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, 1999, 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, 1999 through September 8, 2000. 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: March 9, 1999.

ADDRESSES: National Credit Union Administration, 1775 Duke Street,

Alexandria, Virginia, 22314-3428.

FOR FURTHER INFORMATION CONTACT: Dan Gordon, Senior Investment Officer,

Office of Investment Services, at the above address or telephone: (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 the 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 lowered the loan rate ceiling form 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 that balance loan

and share rates consistent with the needs of their members and

prevailing market interest rates.

The Board supports free lending markets and the ability of federal

credit unions 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 actions at any time should

changes in economic conditions warrant.

Money Market Interest Rates

Interest rates and the expectations about the future level of

economic activity have recently been dominated by concerns in worldwide

financial markets. The downfall of many Asian economies and the

unprecedented recession in Japan required the Federal Reserve, as the

central bank most capable of preventing a world-wide economic downturn,

to substantially lower interest rates in early October of last year.

There are now indications that the actions taken at that time had the

intended effect. Several of the Asian economics have recently shown

signs of recovery and Japan, recognizing its vulnerability, has

undertaken a massive fiscal stimulus package.

The result is that inflation fears in the United States, which only

recently were overshadowed by the Asian economic crisis, are

reemerging. With the economy still growing in excess of 3.5 percent per

annum, and recovery now underway in foreign economies, there are

concerns that conditions exist for further inflationary pressures. The

recent credit squeeze in financial markets, reflected by tighter bank

credit standards and wider credit spreads, has reduced capital

expenditures, and thus future productivity gains. Yet the strong

productivity gains were a primary factor preventing price increase in

the last few years.

The potential scarcity of capital, the prospective improvement in

the world economies, and the expectation that oil prices could recover

from their now 12-year lows and commodity prices from their 22-year

lows will increase inflationary expectations. In addition, strong

consumer confidence, a strong housing market and continued expansion in

consumer spending will continue to put pressure on the economy. With

unemployment remaining in the 4.5 percent range, and the continued

strong demand for workers, wage pressures will increase. In addition,

as less skilled workers are employed and firms are required to use more

scarce resources, the pressures on costs, and thus on prices, will

intensify. The result may well be further increases in interest rates.

Reinforcing the expectation of higher rates, the Federal Reserve

has strongly suggested it will not lower rates again in the near term.

The result has been an expectation in financial markets that

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interest rates could rise above current levels. Already there have been

substantial increases in yields since lows reached in early October.

For example, on October 1, 1998, the rate on the 6-month Treasury was

4.36 percent, and on January 5, 1999, it was 4.54 percent. The 5-year

Treasury rate was 4.55 percent on January 4, 1999. This was 48 basis

points above the rate on October 1, 1998, while the 10-year Treasury

rate increased 39 basis points in the same interval. Therefore,

although the current rates are below the rates of six months ago, there

is every indication that by March 9, 1999, rates will be higher than

they were on October 1.

Table 1.--Treasury Rates

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Yields as of Yields as of

October 1, January 4, Change in

Maturity 1998 1999 basis points

(percent) (percent)

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3-month......................................................... 4.22 4.67 25

6-month......................................................... 4.36 4.54 18

1-year.......................................................... 4.27 4.57 30

2-year.......................................................... 4.15 4.56 41

5-year.......................................................... 4.07 4.55 48

10-year......................................................... 4.29 4.67 38

30-year......................................................... 4.88 5.15 27

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The fact that long-term rates exceed short-term rates (for example,

the 30-year rate is 61 basis points above the 6-month rate) is more

evidence that the market expects rates to rise in the months ahead.

Investors are unwilling to hold longer term investments unless they are

compensated for these potentially higher future rates.

Further declines in the unemployment rate, rising consumer

confidence, continued income growth and a strong equity market have led

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

the months ahead. We need to be aware of these potential inflationary

pressures which could result in 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 873 credit unions, representing 28 percent \1\ of the

reporting federal 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. 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 873 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 would discourage credit

unions from making these loans. Credit seekers' options would be

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

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

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\1\ Of the 6,907 FCUs, 4,083 had zero balances in the 15 percent

and above category or did not report a balance for the June 1998

reporting period.

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Small credit unions would 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 2 shows the number of credit unions in each asset group where

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

Table 2.--Federal Credit Unions With Most Common Unsecured Loan Rates

Greater Than 15 Percent

[June 1998]

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Number

FCUs w/

Peer group by asset size Total all loan

FCUs rates

>15%

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$0-2 mil.......................................... 1,940 214

$2-10 mil......................................... 2,390 334

$10-50 mil........................................ 1,735 214

$50 mil+.......................................... 842 111

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Total 1....................................... 6,907 873

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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 3) in this category. For these credit unions, lowering

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

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

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

Loans

[June 1998]

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Avg. Number

percentage FCUs

Peer group by asset size of loan meeting

rates >15% both

to assets criteria

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$0-2 mil......................................... 38.31 95

$2-10 mil........................................ 28.46 61

$10-50 mil....................................... 25.62 22

$50 mil+......................................... 23.34 7

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Total........................................ 32.99 185

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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, 1999, through September 9, 2000. 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)(3)(B). Due to the need for a planning period prior to the March

9, 1999, 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.

By the National Credit Union Administration Board on January 28,

1999.

Becky Baker,

Secretary of the Board.

Accordingly, NCUA amends 12 CFR ch. VII as follows:

PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS

1. The authority citation for part 701 continues to read as

follows:

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

1761b, 1766, 1767, 1782, 1784, 1787, and 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 September 9, 2000, 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 May 16, 1987.

* * * * *

[FR Doc. 99-2843 Filed 2-5-99; 8:45 am]

BILLING CODE 7535-01-U