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NW developers find credit terms shortening.

Bankers Blame Arkansas' Stringent Usury Law for Business Leaving State

WHILE COMMERCIAL BANK loans are still quite plentiful, the terms have become more stringent this year because of the state's restrictive usury laws, according to developers and bankers.

"What I've seen in the last few months is that you can't find any longer term financing for commercial projects," says Kirk Elsass, a commercial developer and executive vice president of Fayetteville-based realtor Lindsey & Associates Inc. "All you can get is two or three years maximum, and then you have to have an established reputation. That's causing some developers to look out of state for financing."

The situation is becoming more evident in northwest Arkansas as hungry developers turn to out-of-state sources. With interstate banking deregulation legislation passed earlier this year, the problem promises to get worse.

Bankers say commercial notes are maturing much earlier than those issued at the beginning of the year.

"Commercial banks in Arkansas really don't do any long-term fixed rate financing because of the usury law, but there was a point in time earlier this year when we were seeing some five- and even seven-year fixed rates," says James Stobaugh, president of Worthen National Bank of Northwest Arkansas. "But I don't think you'll see any of that for a while."

Bankers blame the change on rising interest rates and the state's stringent usury law, which they have tried to change unsuccessfully for years. Arkansas law sets the maximum interest rates commercial banks can charge on loans as five percentage points above the Federal Reserve Board's discount rate. When the Federal Reserve raises interest rates, as it has six times this year, banks are less willing to lock into those lower rates, meaning the terms of the notes have shortened.

"I think probably the feel back earlier in the year was more along the lines that we'd see rates stay more stable and in those lower ranges, certainly lower than they are now," Stobaugh says. "As the economy has heated and the [Federal Reserve] has done everything they can to make sure that it doesn't overheat, they've raised the rates. When rates are rising, lenders just aren't willing to make long term-fixed rate commitments."

Floating rate loans, which are intended to insulate banks from rate fluctuations, are also being affected because of the usury law ceiling.

"Most Arkansas lenders are willing to loan longer term, but they're locked into an artificial ceiling established today by our usury laws," says Jim Cargill, executive vice president of the Bank of Bentonville, a member of the Arvest Bank Group. "For example, if I make a commitment, even on a floating rate basis for commercial projects, I can never charge a rate higher than today's ceiling, even if rates rise above that."

State and federal laws provide exemptions for residential loans, credit unions, and nearly every other lender, meaning primarily commercial loans at commercial banks are affected. Because of that, bankers say they are losing business to other lenders in the state and across the border.

In addition, with rates as low as they have been, banks are reluctant to lend some higher risk commercial ventures funds because the five-point premium is not enough to offset the potential risk. That often sends developers to bordering states, which concerns Arkansas bankers.

"I think Arkansas is losing business," says Curtis Hutchins, chairman, president and chief executive officer of Fordyce Bank & Trust Co. and first vice president of the Arkansas Bankers Association. "Everybody and their dog can get around the state usury law. Developers are going out of state to sign papers and with the advent of interstate banking and branching they won't even have to do that."

In September, Congress passed long-awaited legislation relaxing regulations concerning interstate banking and branching across state lines. The Riegle-Neal Interstate Banking Efficiency Act of 1994 will supercede Arkansas law, allowing banks in Tulsa, Okla., and Memphis, Tenn., for example, to open branches across state lines after June 1, 1997.

The state has the right to opt out, but that is not likely because it would close routes both in and out of the state, precluding Arkansas banks from branching across state lines as well.

Some bank observers believe that because banks branching into Arkansas would not be based in the state, they would be exempt from the state's usury law. Arkansas bankers say such a scenario would be devastating and give out-of-state-based banks a competitive advantage with long-term financing.

"It's a critical issue for Arkansas," Cargill says. "You're going to have banks moving across state lines ... so Arkansas banks will basically be unable to compete for the basic business opportunities that exist. It's already a problem, has been for many years, and it will become a much more critical issue with those other banking companies coming into Arkansas."

The issue is likely to be settled in court.

"The law explicitly states that nothing in it will affect whether state usury laws will apply to bank loans made across state lines, leaving it to the courts to determine which state usury law will apply in an interstate branching environment," according to the American Banking Association.

Conversely, bankers fear a drain of capital from the state. They argue deposits made in Arkansas branches of out of state banks will be funnelled across state lines where they can charge higher rates because of less stringent usury laws.

Discount Rate Increases in 1994

Since the beginning of the year, the Federal Reserve has raised interest rates six times, most recently last week. The discount rate, the rate the Fed charges commercial banks and what Arkansas usury law ties the interest rate ceiling to, has been raised three times.

Under Arkansas law, the maximum interest rate commercial banks can charge on commercial loans is 5 percent above the discount rate. For loans issued in January, the ceiling was set at 8.5 percent, even for floating loans. Since then, the ceiling has risen to 9.75 percent because of changes in the discount rate. Because of that, banks are reluctant to make longer term loans for fear of being locked into the lower rate ceiling.
 % Rate

January 3.50
February 3.50
March 3.50
April 3.50
May 3.75
June 3.75
July 3.75
August 4.00
September 4.00
October 4.00
November 4.75
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No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1994 Gale, Cengage Learning. All rights reserved.

Article Details
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Title Annotation:rising interest rates deter real estate development in Arkansas
Author:Tobler, Christopher
Publication:Arkansas Business
Article Type:Industry Overview
Date:Nov 21, 1994
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