On May 7, 2025, the Federal Open Market Committee (FOMC) concluded its third meeting this year. The Fed maintained the federal funds target range at between 4.25% and 4.5% while emphasizing that it sees a growing risk of both higher inflation and rising unemployment. The statement issued by the Fed at the conclusion of the FOMC meeting gave no hint that it was considering a further cut to the fed funds rate, at least not any time soon. Despite the weakness in first-quarter GDP, economic activity was still described as expanding at a “solid” pace. As of the time of this writing, the average interest rate for 30-year fixed-rate mortgages stands at 6.76%, almost 68 bps higher than the lows reached in September 2024. Despite the uptick in mortgage rates, the latest Mortgage Bankers Association’s forecast calls for mortgage origination volumes to grow to $2.07 trillion in 2025, a 16% increase versus 2024. With demographic support for housing demand and the gradual increase in housing supply that is expected, mortgage originations are expected to grow further, increasing to $2.37 trillion and $2.46 trillion in 2026 and 2027, respectively. 

Advances from Federal Home Loan Bank of San Francisco (FHLBank San Francisco) can provide member institutions with flexible, low-cost funding to efficiently meet expected mortgage demand increases. By leveraging FHLBank San Francisco’s reliable and price competitive financing products, members can stay ahead of market demand, lock in favorable rates, and support the growth of their mortgage portfolio.

In this article, we use a hypothetical mortgage portfolio to demonstrate how a member institution could leverage various FHLBank San Francisco advance products to fund the portfolio while locking in a healthy net interest margin (NIM) and managing interest rate and liquidity risks.

Match Funding Mortgage Cash Flows

The hypothetical funding solution is based on cash flow matching, a well-known asset liability management strategy that strives to align the maturities and cash flows of assets and liabilities to minimize interest rate and liquidity risks. The goal is to ensure that incoming cash flows from assets (e.g., interest, scheduled and unscheduled principal payments) coincide with the timing and amount of outgoing cash flows for liabilities (e.g., advance repayments). By matching these cash flows, a member can more effectively manage liquidity needs and avoid having to sell assets prematurely or borrow at unfavorable rates to meet obligations.

This cash flow matching strategy can provide a natural hedge against interest rate risk and reduce the need to actively manage mismatched positions. Cash flow matching is especially relevant in a post-March 2023 banking environment where bank treasurers, corporate boards, and regulators pay a lot more attention to interest rate and liquidity risk management.

Match-funding mortgage cash flows involves some challenges due to potential prepayments that can introduce uncertainty around the timing and amount of these cash flows. Because residential mortgage assets are subject to prepayments where borrowers have the option to prepay their mortgage early without incurring a prepayment fee, mortgage prepayment behavior can be highly influenced by interest rate movements. When rates fall, borrowers are more likely to refinance or pay off their mortgages early to lock in lower rates, leading to higher prepayment rates. Conversely, when interest rates rise, prepayment rates tend to decline as refinancing becomes less attractive, and borrowers prefer to keep their current loans. If these asset cash flows are not well-matched on the liability side of the balance sheet, an institution can expose itself to interest rate and liquidity risks.

A mortgage funding strategy using FHLBank San Francisco advances, as presented here, can help address the uncertainty inherent in mortgage cash flows and the associated financial risks. We consider cash flows across multiple interest rate scenarios (e.g., base, up and down shocks) and identify advance structures that could provide potential risk management by extending in higher rate scenarios (slower mortgage prepayments) and contracting when rates are lower (faster mortgage prepayments).

Mortgage Origination and Funding Assumptions

Let’s consider a hypothetical origination scenario where a member originates 50%, 25%, and 25% of 30-year fixed, 15-year fixed, and 7-year hybrid/ARM mortgages, respectively.[1] For the funding requirements, we assume that a member is looking to match-fund the hybrid product while it is in the initial fixed rate period.

Proposed Funding Solution Review

The funding solution presented below in Table 2 consists of a FHLBank San Francisco Fixed Rate Credit (FRC) and callable advance ladder.

