Wednesday, January 28, 2009

Good Times

The recent paper published by Harvard regarding multifamily reminds of the well-intentioned JJ in Good Times who had admirable goals but bungled the delivery every time. The ultimate goal of the Harvard paper is admirable, and some of the recommendations are tenable and realistic, but they bungled some of the facts.

Lending has dropped, significantly, across all sectors, and no one would dispute even after looking at the actual numbers. You want to build a new apartment? Good luck getting a loan, it'll be tougher than it was two years ago. Want to rehab some apartments or convert them to condos? The hurdle gets set significantly higher. Want to refinance a 10-year old loan on a performing multifamily asset? - much more realistic. I've seen lists of closed multifamily loans from the last 2 or 3 months and the average weekly volume was around $1 billion.

Most CMBS loans, and loans from other sectors too, on stabilized properties (there are no construction or rehab loans in CMBS, except for in a handful of deals that are considered esoteric), are 10-year balloon loans, fixed-rate, and have 30-year amortization periods. Obviously there are variations, but that is 75% or more of the market.

Multifamily loan performance remains quite strong and underwriting standards appear to have remained prudent, unlike in the
single-family market.

MF has the highest delinquency rate amongst the various property types in CMBS at year-end 2008, and had the largest increase during the 4th quarter. Regarding the 'prudent' underwriting standards, I give you Peter Cooper Village/Stuy Town.

Let's pretend we have a loan called Manor Apartments, it's fictitious but based on an actual portfolio of 1999 originated loans that are coming due this year. These loans had an average LTV of 64.5%, coupons of 7.5% (or 170 bps over Treasuries at the time), and have an average 58% appreciation embedded in them since origination (based on NCREIF appreciation indices). It's also performing. Even in today's stressed lending environment, with coupons several hundred basis points above Treasuries, borrower's are likely to get a comparable or lower debt service, and can leverage up even in the face of expected 30+% price declines in CRE.
Instead, Fannie Mae and Freddie Mac simply lost market share to the CMBS market channel
They didn't lose market share, they changed their model just like the insurance companies did. Do you keep a department in place to manage a loan portfolio? or do you buy one that is prepackaged in a CMBS that by nature is diverse and pays a good yield? The Agencies got a sweet deal - CMBS market created a tranche just for them, all the multifamily loans provide cashflows to the A1A tranche, while losses on foreclosed loans hit the lower rated tranches in a deal along with losses from other property types. Frankly, historically, multifamily is a more volatile sector and without the Agencies supporting them in the CMBS world, financing would have been much more expensive the last couple of decades.

A good point made is that the Agencies will shortly have to reduce their portfolio holdings, and this will be disastrous for the multifamily market. Currently there is not enough demand in the CMBS secondary market and spreads continue to widen - imagine adding another 30% in supply (about the size of the Agency's holdings of Multifamily CMBS via the A1A tranche)...
many believe that underwriting standards have been looser in the CMBS market channel, though it is difficult to judge whether this is true.
*cough* *cough* *Riverton* I could name names, but the list is too long.

There are some good points made in the paper, but its overshadowed by the apparent lack of knowledge of the author. There are several points that feel wrong, but I frankly just don't have my arms around it. Case in point, investors will likely demand the kind of uniform
standards and transparency in underwriting more associated with the GSEs than CMBS.
I think with your typical GNMA deal you know the weighted average stats of a pool - compared to the transparency you get with a CMBS deal (property level financials) this seems wrong, but again, I'm not that familiar with the GNMA deals. I do not think transparency when I think GSE, though... at all.


Anonymous said...

Are the only buyers of A-1A tranches Freddie and Fannie? How can I verify this? Is there any way to gauge the magnitude of their A-1A holdings? Thanks.

Concrete Jungle said...

Yes, the A1A tranche was expressly developed for Fannie and Freddie to buy. You could rough into it by assuming 1/3 or the CMBS collateral was multifamily, and excluding esoteric deals, you have about $700billion outstanding, and give them a 1/3rd of that, $230ish billion.

Alternatively, you could add up all the A1A classes, or just go to the most recent quarterly/annual reports for Fannie and Freddie and add it up. Fannie issues some DUS bonds, and Ginnie has a large securitization that they sell off, and there are some wraps you want to exclude.

It's no secret, and it's probably not a real problem so long as they're allowed to hold to maturity. You would have to experience 30% realized losses before the A1A actually takes a hit (all market pricing aside). So, in your typical CMBS deal which is 30%-some odd percent multifamily, you'd have to default 100% of the multifamily loans (for instance) and sell the properties off for $0 so there is no recovery. I'm not suggesting that won't happen on a few extremely poorly underwritten deals, but it will not happen in any substantial size unless we get to a spot that is substantially worse than the Great Depression (losses on corporate debt in the Great Depression were in the low-20% area).