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 March 9, 1996, 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 March 9, 1996 through September 8, 1997. Loans and

lines 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: March 9, 1996.

ADDRESSES: National Credit Union Administration, 1775 Duke Street,

Alexandria, Virginia, 22314-3428.

FOR FURTHER INFORMATION CONTACT:

James F. Feeney, Office of Investment Services, Senior Investment

Officer, at the above address. Telephone number: (703) 518-6620.

SUPPLEMENTARY INFORMATION:

Background

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

ceiling for federal credit 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 consulting 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: (1) money

market interest rates have risen over the preceding 6 months; and (2)

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 18, 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 loan 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

During the six-month period following the Board's July 1994

decision to continue the 18 percent ceiling, short-term money market

rates increased about 150 basis points. For example, the two-year

treasury note increased in yield from 6.15 percent to 7.69 percent for

a gain of 154 basis points and a 25 percent change (see table 1).

Table 1.--Money Market Interest Rates

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Yields Yields

as of as of Change

Maturity July 1, December in basis

1994 30, 1994 points

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3-month................................... 4.29 5.68 139

6-month................................... 4.82 6.50 168

1-year.................................... 5.49 7.16 167

2-year.................................... 6.15 7.69 154

3-year.................................... 6.46 7.78 132

5-year.................................... 6.94 7.83 89

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During the recent six-month period from July through December 1995,

short-term money market rates decreased about 50 basis points. For

example, the rate on the two-year treasury note dropped 60 basis points

from 5.79 percent to 5.19 percent for a 10 percent change (see table

2). Although interest rates have fallen since July 1995, there is no

assurance that they will remain at current levels during the period of

this extension (from March 9,1996 through September 8, 1997). Most

economists believe that rates will fall a bit further in early 1996 and

then rise in the fourth quarter of 1996 or early in 1997.

Despite the market improvement in interest rates in the last six

months, the NCUA board believes that, in view of the uncertain outlook

for interest over the next 18 months, lowering the interest rate

ceiling at this time could cause an unnecessary burden on credit

unions, especially those with 20% or more of their assets in high-

interest rate loans.

Table 2.--Money Market Interest Rates

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Yields Yields

as of as of Change

Maturity July 1, December in basis

1995 30, 1995 points

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3-month................................... 5.60 5.12 48

6-month................................... 5.60 5.18 42

1-year.................................... 5.62 5.16 46

2-year.................................... 5.79 5.19 60

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3-year.................................... 5.85 5.25 60

5-year.................................... 5.96 5.41 55

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Liquidity, Capital, Earnings and Growth of Individual Credit Unions

For at least 1,673 (14%) credit unions, market conditions call for

rates on unsecured loans to be above 15%. 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.

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

unions with under $2 million in assets have many unsecured loans with

loan balances below $1000.

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 loan balance on which interest will be collected,

these costs can be very high on small loans.

Many other types of financial institutions will not even consider

loan applications for less than $1000. 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 alternative 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 sufficiently high enough to cover higher-than usual losses

for such loans. There are undoubtedly more than 1,673 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 members 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. 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 3 shows the number of credit unions in each asset 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 is not

aware of any complaints from members of those credit unions offering

high-risk, high-interest rate loans.

Table 3.--Credit Unions Charging More Than 15 Percent on Unsecured Loans

as of June 1995

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Count of Charging more than

all CUs 15% on unsecured

Asset size group this loans

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

size Number Percent

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Less than $2MM............................ 3,666 386 10.5

$2MM to $10MM............................. 4,157 613 14.7

$10MM to $50MM............................ 2,813 459 16.3

Over $50MM................................ 1,200 215 17.9

Total............................... 11,836 1,673 14.1

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Among the 1,673 credit unions charging more than 15 percent for

unsecured loans, there are 367 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 4 shows credit unions charging more than 15 percent that have

more than 20 percent of their assets in these loans.

Table 4.--Credit Unions With More Than 20 Percent of Assets in Unsecured

Loans as of June 1995

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Average

percent

Number Percent of assets

Asset size group of CUs of size in

group unsecured

loans

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Less than $2MM........................... 152 4.1 381.1

$2MM to $10MM............................ 133 3.2% 26.9

$10MM to $50MM........................... 65 2.3 26.7

Over $50MM............................... 17 1.4 25.5

Total.............................. 367 3.1 31.4

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In conclusion, the Board has continued the federal credit union

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

March 9, 1996 through September 8, 1997. Loans and line of credit

balances existing on May 15, 1987 may continue to bear interest at

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 to economic conditions warrant it.

Regulatory Procedures

Administrative Procedure 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 March 8,

1996 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 are no paperwork requirements.

Executive Order 12612

The 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, Credit unions, Loan interest rates.

By the National Credit Union Administration Board on January 25,

1996.

Becky Baker,

Secretary of the Board.

Accordingly, NCUA amends 12 CFR part 701 as follows:

PART 701--[AMENDED]

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

follows:

Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a,

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

also authorized by 31 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. Section

701.35 is also authorized by 42 U.S.C. 4311-4312.

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

[[Page 4215]]

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

* * * * *

(c) * * *

(7) * * *

(ii) * * *

(C) Expiration. After September 8, 1997, 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 paragraphs (c)(7)(ii) (A)

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

on or before September 8, 1997.

* * * * *

[FR Doc. 96-2016 Filed 2-2-96; 8:45 am]

BILLING CODE 7535-01-M