Professional Documents
Culture Documents
Please see the disclosure appendix of this publication for certification and disclosure information
This report is available on wellsfargo.com/research and on Bloomberg WFSP
Note: Fannie Mae only includes 10/9.5 mortgage loans, Ginnie Mae only inlcludes GNR Remic transactions and Freddie Mac only includes K-Certificates. Source: Wells Fargo Securities, LLC, Fannie Mae and Intex Solutions, Inc.
Freddie Mac-K-Certificates
Introduction
Since 2009, Freddie Mac has been using the Structured Pass-Through Certificates (K Certificates) program to securitize multifamily mortgages. These transactions largely resemble conventional CMBS deals by featuring time-tranched cash flows, structured credit enhancement and the use of master servicer, special servicer and directing certificate holder roles. Senior bonds receive a guaranty of timely payment of interest and payment of principal at loan maturity guaranty provided by Freddie Mac. The program is growing; eight K deals priced in 2009 and 2010, and 10 may be brought to market in 2011. The K Certificates program has proven to be versatile, as evidenced by the funding of a single-asset deal in 2010 and a transaction backed entirely by seven-year mortgages in 2011. Finally, the dearth of publicly registered CMBS deals over the past two years may steer investors that have a constrained 144A mandate to consider K Certificates. Exhibit 2: Summary of K Certificate Deals
Deal COMM 2009-K3 FREMF 2009-K4 FREMF 2010-K5 FREMF 2010-K6 FREMF 2010-K7 FREMF 2010-K8 FREMF 2010-K9 FREMF 2010-KSCT FREMF 2011-K10 FREMF 2011-K701 Total:
1
Orig. Pricing Bal. ($mm) Date 984.8 6/5/09 994.6 10/7/09 1,024.3 1/26/10 1,081.1 3/24/10 1,012.4 6/11/10 1,010.9 9/16/10 1,089.0 11/17/10 476.0 2/25/10 1,009.5 1/12/11 1,877.6 2/11/11 10,560.4 Average:
WAC 5.85 5.56 5.68 5.55 5.63 5.54 5.26 5.77 4.89 4.58 5.43
Loans 62 46 70 68 83 72 70 1 76 44 59.20
WA LTV 68.77 69.16 67.68 70.04 70.06 69.24 70.55 68.70 70.59 69.21 69.40
DSCR 1.67 1.35 1.56 1.39 1.36 1.35 1.39 1.25 1.54 1.47 1.43
Largest Top 3 Loan % Loan % 5.71 4.41 14.19 6.71 11.35 2.83 7.35 4.44 10.31 2.85 12.03 3.73 7.20 6.88 100.00 0.00 11.36 3.52 23.76 5.34 20.33 4.07
Partial IO % 64.10 39.15 40.37 38.55 27.29 35.61 30.66 0.00 43.74 53.95 37.34
Full IO % 2.78 0.00 18.28 3.66 1.35 3.75 14.41 0.00 6.74 10.03 6.10
Defeasance 78% 100% 98% 98% 94% 97% 95% 0% 94% 0.84
Includes loans that require a static prepayment premium charge. Source: Bloomberg, LP. and deal documents.
Collateral Characteristics
Freddie Mac K Certificate loans are originated directly through the Freddie Mac Capital Markets Execution (CME) program. All Freddie Mac loans are underwritten in house by Freddie Mac employees. This provides meaningful continuity in loan quality and loan risk assessment. In-house underwriting is unique to the Freddie Mac program as Fannie Mae and Ginne Mae utilize designated third-party underwriters that adhere to specific guidelines. Freddie Mac underwriting criteria balance flexibility to the borrower against standardization for efficient securitization. To this end, leverage and coverage terms are keyed to the loan term, amortization schedule and loan type (e.g., acquisition or cash-out refinance). Prepayment protection most commonly takes the form of a two-year lockout period with defeasance thereafter.
