Washington credit unions, once seemingly sheltered from the financial crisis, now are facing one of the biggest challenges to their health since they were formed in the wake of the Great Depression.

As a result of a trio of problems, stemming largely from the national credit union system, the state regulator sees big hits to earnings and foresees that capital levels at several will plunge below the regulatory "well-capitalized" threshold.

Struggling credit unions that face deteriorating capital levels for multiple quarters likely will be forced to merge into their larger counterparts if they can't come up with a turnaround plan, says Linda Jekel, director of credit unions for the Washington state Department of Financial Institutions.

The challenges facing credit unions are a strong indication that the next stage of the financial crisis has arrived in Washington.

BECU, the state's largest credit union, reported a first quarter loss of $65.7 million—the largest quarterly loss in the not-for-profit's history, according to BECU executives.

The loss was made up largely of a $56.4 million charge associated with problems facing the national credit union system. It also includes a $25 million provision to buffer against bad loans. The charges were offset by the institution's net income growth in January and February.

The loss has pushed BECU below the "well-capitalized" threshold into "adequately capitalized," despite the credit union's strong market growth, according to the credit union.

"We're responding to some extraordinary events," says Gary Oakland, the credit union's chief executive.

Among those events: The state's 122 credit unions—along with other retail credit unions nationwide—are forced to pay part of the multibillion-dollar tab for national regulators' seizure of two national corporate credit unions, U.S. Central Federal Credit Union (U.S. Central) and Western Corporate Federal Credit Union (WesCorp).

Washington credit unions also must write down millions of dollars in devalued investments in the corporate credit unions, which provide wholesale financing to member institutions, much like the Federal Home Loan Bank system.

On top of that, credit unions already are dealing with a steep increase in problem loans, as homeowners miss mortgage and car payments.

Until this year, it appeared that credit unions were strongly positioned to withstand—and even benefit from—the financial crisis storming around them.

Washington's community banks have struggled for the past year, largely as a result of sour construction loans, and several now are operating under regulatory enforcement. Credit unions, meanwhile, had seen minimal problem loans, and many in Washington were seeing a surge in new customers who had abandoned banks in the face of negative publicity.

Now credit unions also are feeling the pain. While credit union customers likely won't notice a difference—and all their deposits are insured up to $250,000—credit unions likely will be forced to deal with the consumer confidence issues facing banks.

Credit unions' latest problems are a result of the heavy losses facing their corporate counterparts, U.S. Central and WesCorp, which held investments in mortgage-backed securities that have lost value.

Because of those potential losses, the National Credit Union Administration (NCUA)—the credit union system's insurance system—recently seized the two corporate credit unions and placed them under conservatorship.

To keep the corporate credit unions running, the NCUA pulled $5.9 billion from a joint insurance fund that's paid into by retail credit unions, including BECU.

Now the retail credit unions are forced to rebuild that fund, paying a percentage of their deposits. They have to absorb the charge immediately—which shows up in their income statement—because regulations require the insurance fund to be repaid within a year.

In addition, credit unions also held capital accounts, or investments in the corporate credit unions, that they now must write off. BECU, for example, held a capital account of $9.1 million at WesCorp. And the write-off contributed to its first-quarter loss.

"The consequences of resolving a couple of big institutions is impacting the greater body of smaller community institutions," says John Annaloro, president of the Washington Credit Union League.

The Washington state Department of Financial Institutions (DFI) is expecting at least four Washington credit unions in addition to BECU to fall below the "well-capitalized" ratio in part because of the corporate credit union payments, says the agency's Jekel. If a financial institution falls below its capital levels, it has an increasingly harder time buffering against bad loans, a problem that's being closely watched by regulators.

Credit unions encountering this level of multiple problems at once is new for state regulators, who haven't seen one fail in at least two decades.

But the DFI currently is working with several credit unions that are struggling to work through a pile up of bad loans as well as operational issues.

One, Tulip Cooperative Credit Union, in Olympia, is operating under regulatory enforcement and has to come up with a plan to restore its capital, Jekel says.

Part of the problem is that credit unions, as dictated by their charters, can't look for capital to bulk up their books the way banks can. They don't have access to federal bailout money and they can't look for private equity infusions. Their capital comes solely from earnings.

As a result, Jekel is anticipating a wave of mergers as stronger, larger credit unions snap up troubled institutions that won't make it through the downturn.

"Luckily, most credit unions have good strong capital," she says.

There's a chance that credit unions might get a break, if Congress approves new legislation that would allow the NCUA to collect payments from credit unions to restore their insurance fund over five years rather than one.

The legislation, still making its way through Congress, also would establish a special fund that would allow the NCUA to borrow from the U.S. Treasury Department to pay for corporate credit union losses.

That could mean that some Washington credit unions might have to revise first-quarter earnings, says Jekel.

But the turmoil in the corporate credit union system is frustrating for Washington credit unions, particularly because it's largely out of their control.

BECU, for example, has seen its new membership increase by about 20 percent in the past year and its dollar volume of loans jump 63 percent to $1.4 billion.

The credit union would have reported a loss of $9.3 million for the first quarter—much less than the $65.7 million loss it did report—if not for the corporate credit union charge.

"It's a learning experience," says Oakland, diplomatically.