Pressure Busts Pipes

No doubt you may have heard that Fannie unloaded about 2 yards of A1A CMBS recently as it joins the ranks of large bailed-out institutions who are looking to take part in the extraordinary structured products rally.

1. UBS: WAVE CDOs - May 2012
2. AIG: Maiden Lane - February 2012
3. Lloyds Banking Group: RMBS - May 2013
4. Fannie Mae: A1A CMBS - May 2013

And while we're at it, who could ever forget Merrill's infamous deal with LoneStar back in 2008.  I remember as I, a young neophyte in the game at the time, was perplexed by the twenty-cent handle and the fact that MER financed 75% of the deal.

But as you can tell by today's picture at the top of this page, this beloved blog is going to focus on Fannie's particular type of bond that it sold into the market.  If you want to know how the sale went, I recommend this rather robust piece by Real Estate Finance Intelligence.

In other words, "price talk for the bonds ranged from low 70s basis points for higher quality items to 200 basis points for less attractive securities."

Today's lesson will be for the newbs and for the intermediates.  There is some ground to cover here in terms of understanding what exactly these kinds of securities are and how they came to be.  The goal is to understand what Fannie's multifamily loan business is, and then try to grasp the idea of securitizing those loans into the special "A1A' bonds that I mentioned above.  Please take a seat and make sure you have your glass of water handy.

 The following is a primer I picked up via Fannie and it covers what their multifamily business is. Give it a quick read or you may proceed if you're already familiar:

1. Fannie Mae: Multifamily Overview - May 2012

Good, so hopefully now you understand how and why FNM is a  MAJOR player in the market.  Interesting how in 2008, as multifamily contracted, Fannie and Freddie stepped in to counterbalance the sudden dearth of capital and their market share went from less than 1/2 to nearly 3/4.

"The market share held by Fannie Mae and Freddie Mac (“GSEs”) expanded significantly from less than 40% historically to more than 70% in 2009".

Interesting.

We're halfway there people.  The first half of structured-product investing is to understand and make assumptions about the collateral; that being the multifamily loans that serve as the assets for the CMBS bonds.  The second half, and dare I say, sometimes the most important, is understanding how much cash will be generated from those assets and how much cash YOU (the individual tranche) is due to receive.

Please remember this important piece from the Multifamily Overview pdf that I linked to above:

1. In MBS executions, lenders deliver loans to Fannie Mae in exchange for an MBS that is backed by the mortgage loan.

The A1A class is the MBS that is backed by the multifamily mortgage loans contributed to the CMBS trust by the originators (typically banks, such BAML, Wells Fargo, etc).  In a lot of deals, the A1A class is essentially stuffed into the deal and that tranche carries no guarantee by Fannie Mae, but is instead supported by subordination from the entire pool of assets in the Trust (including non-Multifamily assets).  

From Nomura:

1. The A1A Class: The practice of "carving-out" a multifamily tranche started in approximately 1998, and still happens in selected deals today. 
1. The collateral is split into two groups, and a AAA-rated bond is created that is primarily backed by 100% multifamily loans.
2.  Freddie Mac and Fannie Mae are the only known buyers of this tranche, and the bond is created to conform to the investment rules specified in their charters.

Seriously, take a look here, as to how this all looks when jammed into the securitization.  Notice how in the "Notes" column, it says "multifamily carve-out."

Hopefully that makes a little more sense.  But what initially perplexed me the first time I heard of A1As was why they were there to begin with and also, if they received credit enhancement from the subordinate bonds in the deal?  In most cases, they do.

1. In response to investor worries about falling subordination levels in CMBS conduit/fusion deals, dealers started to break up the triple-A rated class into super-senior, "mezzanine," and "junior parts. In the structure shown in Figure 3, classes A1, A2, A3B, A3FL, A4, ASB, and A1A have 30% credit support from subordination and are called "Super Duper Seniors." 

Basically, since Fannie and Freddie are the only real buyers of A1A bonds (and hence, they finance the multifamily housing collateral), these particular tranches are made AAA in order to protect Fannie and Freddie from default risk.  Pretty good trick.  

