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Funding 5-Year CRE Loans

May 5, 2015

By Kevin Martin, Member Financial Strategies Manager

Based on conversations with members, commercial real estate lending appears to be returning to levels that haven't been seen since before the Great Recession. As a result, the Bank has been seeing an increase in requests for funding strategies.

And while many of these strategies met member spread requirements, several confirmed what they had already suspected — that the competitor's rate was just too low and they would have to walk away from the deal.

One strategy that met the profitability target was a plan to fund a $5 million, 5/20 CRE loan with a 4 percent coupon with FHLB Boston advances. After five years, this loan would have a balance of just under $4.1 million.

Since the member needed to hedge rising interest rates, we used $4 million of a five-year Classic advance and $1 million of a one-month Classic advance to fund the loan. If rates increase, the long-term advance will stabilize the cost of funds in years one through five.

While the cost of the short-term advance will fluctuate based on the interest rate scenario modeled, less short-term funding will be required over time as the CRE loan amortizes. In fact, short-term funding will average only about $400,000 over the period.

The high proportion of long-term funding stabilizes the cost of funds and, compared to the base case, shows only a 30-basis-point increase in the plus 500-basis-point scenario.

The strategy results are summarized below:

Table 1

The member also looked at a strategy that substituted a three-year Classic advance for some of the five-year Classic advances. We reduced the five-year Classic advance to $2.5 million and used $1.5 million of a three-year Classic advance. This introduced additional interest rate risk into the transaction, though the risk/return trade-off was acceptable to the institution.

The cost of funds fluctuates more in this strategy than in the prior strategy, increasing almost 100 basis points between the base case and the plus-500-basis-point scenario. This strategy outperforms the previous strategy except when rates increase by 300 basis points or more. Because of the shorter funding, NII is off by 5 percent if rates rise 300 basis points, and off by 18 percent if rates rise 500 basis points, compared to the previous strategy.

The strategy results are summarized below:

Table 1

The funding strategy model is a powerful tool to assist members in quantifying the risks and returns associated with holding long-term, fixed-rate assets. Please contact Kevin Martin at to learn how FHLB Boston advances can help you hedge the IRR of holding loans in your pipeline or evaluating investment opportunities.

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