Loan Interest Rates

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 701

Loan Interest Rates

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: The current 18 percent per year federal credit union loan rate

ceiling is scheduled to revert to 15 percent on September 9, 1994,

unless otherwise provided by the NCUA Board (Board). A 15 percent

ceiling would restrict certain categories of credit and adversely

affect the financial condition of a number of federal credit unions. At

the same time, prevailing market rates and economic conditions do not

justify a rate higher than the current 18 percent ceiling. Accordingly,

the Board hereby continues an 18 percent federal credit union loan rate

ceiling for the period from September 9, 1994 through March 8, 1996.

Loans and line of credit balances existing prior to May 15, 1987, may

continue to bear their contractual rate of interest, not to exceed 21

percent. The Board is prepared to reconsider the 18 percent ceiling at

any time should changes in economic conditions warrant.

EFFECTIVE DATE: September 9, 1994.

ADDRESSES: National Credit Union Administration, 1775 Duke Street,

Alexandria, Virginia, 22314-3428.

FOR FURTHER INFORMATION CONTACT:

Lindsay L. Neunlist, at the above address. Telephone number: (703) 518-

6625.

SUPPLEMENTARY INFORMATION:

Background

Public Law 96-221, enacted in 1979, raised the loan interest rate

ceiling for federal credit unions from 1 percent per month (12 percent

per year) to 15 percent per year. It also authorized the Board to set a

higher limit, after consultation with Congress, the Department of the

Treasury, and other federal financial agencies, for a period not to

exceed 18 months, if the Board should determine that: (i) money market

interest rates have risen over the preceding 6 months: and (ii)

prevailing interest rate levels threaten the safety and soundness of

individual credit unions as evidenced by adverse trends in growth,

liquidity, capital, and earnings.

On December 3, 1980, the Board determined that the foregoing

conditions had been met. Accordingly, the Board raised the loan ceiling

for 9 months to 21 percent. In the unstable environment of the first

half of the 1980s, the Board extended the 21 percent ceiling four

times. On March 11, 1987, the Board lowered the loan rate ceiling from

21 percent to 18 percent effective May 15, 1987. This action was taken

in an environment of falling market interest rates from 1980 to early

1987. The ceiling has remained at 18 percent to the present.

The Board felt, and continues to feel, that the 18 percent ceiling

will fully accommodate an inflow of liquidity into the system, preserve

flexibility in the system so that credit unions can react to any

adverse economic developments, and will ensure that any increase in the

cost of funds would not impinge on earnings of federal credit unions.

The Board would prefer not to set loan interest rate ceilings for

federal credit unions. In the final analysis, the market sets the

rates. The Board supports free lending markets and the ability of

federal credit union boards of directors to establish ban rates that

reflect current market conditions and the interests of credit union

members. Congress has, however, imposed loan rate ceilings since 1934.

In 1979, Congress set the ceiling at 15 percent but authorized the

Board to set a ceiling in excess of 15 percent if the Board can justify

it. The following analysis justifies a ceiling above 15 percent, but at

the same time does not support a ceiling above the current 18 percent.

The Board is prepared to reconsider this action at any time should

changes in economic conditions warrant.

Justification for a Ceiling No Higher Than 18 Percent

Money Market Interest Rates

Both long and short rates have increased significantly in the last

few months. Table 1 gives information on past interest rates. There is

a general consensus among economists that money market rates will

continue to rise as economic growth accelerates. Implied forward rates,

the money market's best guess about where interest rates are going, are

significantly higher over the next year. By the time this rule becomes

effective, money markets will have experienced 6 months of rising

rates. The Board is ready to revisit this issue should this expectation

not be confirmed.

Liquidity, Capital, Earnings, and Growth and Individual Credit Unions

For at least 1,477 credit unions, market conditions call for rates

on unsecured loans to be above 15 percent. For some of these credit

unions, three factors combine to require interest rate charges above 15

percent in order to maintain liquidity, capital, earnings, and growth.

Table 1.--Money Market Interest Rates

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Change

since

Yields as Jan. 1,

Maturity of July 1994 in

5, 1994 basis

points

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3-month........................................... 4.29 121

6-month........................................... 4.82 148

1-year............................................ 5.49 186

2-year............................................ 6.15 184

3-year............................................ 6.46 185

5-year............................................ 6.94 165

10-year........................................... 7.32 141

30-year........................................... 7.61 192

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The first factor is low average loan balance. For example, the

credit unions with under $2,000,000 in assets have an average unsecured

balance of $1,314, with many loans below $1,000. There are fixed costs

of granting and processing a loan. Many of these costs are incurred

regardless of the size of the loan. Expressed as a percentage of the

loan balance on which interest will be collected, these costs can be

very high on small loans. As one credit union states, ``The total

interest earned on a $200 loan at 17 percent for 12 months is $34. Even

at 17 percent it costs us more to make the loan than we recover in

interest income, assuming it does pay to maturity and is not charged

off.'' The Functional Cost and Profit Analysis by the Federal Reserve

System calculates the average cost to a credit union for making an

installment loan to be $95.66 plus $5.49 per payment. The $34 does not

even cover the cost of accepting the twelve payments.

Many banks will not even consider loan applications for less than

$1,000. Lowering the interest rate ceiling for credit unions will

discourage credit unions, too, from making these loans. Credit seekers'

options will be reduced, with most of the affected members having no

choice but to turn to neighborhood lenders.

The second factor is credit risk. Loans to young members who have

not yet established a credit history and loans to those who have built

weak credit histories both carry high credit risk. Credit unions must

charge rates high enough to cover higher-than-usual losses for such

loans. There are undoubtedly more than 1,477 credit unions charging

over 15 percent for unsecured loans to such members. Many credit unions

have ``Credit Builder'' or ``Credit Rebuilder'' loans but must report

the ``most common'' rate on the Call Report for unsecured loans.