Do remember however that:

1. Because of its position on the capital structure, if there are defaults in the multifamily loans, generally the bond will get cash from other property types as well, so the name “multifamily carve-out” can be slightly misleading. 
2. Also, if other property types default, cash may be taken from the “multifamily carve-out” to help make other AAA rated bonds whole. 

Honestly, a round of applause to Nomura for consistently doing a good job on structured products primers.  Cheers.

Hopefully the Real Estate Finance Intelligence article makes more sense at this point.  I suggest you give it another look.

Until next time.

~ Jingle Male

A Brief Introduction from Jingle Male

My Fellow Americans,

It is an honor to be able to contribute to The CRE Review.  I look forward to helping this fine blog and its readership stay abreast of what's going on in real-estate.

If you need to reach me: creJingleMale@gmail.com

Now let's get back to business.  Here is what has been going in this sphere recently:

1. Demand for Commercial Real Estate Loans is on the Rise - SoberLook
1. According to JPMorgan, interest-only loans (equivalent to "balloon" mortgage) are on the rise and average loan coupon has been declining.
2. Wall Street Sees Promise in Multifamily Loans - WSJ Developments
1. “Multifamily loans lead the pack in terms of how aggressive the lenders will get” within commercial real estate, said Christopher Haynes...
3. Germany to Sell Real Estate to Lone Star for $1.4 Billion - Bloomberg
1. It’s the country’s biggest commercial-property deal of the year.
4.  Blackstone, Ranieri Betting on Bad FHA Loans: Mortgages - Bloomberg
1.  The FHA’s recent auction had 13 loan pools that sold for 24.8 cents to 59.3 cents per dollar of unpaid principal balance. The sales prevented $1 billion in fiscal 2013 losses for the agency’s insurance fund, Galante said 
5. Starwood Books Upgrade as Hotel Demand Slows: Corporate Finance - Bloomberg
1. The company plans to generate 65 percent of its earnings from fees, Chief Executive Officer Frits van Paasschen said on an Oct. 25 conference call. 

 - Jingle Male

Improvements in Multifamily sector driven by NYC MSA

Herschmeyer at Co-Star notes:

Removing these loans [see list below] reduces the multifamily Fitch Loan Delinquency Index from 14.4% to 9.3% at the end of 2011. This moves multifamily from the worst performing of the five asset classes to the middle of the range with office (6.8%) and retail (6.9%) being the best performers and hotel (12.0%) and industrial (10.25%) being the worst.

In 2006 and 2007, issuers underwrote fixed-rate multifamily loans with stabilization plans, whereby rent stabilized units were converted to market. These loans, Stuyvesant Town/Peter Cooper Village ($2.8 billion), The Belnord ($375 million), Riverton ($225 million), and Savoy Park ($210 million) for a total of $3.6 billion did not see their stabilization plans pan out.

I might add to that last paragraph, "because each of the aforementioned projects were blatantly attempting to evade taxes, break NY state law, and all had ludicrous plans based on the expectation that they could simply kick out the rent control tenants and replace them with market rents - a strategy that has parted fools with their money for nearly a century". But I wasn't consulted, so I'll keep my thoughts to myself.

No Problems at Fannie & Freddie due to Multifamily?

The Wall Street Transcript had an interview with Michael Levy titled "CMBS Risk Even Fannie And Freddie Would Not Underwrite" that got picked up by a few outlets. They kind of glaze over some of the facts and imply that the Enterprises (or Agencies, whatever you want to call them) are not exposed to the multifamily in CMBS?!? Obviously, we all know that there was a directed tranche (A1A) in every Conduit deal that contained all the Multifamily loans, and it was solely purchased by Freddie and Fannie.

The fact they skip this little factoid makes you question the entire article.

