A new multifamily investment product will for the first time allow Freddie Mac to buy and guarantee bonds backed by multifamily loans that were originally underwritten by private entities.
The program is similar to Freddie’s multifamily K Certificates, where it issues structured pass-through certificates by acquiring and guaranteeing select tranches of commercial mortgage-backed securities. But while K Certificates are built using CMBS originally sold by Freddie Mac with mortgages underwritten to its specific guidelines, the new Q Certificate deals are built using private-label CMBS tranches.
Even though the underlying loans in the private-label CMBS were not underwritten using Freddie Mac’s guidelines, the mortgages do meet Freddie’s existing underwriting standards.
In Freddie’s inaugural Q Certificates transaction, the loans in the underlying CMBS are affordable mortgages with historically low default rates, which could help mitigate the increased risk that could result from the fact that Freddie has less control over the original underwriting. But Freddie will likely have to expand into new types of collateral in subsequent transactions because the type of loans used in the first deal generally take years to amass enough volume in to make a securitization cost effective.
Future Q deals may not be backed by the same type of collateral, confirmed Freddie Mac spokesperson Patti Boerger. “The current Q deal is made up of very affordable loans. Future Q deals may or may not be comprised of all affordable loans,” she said in an email.
Freddie Mac has been targeting expansion in the small multifamily loan market. But it may moderate that activity to an extent going forward, given that it recently showed more interest in refocusing on the single-family market instead.
In recent years, the structured CMBS pass-through certificates have taken off in popularity because they offer investors a broader range of options. While not identical, the multifamily certificates share some characteristics with the single-family risk-sharing deals that both Fannie and Freddie began offering following the housing crisis.
Freddie expects to be involved in only “a few” Q deals a year going forward, according to a press release. But even that would be challenging if it limited itself to the loan type involved in the first transaction, which isn’t frequently securitized and has been threatened in the past by tax reform.
The underlying CMBS in the Q Certificate deal, known as “Impact Funding Affordable Multifamily Housing Mortgage Loan Trust 2014-1,” has a total value of $215 million. Properties with rents affordable to tenants with low and very low incomes back the loans in the CMBS. It is a rare securitization of Low Income Housing Tax Credit Program loans, said Mary Jane Potthoff, a managing director at DBRS, one the ratings agencies hired to rate the private securitization Freddie is wrapping in its first Q deal.
“There hasn’t been a deal like this done in four years,” she said.
For its first Q Certificates deal, dubbed Q-001, Freddie acquired tranches of the Impact CMBS totaling $189 million, which consists of 124 loans originated by Wells Fargo, Bank of America and JPMorgan.
“Freddie is not involved in the underwriting or the origination of these loans. It’s different from that regard,” said Potthoff.
The Department of Housing and Urban Development’s LIHTC program allows developers of qualified projects to get tax credits. The developers can sell the credits to investors to raise capital for their projects. This reduces the debt that the developer would otherwise have to borrow. In return, developers offer lower, more affordable rents.
LIHTC loans are not commonly securitized because it takes a long time to have enough volume to make the cost-benefit ratio worthwhile. They are relatively small in the context of the multifamily market, said DBRS assistant vice president Andrea Lange. The loans in this deal on average are less than $2 million in size.
Low Income Housing Tax Credit loans have a strong performance track record. Government-enhanced multifamily loans, including those for LIHTC projects, have a less than 1% default rate on average, according to a Standard Poor’s report on the private securitization. As such, Freddie will most likely be taking on very little credit risk in guaranteeing the senior tranches of the private deal, Impact Funding Affordable Multifamily Housing Mortgage Loan Trust 2014-1.
“The LIHTC program brings with it the sponsorship of this tax credit investor that’s economically incentivized through tax credits to keep the deal out of foreclosure,” said DBRS senior vice president David Nabwangu. The housing must be new construction or have undergone significant rehabilitation.
“In the history of the program we’ve experienced very, very, very low default rates,” he said. The properties also have historically had a strong occupancy rate and very short downtimes when there is a vacancy, according to Nabwangu.