A callable advance allows members to purchase an option where they can choose to prepay the advance in full after the initial lockout period without a prepayment fee. Essentially, callable advances provide members more flexibility to manage their interest rate risk and liquidity needs. In exchange for this flexibility, pricing on callable advances is higher than on FRC advances of the same tenor.

We suggest a mix of FRC and callable advances to try to match-fund mortgage cash flows over a range of interest rate scenarios. The FRC advances provide a low-cost funding source with known upfront maturities, while the more expensive callable advances allow for much needed flexibility to offset accelerating mortgage prepayments in “down rate” scenarios.

Please note that the mix between FRC and callable advances can be optimized based on a member’s particular risk and return preferences. In general, tilting the funding solution towards more callable advances with shorter lockout periods (buying more optionality) could provide more protection against interest rate risk but could come at the expense of lower profitability at the margin. Conversely, tilting the solution towards more FRC advances (buying less optionality) could expose members to more interest rate risk but could offer a better return profile at the margin.

Cash Flow Matching 

Chart 1 below demonstrates how the funding solution shown in Table 2 performs over a 15-year window under multiple interest rate scenarios. While the base case cash flows are matched well, in the “up rate” scenarios, the solution is underfunded at the margin as mortgages extend while funding continues to roll off in accordance with their scheduled maturities. Members always have the option to add short-term advances or leverage excess deposits to fill in the gaps in this scenario. Conversely, in the “down rate” scenarios, the solution is slightly overfunded initially as prepayments accelerate faster than the funding matures. The funding solution discussed here targets the funding mismatch within +/- 10 percent of the original mortgage balance.

FHLBank San Francisco can work with members to customize the mix of advances based on the member’s risk tolerances and profitability objectives. For example, to lessen the cash flow mismatch (less interest rate risk exposure), a member could opt to put more weight on callable advances and/or shorten their lockout period.

Interest Rate Risk Analysis

The interest rate shock analysis presented below in Table 3 further confirms that the proposed funding solution can work as expected. As the Table below shows, both mortgages and advances extend or contract when rates are higher or lower respectively, keeping the overall portfolio duration in balance. The somewhat positive net duration gap in the “up rate” scenarios can be minimized by purchasing more optionality (more callable advances/shorter lockouts). However, it would increase the cost of the funding bundle.

Net Interest Margin Simulations

Table 4 below presents 10-year NIM simulations over a range of interest rate scenarios. With the assumptions used for the hypothetical mortgage portfolio, the FHLBank San Francisco funding solution earns a positive return over its life, with “down rate” scenarios outperforming the “up rate” ones at the margin. The relative underperformance in the “up rate” scenarios is driven by a funding gap, where mortgage assets are extending while advances are rolling off, requiring short-term (more expensive) advances to fund the shortfall. As discussed earlier, tilting the funding solution toward using more callable advances can mitigate this gap. This could provide the needed extension in the “up rate” scenarios while, at the same time, allowing funding to roll off faster when mortgage prepayments accelerate in the “down rate” scenarios.

To Learn More

Including FHLBank San Francisco advances in your mortgage funding strategy can provide flexible and effective solutions to support mortgage originations and related risks. By using a mix of FRC and callable advances that is attuned to a member’s risk and return objectives, members can efficiently manage interest rate and liquidity risks inherent in funding mortgage cash flows. This approach can support a healthy NIM and position institutions to meet potential increases in mortgage originations, helping them stay competitive in a changing market. If you want to learn more about liquidity products and solutions from FHLBank San Francisco, please contact your Relationship Manager or the Member Services Desk at (415) 616-2500.

FHLBank San Francisco Membership Also Benefits Communities

FHLBank San Francisco makes a portion of its net income available through grants to finance the purchase, construction, or rehabilitation of housing for low- or moderate- income households in member communities. Utilizing FHLBank San Francisco products to help manage your mortgage funding strategy could result in more financing available for housing needs in your communities.