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, 1997,

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, 1997 through March 8, 1999.

Loans and lines of credit balances existing prior to May 18, 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, 1997.

ADDRESSES: National Credit Union Administration, 1775 Duke Street,

Alexandria, Virginia, 22314-3428.

FOR FURTHER INFORMATION CONTACT: Evan Gillette, Investment Officer,

Office of Investment Services, 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 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

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

exceed 18 months, if the Board determined 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 believes that the 18 percent ceiling will permit credit

unions to continue to meet their current lending programs, permit

flexibility so that credit unions can react to any adverse economic

developments, and ensure that any increase in the cost of funds would

not affect the safety and soundness of federal credit unions.

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

federal credit unions. Credit unions are cooperatives and balance loan

and share rates consistent with the needs of their members and

prevailing market 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

their 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 conditions

warrant. 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.

Money Market Interest Rates

During the 16-month period following the Board's March 1996

decision to continue the 18 percent ceiling, short-term Treasury rates

(3, 6 and 12 months) increased from 11 to 19 basis points (Table 1).

Table 1.--Treasury Rates

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Yields as Yields as Change

of Mar. of July in

Maturity 11, 1996 17, 1997 basis

(percent) (percent) points

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3-month.................................. 5.09 5.20 11

6-month.................................. 5.17 5.31 14

1-year................................... 5.37 5.56 19

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Treasury rates rose slightly during the recent six-month period

from January 1 to July 17, 1997. Treasury rates on the 3, 6 and 12

month maturities increased

[[Page 40929]]

between 1 and 7 basis points (Table 2). During this period, the Federal

Reserve (Fed) increased the overnight Fed Funds rate by 25 basis points

to a target rate of 5.50 percent.

Table 2.--Treasury Rates

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Yields as Yields as Change

of Jan. of July in

Maturity 1, 1997 17, 1997 basis

(percent) (percent) points

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3-month.................................. 5.19 5.20 1

6-month.................................. 5.30 5.31 1

1-year................................... 5.49 5.56 7

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There are also expectations that rates may rise in the months

ahead. The US economy has continued to expand. Since early 1996,

employment growth and labor force participation has been quite strong,

with unemployment rates declining from 5.6 percent (Dec. 1995) to 5.0

percent (June 1997).

Further declines in the unemployment rate, rising consumer

confidence, continued income growth and a strong equity market have

lead many to be concerned that consumer demand may rise at a faster

pace in the months ahead. This could result in inflationary pressures

and higher interest rates. Therefore, it is important to maintain the

18 percent ceiling. Lowering the interest rate ceiling at this time

could cause an unnecessary burden on credit unions.

Financial Implications for Credit Unions

For at least 871, 28% \1\ of the reporting credit unions, the most

common rate on unsecured loans was above 15 percent. While the bulk of

credit union lending is below 15 percent, small credit unions and

credit unions that have instituted risk based lending programs require

interest rates above 15 percent to maintain liquidity, capital,

earnings and growth.

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\1\ Of the 7,152 FCUs, 4,083 had zero balances in the 15 percent

and above category or did not report a balance for the year-end 1996

reporting period.

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Loans to members who have not yet established a credit history or

have weak credit histories have more credit risk. Credit unions must

charge rates to cover the potential of higher than usual losses for

such loans. There are undoubtedly more than 871 credit unions charging

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

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

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

Lowering the interest rate ceiling for credit unions will discourage

credit unions from making these loans. Credit seekers' options will be

reduced and most of the affected members will have no alternative but

to turn to other lenders who will charge much higher rates.

Small credit unions will be particularly affected by a lower loan

ceiling since they tend to have a higher level of unsecured loans,

typically with lower loan balances. 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 other lenders.

Rates between 15 and 18 percent are attractive to such members.

Table 3 shows the number of credit unions in each asset group where

the most common rate is more than 15 percent for unsecured loans.

Table 3.--Federal Credit Unions With Most Common Unsecured Loan Rates

Greater Than 15 Percent (December 1996)

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Number of

Total FCUs w/

Peer group by asset size all loan

FCUs rates>15%

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$0-2 mil............................................ 2,132 231

$2-10 mil........................................... 2,490 317

$10-50 mil.......................................... 1,733 208

$50 mil +........................................... 797 115

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Total \1\....................................... 7,152 871

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\1\ Of this total, 4,083 had either a zero balance or did not report

rate balances 15 percent and above.

Among the 871 credit unions where the most common rate is more than

15 percent for unsecured loans, 242 have 20 percent or more of their

assets (Table 4) in this category. For these credit unions, lowering

the rates would damage their liquidity, capital, earnings and growth.

Table 4.--Federal Credit Unions With Most Common Unsecured Loan Rates

Greater Than 15 Percent and More Than 20 Percent of Assets in Unsecured

Loans (December 1996)

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Avg. Number of

percentage FCUs

Peer group by asset size of loan meeting

rates >15% both

to assets criteria

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$0-2 mil......................................... 43.8 108

$2-10 mil........................................ 29.6 75

$10-50 mil....................................... 26.8 45

$50 mil +........................................ 24.9 14

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Total........................................ 35.1 242

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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

September 9, 1997, through March 8, 1999. Loans and line of credit

balances existing on May 16, 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 in economic conditions warrant.

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 September

9, 1997, 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 of 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

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, Credit unions, Loan interest rates.

[[Page 40930]]

By the National Credit Union Administration Board on July 23,

1997.

Becky Baker,

Secretary of the Board.

Accordingly, NCUA amends 12 CFR chapter VII 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. 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. 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:

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

* * * * *

(c) * * *

(7) * * *

(ii) * * *

(C) Expiration. After March 8, 1999, 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 March 8, 1999.

* * * * *

[FR Doc. 97-19935 Filed 7-30-97; 8:45 am]

BILLING CODE 7535-01-U