A good example of that would be Peter Cooper Village and Stuyvesant Town - that was something that the agencies wouldn't issue a traditional mortgage for because it was underwritten with very little equity and at a relatively low debt service coverage ratio. That's really the prime example of where an apartment operator wouldn't go to Fannie and Freddie to get a mortgage at the peak of the market because they couldn't, because it didn't meet Fannie and Freddie underwriting standards. So they went to the CMBS market, and that's why, in my opinion, to some degree apartment CMBS has had weaker performance than non-apartment CMBS debt.

Uh, all the current problems aside, and even realizing that many (most) questioned the viability of the sub-1% cap rate trade of PCV/ST, the original LTV was something like 54% on the senior debt in question. That was not the issue. Further, guess who is exposed directly to the senior mortgage of PCV/ST, wait for it, wait for ... Freddie Mac and Fannie Mae, of course. They bought up the A1A notes on the CMBS deals that contain the mortgage.

So, let's leave aside their multifamily "portfolio" lending for a second and focus on their CMBS-like exposure. Freddie has a multifamily shelf called FHLMC Multifamily Structured Pass Through Certificates, off which they've issued $7.7 billion since late 2006, with $6.6 billion of that done since the crisis began (they just closed a deal this week run by BankofAmerillwide). Fannie has their DUS program (Delegated Underwriting and Servicing) - I don't know how bit it is, but I'll take a guess it is $50 billion-ish, and I'd be surprised if I were off by more than 20% (sorry not more firm).

Finally, let's look at their actual exposure to pure CMBS Conduit deals. Since 2003, virtually every Conduit deal had an A1A tranche that was purposefully designed and pre-sold to one of the Agencies. Guess how many deals Freddie/Fannie bought virtually all of the multifamily exposure (approximately 16% of the total deal size) from? 221 deals worth $562 billion dollars!

The current outstanding balance of the A1A bonds on their balance sheets is approximately $75 billion (the factor is just 0.90838 because most of the underlying loans have not started to mature yet). In all fairness, the A1A does have a 30% subordination, giving them additional protection as well.

The Enterprises were part of the problem. They deserve no slack, and you especially can't congratulate them for "avoiding" the problems with the CMBS multifamily mortgages, when they were the only two companies investing in them!

Occupancy, Rents Continue downward - Apartments & Office

From Bloomberg:

Manhattan’s third-quarter office vacancy rate hit a five-year high as unemployment rose and companies cut space in the recession.

The rate rose to 11.1 percent, the highest since the third quarter of 2004, New York-based broker Cushman & Wakefield said in a statement today. Rents fell 5.2 percent from the second quarter to $57.08 a square foot and were down 22 percent from a year earlier.

see earlier post from Vornado regarding Manhattan's leasing market stabilization.

and From Reuters:

The U.S. apartment market in the third quarter turned in one of its weakest performances ever as the national vacancy rate hit a 23-year high despite being propped up by landlords willing to take lower rent to keep tenants, according to real estate research firm Reis Inc.

The U.S. apartment vacancy rate rose to 7.8 percent in the third quarter, its highest since 1986, according to the report released on Tuesday. Vacancies have been rising since the third quarter of 2007, according to Reis.

Riverton defaulting

Riverton's foreclosure is today. It seems that the mezz lender (CBRE) is going to take a turn at the helm to see if they can make it profitable after taking out the current equity holder (Stellar).

Reuters

Fitch

It's just the most obvious rent-control flip problem on the radar. There are several others I've written about previously. Jeff Bernstein details some of the new rent control laws in the pipeline that are going to further exacerbate the problem for PE landlords playing the deregulation game The game was mostly played in NYC, but also in San Francisco (The owner of Riverton actually has a similar project in SF) and other cities with rent-regulation.

Either way - you know you have problems when 96-year old women (see image from NYTimes to the right) are gathering in the streets protesting with signs disparaging Private Equity - I mean really...

PCV/ST Deals Downgraded

How prescient. Deal Junkie brought a lengthy article on PCV/ST to our attention this morning, and by this afternoon Moody's had started it's wave of mutilation in CMBS due to the same transaction. The Aaa-rated AJ class was downgraded to A2...

Frankly, I don't think it was unexpected and I figured it was mostly priced in, but it is putting surprising pressure on spreads.

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.