More Consumer Loans Based on Prime

The prime used to be the rate that big banks charged their best corporate customers. But in recent years fewer and fewer companies are getting prime-rate loans.

Meanwhile, consumers are increasingly snapping up a wide variety of loans--from home equity lines of credit to credit card loans--based on the prime.

The rising consumer use of loans based on the prime has its roots in two factors. First, there are more variable-rate consumer loans than ever before. Second, many less-seasoned consumers still view the prime as a preferential business rate.

Still, the reason big companies have abandoned the rate may be pertinent to consumers. Even some bankers argue that prime-based loans are not always the best deal.

“In the old days, the prime rate was the loan rate you gave your best corporate borrowers,” said John O. Wilson, senior vice president and chief economist at Bank of America. “But that went years ago.”

Now big corporate borrowers shun the prime altogether in favor of international indexes, such as the London Interbank Offered Rate (LIBOR), and fast-moving reference rates such as those based on 30-day certificates of deposit. Even small- and mid-sized companies are less than enthusiastic about borrowing based on the prime.

“There is a trend to abandon prime even in the middle market,” said Dick S. Cupp, executive vice president of California Federal Bank in Los Angeles, which defines the middle market as companies with sales between $15 million and $100 million. “At the upper end of the middle market, particularly, they want to borrow at rates that directly relate to the bank’s cost of funds.”

The problem with the prime, these experts said, is that it is an “administered” rate. In other words, banks set the prime rate themselves, which makes it less sensitive to economic conditions and more sensitive to political pressures or to banks’ needs to boost their profits.

If bankers believe that the Federal Reserve is likely to tighten credit, for example, they will not lower the prime even when other rates have fallen. Cuts in the prime rate can also be delayed if there is strong demand for money, bankers said.

“The prime rate is more impacted by political and business events rather than the things that should be affecting consumer rates,” said Derrald K. Johnson, vice president and director of marketing for Bank of America. “It also can be somewhat sticky coming down, and therefore preclude consumers getting the benefit of a rate decrease.”

On the other hand, the prime can also rise more slowly than other rates. So, in a rising rate environment, loans based on it can sometimes be the better deal, said Jim Jones, executive vice president of consumer credit at Wells Fargo Bank.

However, consumers often have few choices when they borrow.

Individual lenders usually offer only one index on any given type of loan product. And if that index is not to the consumer’s liking, his only choice is to find another lender.

Merrill Lynch, for example, offers home equity loans based solely on the prime. Typically, consumers would pay 1.5 to 2 percentage points above the going prime rate for this loan, which would now run between 11.5% and 12%.

However, California Federal doesn’t offer any prime-based home equity loans. Its variable rate equity loans float based on the 6-month Treasury bill index. Based on Monday’s rates, that loan would cost 11.4%.