Wall Street Prime Rate
The Wall Street Prime Rate (Prime Rate) is the interest rate charged between the largest banks in the United States. The rate is not linked to the Fed funds rate although there is typically a 300 basis points (3%) spread between them. The WSJP is widely utilized by lenders as an index against which other loans are measured i.e. WSJP + 1.5%.
Putting ‘Wall Street Prime Rate (Prime Rate)’ in Context
Overview
Lone Star Bank, a regional bank headquartered in Dallas, Texas, has agreed to originate a senior loan for The Shoppes at Preston Hollow, a newly developed grocery-anchored retail center in the bustling Preston Hollow neighborhood. The Shoppes at Preston Hollow is a 75,000-square-foot retail center with a prominent national grocery chain as the anchor tenant, accompanied by 12 smaller retail tenants, including cafes, boutiques, and local service providers.
The Deal
The borrower, Blue Ridge Retail Partners, is seeking a senior loan of $18 million to finance the purchase of The Shoppes at Preston Hollow. The total acquisition cost is $24 million, and Blue Ridge Retail Partners is contributing $6 million in equity, resulting in a 75% Loan-to-Cost (LTC) ratio.
To determine the interest rate for the loan, Lone Star Bank references the Wall Street Prime Rate (WSJP), which at the time of origination is 7.5%. Lone Star Bank structures its loan with a rate of WSJP + 2.0%, meaning the total interest rate on the loan is:
Interest Rate = WSJP + 2.0%
Interest Rate = 7.5% + 2.0% = 9.5%
This “WSJP plus a spread” structure is a common method used by lenders to adjust loan pricing in response to changes in the broader interest rate environment.
Loan Terms
- Loan Amount: $18,000,000
- Term: 10 years
- Interest Rate: 9.5% (WSJP + 2.0%)
- Amortization: 30 years
- Type: Senior Loan
How the Prime Rate Impacts the Loan
The Wall Street Prime Rate (WSJP) is crucial to this transaction because it serves as the “index” upon which the loan’s interest rate is built. If the Federal Reserve raises interest rates, there is typically a corresponding increase in the WSJP. For example, if the Federal Reserve raises its federal funds rate by 50 basis points (0.50%), banks may increase the WSJP by the same amount.
If the WSJP increases from 7.5% to 8.0%, the interest rate on this loan would also increase:
New Interest Rate = 8.0% + 2.0% = 10.0%
This increase would directly impact the borrower’s monthly payments. For illustrative purposes, let’s calculate the monthly payment before and after the rate increase.
Monthly Payment Calculation
Original Rate (9.5%)
- Loan Amount: $18,000,000
- Interest Rate: 9.5% / 12 = 0.7917% per month
- Amortization Period: 30 years = 360 months
Monthly Payment Calculation:
M = P * (r(1 + r)^n) / ((1 + r)^n – 1)
Where:
M = Monthly payment
P = Loan amount ($18,000,000)
r = Monthly interest rate (0.7917%)
n = Total number of payments (360)
New Rate (10.0%)
- Interest Rate: 10.0% / 12 = 0.8333% per month
Monthly Payment Comparison
- Original Rate (9.5%): Monthly Payment = $151,354
- New Rate (10.0%): Monthly Payment = $157,963
The increase in the Wall Street Prime Rate from 7.5% to 8.0% results in an increase in the borrower’s monthly payment of $6,609 per month. Over the course of a year, this results in an additional $79,308 in payments.
Key Takeaways
- Floating Rate Risk: By linking the loan rate to the Wall Street Prime Rate, borrowers like Blue Ridge Retail Partners are exposed to potential interest rate increases.
- Predictable Spread: The “WSJP + 2.0%” structure provides clarity on how changes in the interest rate environment will affect the loan.
- Monthly Payment Impact: As seen in the payment calculation, even a small increase in the Wall Street Prime Rate (0.5%) can have a significant impact on the borrower’s monthly payment.
This example illustrates how lenders like Lone Star Bank use the Wall Street Prime Rate as a reference point to price loans, and how changes in the rate can directly affect loan payments.
Click here to get this CRE Glossary in an eBook (PDF) format.