Member Services | Member Resources « Market Intelligence»

Market Intelligence

As Commercial Loans Surge, Set Rates & Terms Wisely

With the demand for mortgage loans softening in our region, FHLBank Pittsburgh members are becoming increasingly interested in commercial lending. But setting interest rates and terms for commercial lending in this competitive environment can be tricky business. Here are some options to consider when setting commercial loan interest rates and terms.

The Surge in Commercial Lending

It's clear that members are attracted to commercial loans. According to a recent FDIC profile of lending in West Virginia, for example: "Commercial real estate lending has been the primary source of real estate income, with construction and development the most rapidly growing loan segment."¹ The FDIC also reports that construction and development lending in Pennsylvania grew 30% from June 2005 to June 2006.

While it may be true that, nationwide, this same construction and development lending is responsible for an increase in loans 90 days past due, regionally loan performance remains strong. The Federal Reserve's latest economic update reports similar findings for Federal Reserve districts that overlap FHLBank Pittsburgh's district.²

FHLBank members concur, with many members reporting an increase in competition for commercial loans. "Over the past few months, we have seen a noticeable increase in competition for commercial loans," said Thomas Tulaney, executive vice president and commercial sales division manager for First National Community Bank in Dunmore, PA. "In order to increase our loan portfolio and customer base, we need to gain every possible advantage over the competition. Now more than ever, it is critical for us to explore all of the various financing options and programs available to our customers."

Dealing with Volatility in the Market

Some players in the market are being very aggressive in setting interest rates, or they are eliminating prepayment fees to enhance commercial deals. Many financial institutions are also shifting away from the comfort of offering prime, adjustable-rate loans to a concentration on fixed-rate deals to meet customer demand. All these variables add volatility in commercial lending rates.

While commercial loan pricing differs from market to market and is dependent on the level of competition, the capital markets can offer you a reality check regarding commercial loan rate setting. Many of the lending structures you offer your commercial customers can be duplicated in wholesale funding form or in the derivatives market.

FHLBank Advances Can Help You Set Rates, Terms

The rates and terms FHLBank Pittsburgh offers you on its advances can provide strong market-rate indications of how you might price and structure your own commercial loans. FHLBank advances to watch are (a) the 3-month LIBOR, floating-rate advance in which you can embed caps, or (b) fixed-rate advances that are fully amortizing or with balloon payments. The rates and terms of these advances can help you in setting rates and terms for your own commercial loans. Or you may want to match fund your own loans with these customizable FHLBank advances, helping you reduce your interest-rate risk.

The FHLBank returnable advance can also help by giving you an idea of the cost of excluding prepayment fees from new deals. The returnable advance gives you the option of prepayment without fee at specific dates during the life of the advance. For example, you could enter into a 5-year, fixed-rate advance and include a yearly prepayment option at a rate of 5.86%. The standard fixed-rate advance would cost 5.18%, so the difference in rates between the two structures is 68 basis points, the cost of the prepayment option. You should consider this option cost when offering loans without prepayment fees to your customers.

FHLBank advances aside, you can also garner valuable pricing data on many structures offered by other players in the capital markets. If you want to find the fixed rate that would be comparable to the rate on a prime, adjustable-rate deal, all you need to do is look to the swap market. Swap indications can provide you with the market's willingness to pay a fixed rate for receiving an adjustable rate for specific terms — important information you should consider when setting your own rates and terms.

Market Intelligence

When deciding on the interest rates and terms of your commercial loans, especially loans with options, look to the capital markets or speak with your vendors that have access to the street. By doing so, you can get a true understanding of option costs, leading to sound loan pricing and structuring decisions. As always, feel free to consult with the FHLBank's Market Money Desk (1-800-288-3400) for more information on how you can best maximize your membership and funding resources.

¹Federal Deposit Insurance Corporation, FDIC State Profiles, Fall 2006.

²Federal Reserve Board, Beige Book, 2006 Summary of Commentary on Current Economic Conditions by Federal Reserve District, October 12, 2006 (Prepared at the Federal Reserve Bank of Richmond and based on information collected before October 2, 2006).

DISCLAIMER

FHLBank Pittsburgh has taken reasonable steps to compile the data presented above, or has obtained such data from generally available public sources. FHLBank makes no representations or warranties, express or implied, as to the accuracy, completeness and timeliness of any assumptions or any other data presented herein.

The information presented herein is not investment or business advice, nor is it an offer to extend credit or buy any security or financial product; it is provided for informational purposes only. The customer must not rely on any of this information when making any investment, business or credit decision.

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 herein and such agreements, policies and regulations, the agreements, policies and regulations will be determinative.