions by creating customer expectations of similar pricing from them. When resolution of a weak credit union finally occurs, there is little left to attract suitors.

Thus, an unintended consequence of regulatory forbearance and insufficient merger and acquisition activity is reduced income for all and a growth tax on healthier credit unions. As marginal and weak credit unions shrink, the top credit unions pay higher assessments because their percentage of the industry's total shares  increases. To illustrate, one credit union grew shares by 16.2% in 2009-2010. The credit union's total documented assessment was $19.3 million, of which $5.2 million is due to its growth combined with the shrinkage that occurred at many credit unions. Documented assessments are those identified by the NCUA as a result of funds owed to investors in medium-term notes issued by the NCUA and funds owed the U.S. Treasury from previous borrowings but do not include additional assessments that may occur from continued losses on the legacy assets of failed corporate credit unions or failure of natural person credit unions.

In a previous article, I wrote about the possibility for a Plan B to deal with the outcome of the credit bubble. (See CU Times, March 31, 2010, or CUTimes.com/BigBang.) Plan B called for the healthy banks, thrifts and credit unions to move under one prudential regulator, as articulated in the Treasury's “Blueprint for Regulatory Reform,” and team up with the FDIC in assisted transactions. Perhaps it's time to revisit Plan B. 

Peter F. Duffy is managing director with Sandler O'Neill & Partners LP.
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