Demand for fixed-rate commercial real estate loans in New England continues to be strong, particularly for five-year maturities with 20-year amortization periods.

Over the past 10-plus years, the industry has not experienced a credit downturn like the one we suffered in the early 1990s. However, members booking this type of commercial loan might consider minimizing the interest-rate risk associated with holding the loan given the credit risk they are taking on. The Federal Home Loan Bank of Boston structures advances that make this possible. The Bank's 5/20-year Amortizing advance matches the cash-flow characteristics of the loan and allows the member to minimize interest-rate risk while still earning a strong spread.

The Strategy
Our financial strategy model shows a 5/20-year commercial real estate loan at 6.25 percent. Funded 100 percent with a 5/20-year Amortizing advance at 3.74 percent, the loan produces an initial spread of 2.51 percent. Net interest spread is stable throughout a range of rate scenarios, from minus 150 basis points to plus 300 basis points. Under these scenarios, the spread varies from 2.31 percent to 2.42 percent. The cost of funds is constant throughout the five-year period. The yield on the loan is constant over the period, but the total asset yield of the transaction varies. The earnings are reinvested at short-term rates, causing yields to fluctuate slightly as short-term rates change. Some members may not wish to fund 100 percent of this loan with an advance, preferring instead to fund 15 percent or 25 percent out of their current liquidity.

Our graph compares the results of funding 100 percent of the loan to funding only 75 percent or 85 percent of it. As the amount of short-term funding increases, the spread in the base case increases (short-term rates being 179 basis points below the 5/20 advance rate) along with the interest-rate risk, causing a tightening of the spread as rates rise. Members match-funding a portion or all of a commercial loan should try to include some type of prepayment protection in the event the borrower wants to refinance. This prevents you from having above-market-rate funding in a lower-cost environment.

Please contact our financial strategists at strategies@fhlbboston.com or 1-800-357-3452 to examine other funding alternatives for this or other loans and investments. When considering any strategy, you should always consider your institution's overall balance sheet sensitivity position.