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Market Intelligence

FHLBank Offers Solutions For Funding Commercial Real Estate Loans

With the continued slowdown in the housing market, some community banks are turning to the commercial real estate sector to offset the decline in residential mortgage lending. Recent data from the U.S. Census Bureau showed that spending for the “hard costs” (i.e., actual construction expenses) of commercial development to create offices, industrial buildings, and stores rose 2.4% in March 2007, compared to a 1% decline in residential construction.⁽¹⁾ Add-in the potential borrowing needs created by “soft costs” such as architectural/engineering fees and site development work before construction, along with expenses incurred to maintain and operate the building after it is completed, and the attractiveness of this market segment from a lending perspective becomes even more apparent.

Recent guidance issued by the Federal Reserve, the Office of the Comptroller of the Currency, and other regulators has increased the scrutiny of banks with high concentrations of construction, multifamily housing and commercial real estate loans. However, for well-capitalized, profitable financial institutions where commercial real estate lending is a portion of a well-diversified portfolio of loans, FHLBank offers advance products that are well suited for meeting member funding needs.

Amortizing Advances Match-fund Loans to Owners/Buyers

Depending on the type of transaction that is being underwritten, FHLBank has a variety of advance structures that can be used to fund commercial real estate loans. An amortizing advance can be an effective tool for match-funding loans made to owners or buyers of existing properties. This advance can be structured with a combination of length to maturity and amortization schedule. Typical lengths to maturity for advances used to fund commercial real estate loans are five, seven, ten, and 15 years, with accompanying amortization schedules of either ten, 15, or 20 years, depending on the preference of the commercial borrower. (The maximum length to maturity and amortization schedule available on this type of advance is a full 30 years.)

As an example, the indicative pricing available to a member bank for a $750,000 amortizing advance with a five-year term and a ten-year amortization schedule was 5.24% as of 5/21/07. On the same day, indicative pricing for an advance with a seven-year term and a 15-year amortization schedule equaled 5.42%, whereas an advance with a ten-year term and a 20-year amortization schedule was priced at 5.48%. To prevent early principal prepayment by the commercial borrower, which could expose the lending institution to the risk of falling interest rates, it is important to include an effective prepayment fee/makewhole provision, which is found in many commercial mortgage transactions.

Advances for Developers and Owner-occupied Construction

Commercial real estate developers, along with owners who are planning to build and then occupy their own property, frequently need funds to pay for construction costs as well as long-term financing for the completed structure. Through a combination of FHLBank’s Mid-Term Repo Adjustable-Rate Advances and a forward-starting amortizing advance, member banks can make available to their commercial loan customers a solution to these funding needs that also offers a valuable guaranteed rate lock.

As an example, assume your customer plans to build a new warehouse with attached office space, and total construction costs are estimated at $1.2 million. Your customer provides a nine-month construction schedule that anticipates monthly draws as outlined in Exhibit 1 below.

One possible solution would be to offer the customer a line of credit with an interest rate that adjusts monthly based on 1-month LIBOR (plus a spread based on your institution’s profitability target), along with a commercial mortgage loan that funds nine-months forward on February 1, 2008. (In this example, assume the customer decided on a commercial mortgage with a seven-year term and a 15-year amortization schedule.) In the current rate environment, this commercial mortgage loan could be match-funded by a forward-starting FHLBank amortizing advance, disbursing on February 1, 2008 and priced at fixed rate of 5.44%.

On May 1, 2007, the $75,000 that is to be advanced to the customer under the construction line of credit could be funded by an FHLBank 1-Month LIBOR Adjustable-Rate Mid-Term Repo Advance, the term of which would be nine months – May 1, 2007 through February 1, 2008. (Based on a recent 1-Month LIBOR setting of 5.32%, the indicative rate for this nine-month adjustable-rate advance would be 5.39%, which would re-set monthly beginning on June 1, 2007.)

On June 1, 2007 the $200,000 that is to be advanced to the customer could again be funded with a 1-Month LIBOR Adjustable-Rate Mid-Term Repo Advance, which in this case would have a term of eight months – June 1, 2007 through February 1, 2008. Continuing with this approach, the remaining $925,000 of construction costs would be funded with seven more FHLBank 1-Month LIBOR Adjustable-Rate Mid-Term Repo advances, each having a shorter term (seven-months, six-months, etc.), and all maturing on February 1, 2008. Proceeds from the forward-starting amortizing advance will be used to repay the $1.2 million of principal plus estimated accrued interest ($30,600 in this example), so the total amount of the amortizing advance would need to equal $1,230,600 (see Exhibit 2).



From the member bank’s perspective, offering this construction line of credit with an adjustable-rate and funding it with a series of Adjustable-Rate Mid-Term Repo advances based on 1-Month LIBOR helps eliminate much of the potential interest rate risk. Furthermore, locking in a fixed rate for the amortizing advance serves as a hedge against potential increases in interest rates during the nine-month construction period.

Whatever your needs, FHLBank has available a wide range of credit products that can be used to fund commercial real estate loans. For assistance with these or other types of funding, contact your Relationship Manager or the Member Money Desk at 800-288-3400, ext. 4000.

⁽¹⁾ U.S. Census Bureau news release, April 30, 2007, “March 2007 Construction at $1,187.8 Billion Annual Rate.”

DISCLAIMER
The rates and other terms used in this article are for informational purposes only and subject to change at any time without notice of any kind. The information presented is not investment, business or accounting advice, nor is it an offer to extend credit or buy any security or financial product. Readers must not rely on any of this information when making any investment, business, credit or accounting decision. Any customer interested in any Hedge Select product is advised to consult with its accounting advisor.

FHLBank products are governed by various agreements between FHLBank and its customers, as well as certain FHLBank policies and applicable regulations. In the event of any inconsistencies between information contained in this article and such agreements, policies and regulations, the agreements, policies and regulations will be determinative.