The third factor is credit union size. Small credit unions have

fewer loans over which to distribute their overhead costs.

Thus, small credit unions making small loans to borrowers with poor

or no credit histories are struggling with far higher costs than the

typical credit union. Both young people and lower income households

have limited access to credit and, absent a credit union, often pay

rates of 24 to 30 percent to small loan companies. Or they may be

forced to resort to the check-cashing outlet where a post-dated check

will be cashed at effective rates of 200, or even 300, percent. Rates

between 15 and 18 percent are attractive to such members. The higher

rates are necessary to help cover the credit unions' costs of providing

this kind of credit.

Table 2 shows the number of credit unions in each asset-size group

that charge more than 15 percent for unsecured loans. It also shows the

percent of credit unions in each group that do so.

NCUA staff are not aware of any complaints from members of those

credit unions offering high-risk, high-interest rate loans.

Table 2.--Credit Unions Charging More Than 15 Percent on Unsecured Loans

[December 1993]

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Count of Charging GT 15%

all CUs on unsecured

Asset size group of this loans

asset -----------------

size Number Percent

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Less than $2 mln........................... 4,133 430 10.4

$2 mln to $10 mln.......................... 4,272 558 13.1

$10 mln to $50 mln......................... 2,796 339 12.1

Over $50 mln............................... 1,115 150 13.5

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Total.................................. 12,317 1,477 12.0

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Among the 1,477 credit unions charging more than 15 percent for

unsecured loans, there are 356 credit unions with 20 percent or more of

their assets in this kind of loan. For these credit unions, lowering

their rates would damage their liquidity, capital, earnings, and

growth. Table 3 shows credit unions charging more than 15 percent that

have more than 20 percent of their assets in these loans. In general

the percent of assets in unsecured loans goes down as credit union size

goes up.

Table 3.--Credit Unions With More Than 20% of Assets in Unsecured Loans

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Avg pcnt

Percent of assets

Asset size group No. of of size in

CUs group unsecured

lns

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Less than $2 mln......................... 198 4.8 37.3

$2 mln to $10 mln........................ 129 3.0 27.9

$10 mln to $50 mln....................... 26 0.9 29.6

Over $50 mln............................. 3 0.3 44.8

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Total................................ 356 2.9 31.9

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At the same time, lowering the ceiling would not change the rates

the vast majority of credit unions are charging, since they are already

at or below market. A ceiling can cause rates to be higher than they

would have been without the ceiling. The closer a loan rate is to

actual market rates, the more likely it is that the ceiling will act as

a floor for rates. There are two reasons why this happens. First,

setting a ceiling close to market rates creates the impression that the

ceiling rate is the ``federally approved'' rate. Second, if credit

unions feel they may not have the flexibility to raise rates in the

near future should market rates rise unexpectedly, they are more likely

to keep current rates higher than they otherwise would, as insurance

against market rate increases. This ceiling-as-floor phenomenon

militates against letting the ceiling approach the more common, typical

market rates.

In conclusion, the Board has continued the federal credit union

loan interest rate ceiling of 18 percent per year for the period from

September 9, 1994 through March 8, 1996. Loans and line of credit

balances existing on May 15, 1987 may continue to bear their

contractual rate, not to exceed 21 percent. Finally, the Board is

prepared to reconsider the 18 percent ceiling at any time during the

extension period, should changes in economic conditions warrant it.

Regulatory Procedures

Administrative Procedures Act

The Board has determined that notice and public comment on this

rule are impractical and not in the public interest, 5 U.S.C.

553(b)(B). Due to the need for a planning period prior to the September

9, 1994 expiration date of the current rule, and the threat to the

safety and soundness of individual credit unions with insufficient

flexibility to determine loan rates, final action on the loan rate

ceiling is necessary.

Regulatory Flexibility Act

For the same reasons, a regulatory flexibility analysis is not

required, 5 U.S.C. 604(a). However, the Board has considered the need

for this rule, and the alternatives, as set forth above.

Paperwork Reduction Act

There has been no change in the paperwork requirements.

Executive Order 12612

This final rule does not affect state regulation of credit unions.

It implements provisions of the Federal Credit Union Act applying only

to federal credit unions.

List of Subjects in 12 CFR Part 701

Credit Unions, Loan interest rates.

By the National Credit Union Administration Board on July 26,

1994.

Becky Baker,

Secretary of the Board.

Accordingly, NCUA has amended its regulations as follows:

PART 701--[AMENDED]

1. The authority citation for Part 701 is revised to read as

follows:

Authority: 12 U.S.C. 7152(5), 1755, 1756, 1757, 1759, 1761a,

1761b, 1766, 1767, 1782, 1784, 1787, 1789, 1798. Section 701.6 is

also authorized by 15 U.S.C. 3717. Section 701.31 is also authorized

by 15 U.S.C. 1601 et seq.; 42 U.S.C. 1981 and 3601-3610.

Sec. 701.21 [Amended]

2. Section 701.21(c)(7)(ii)(C) is revised to read as follows:

Sec. 701.21 Loans to members and lines of credit to members.

* * * * *

(c) * * *

(7) * * *

(ii) * * *

(C) Expiration. After March 8, 1996, or as otherwise ordered by the

NCUA Board, the maximum rate on federal credit union extensions of

credit to members shall revert to 15 percent per year. Higher rates

may, however, be charged, in accordance with paragraph (c)(7)(ii)(A)

and (B) of this section, on loans and line of credit balances existing

on or before March 8, 1996.

* * * * *

[FR Doc. 94-18658 Filed 8-2-94; 8:45 am]

BILLING CODE 7535-01-M