NAFCU Letter to NCUA on FCU Loan Interest Rate Ceiling

The Honorable Rick Metsger, Chairman
The Honorable J. Mark McWatters, Board Member
National Credit Union Administration
1775 Duke Street
Alexandria, VA 22314

            RE: Federal Credit Union Loan Interest Rate Ceiling

Dear Chairman Metsger and Board Member McWatters:

On behalf of the National Association of Federally-Insured Credit Unions (NAFCU), the only national trade association focusing exclusively on federal issues affecting the nation’s federally insured credit unions, I am writing to you regarding the interest rate ceiling applicable to loans made by federal credit unions. As the agency is aware, the current 18 percent rate ceiling expires on March 10, 2017, and I would encourage the NCUA Board to maintain this rate when it considers the issue in advance of its expiration.

General Comments

NAFCU believes that lowering the interest rate will be detrimental to the safety and soundness of credit unions as it could potentially result in a loss of capital.  Further, it could discourage federal credit unions from making loans or approving credit card applications for higher risk members.  This in turn would likely lead to members pursuing loans from other lenders at considerably higher rates.

While the Federal Credit Union Act (FCU Act) generally limits federal credit unions to a 15 percent interest ceiling on loans, it provides NCUA flexibility to establish a higher rate for up to 18 months after considering statutory criteria. 12 U.S.C. § 1757(5)(A)(vi)(I). Specifically, the NCUA Board may increase the rate – or in this case maintain the rate above 15 percent – if it determines interest rates have risen over the preceding six month period and that the prevailing interest rate would threaten the safety and soundness of individual credit unions.  Given that the prevailing interest rates have increased over the last six months, NAFCU believes the NCUA should keep the current 18 percent rate in effect.

Despite the current low rate environment, the following table shows that there has been an increase in short-term interest rates during the past six months.

Table 1: Selected Monthly Interest Rates

Source: Federal Reserve

“Most Common” Interest Rates – All Unsecured Loans

Loans with rates higher than 15 percent

As of September 30, 2016, 280 of the 3,648 federal credit unions in the U.S. had a most common interest rate[1] above 15 percent for their unsecured loans (unsecured credit card loans and/or other unsecured loans).  This means that 7.7 percent of all federal credit unions would be required to change their rate policy if the interest rate ceiling is lowered to 15 percent, which might discourage many of them from making these kinds of loans going forward.  This would not only reduce available credit options for members, but would also reduce the competitiveness of credit unions due to the reduced loan portfolio they would be able to offer to their members.

Moreover, 94 federal credit unions had a most common interest rate of 18 percent. These credit unions would be impacted by any reduction in the interest rate ceiling. A large majority (70.2 percent) of these credit unions have assets below $50 million.  Their growth potential as well as their liquidity, capital and earnings levels would be negatively affected by a reduction in the interest rate ceiling.

Table 2: FCU Interest Rates on Unsecured Loans

Source:  NCUA’s September 2016 5300 Call Report

[1] The 5300 Call Report only provides the “most common” unsecured interest rate which might not capture higher rates for “credit builder” or “credit rebuilder” type of loans.

Floating Interest Rate Ceiling

As noted above, the interest rate ceiling has always been set at a fixed rate, which currently stands at 18 percent.  However, NCUA should explore options to modify the interest rate ceiling away from a fixed rate to a “fixed spread over Prime” or “floating” interest rate ceiling.  Specifically, NCUA should consider amending the interest rate ceiling to “15 percent spread over Prime.”

Using today’s rates, the ceiling would be set at 18.75 percent and it would automatically adjust with the level of Prime.  For years, NCUA has expended a number of resources in an effort to educate and examine credit unions on their exposure to interest rate risk (IRR), as evidenced by IRR being consistently listed as a supervisory focus for the agency. As a result, credit unions have been vigilant in identifying and managing such risk. Using a “fixed spread of Prime” approach to the ceiling could go a long way towards helping credit unions reduce interest rate risk.

While the benefits of a floating interest rate ceiling would be applicable to all variable rate products, such an approach is particularly germane to credit cards.  Credit cards are typically priced to reflect the risk of the borrower. As such, borrowers with higher-risk FICO scores may receive credit cards at, or near, the maximum rate of 18 percent; a rate that still fulfills credit unions’ mission because it is about 600 basis points lower than rates offered by banks for similar credit.

However, even as interest rates continue to rise, as anticipated by the Federal Reserve, these credit cards may not be re-priced because they would exceed the 18 percent ceiling – even though they are variable rate products.  This means, in the likely event of interest rate increases, these cards would no longer be priced correctly given the default risk of the borrower.  This can create adverse trends in credit unions’ earnings and capital which would present an in increased risk to National Credit Union Share Insurance Fund. These are difficulties a floating interest rate ceiling would be able to effectively mitigate.

NAFCU recommends the Board consider its authority provided in setting the interest rate ceiling and explore going forward with a floating interest rate ceiling – specifically at 15 percent spread over Prime. It is NAFCU’s opinion that the Board has this authority so long as they continue to reauthorize such a structure every 18 months, as required by the FCU Act. We suggest this topic be added to the Board’s docket as a potential topic for a Board Briefing, as increasing interest rates are a reality and this issue is of interest to the industry as a whole.

Conclusion

I hope this information is helpful, and we thank you for this opportunity to share our views on this matter.  Should you have any questions or require additional information, please contact me or Alexander Monterrubio, NAFCU’s Director of Regulatory Affairs at 703-842-2244 or amonterrubio@nafcu.org.

Sincerely,

B. Dan Berger

cc:
Mr. Mark Treichel, Executive Director
Mr. Michael McKenna, General Counsel
Mr. Rendell Jones, Chief Financial Officer