Note: The DSCR for Partial Interest-Only and Interest-Only period uses an amortizing payment. Source: Freddie Mac.
covers 1) timely payment of interest, 2) to each class as entitled, the payment of principal at the maturity date of each mortgage, 3) the reimbursement of realized losses or allocated expenses and 4) the ultimate payment of interest. Freddie Mac receives a monthly fee for its guarantee, which varies according to the collateral composition and structure of each transaction. For the K-006 transaction, the guarantee fee was 14 bps on the outstanding principal balance. For the preceding transactions, the guarantee fee was 34 bps. Freddie Mac K certificate deals are structured with IO classes, which have typically been retained by Freddie Mac. Because the timely payment of principal upon loan maturity is guaranteed, the return profiles of these IO classes differ from those of nonagency CMBS IO tranches. For non-agency CMBS deals, the IO classes would receive additional cash flow if loan maturities extend. One notable difference between non-agency CMBS and K Certificates is the controlling Class B-pieces in the K-series transactions are paid principal only. In our view, this structure offers the special servicer a clean incentive to pursue a speedy loan resolution to the highest achievable recovery. Similar to traditional CMBS, performing loans are serviced by the master servicer, which may delegate responsibilities to a sub-servicer. Non-performing loans are transferred to a special servicer that is compensated through a running special serving fee of 25 bps and a workout or liquidation fee of 1%. Exhibit 5: FEMF 2011-K10 Snapshot
Class A1 A2 X1 X3 X2 B C R Orig. Bal. ($mm) 313.8 695.7 1,009.5 87.4 1,165.4 68.5 87.4 0.0 Tranche % of Deal Bal. 27% 60% ---6% 8% -Coupon OWAL 3.32 5.48 4.33 9.58 0.42 8.00 4.60 9.51 0.20 8.50 4.60 9.71 0.00 9.76 0.00 0.00 Fitch Rating AAA AAA AAA NR NR ANR NR Credit Support 13.4% 13.4% ---7.5% 0.0% --
Relative Value
Freddie Mac K Certificates offer investors access to publicly issued securities with stable cash flows and sound collateral performance. Furthermore, the exposure to multifamily collateral is a diversifier in CMBS portfolios as new issue deals of 20102011 have not included multifamily collateral. Cash flows are stabilized through 1) prepayment penalties, 2) loan diversity and 3) the resolution of defaulted loans within the trust. Prepayment penalties most often take the form of defeasance. The sponsor and geographic diversity of loans within the pool diffuses investor exposure to idiosyncratic loan prepayment risk. Finally, defaulted loans are resolved within the trust, rather than bought out as in the case of Fannie Mae DUS. These factors combine to create a stable cash flow stream. Compared to DUS, K-series transactions are differentiated in terms of default-driven prepayment risk.
First, unlike Fannie Mae DUS securities, defaulted loans are not bought out of the pool. The resolution of loans within the trust, complemented with insured timely interest and principal at mortgage maturity during the workout period, may dampen some of the default-driven prepayment sensitivity compared with DUS. Second, because prepayments are not interest-rate driven, a more diversified collateral pool should diffuse the prepayment exposure. Within each deal, the presence of an amortizing first-pay class would also alleviate cash flow variability to the second-pay senior. Exhibit 6: Relative Value Matrix for Agency CMBS
Product Agency CMBS 5 Yr* Agency CMBS 10 Yr* FNMA Dus 10/9.5 2005 AAA 10 Yr CMBS 2010 AAA 5Yr CMBS Agency Unsecured Debt - FHLMC 10 Yr Spread to Swaps (bps) 58 64 82 130 115 6.8
*Agency CMBS includes both Freddie Mac K-Series and Fannie Mae remics. As of 3/24/11 Source: Wells Fargo Securities, LLC
Conclusion
We expect the Freddie Mac K Certificates program to continue to expand. These securities provide access to multifamily collateral, which has been largely absent from 2010 and 2011 vintage nonagency CMBS deals. Moreover, Freddie Mac deals are issued publicly and benefit from structured credit support, the use of a master and special servicer and a controlling classfeatures that CMBS investors are well familiarized with. The delinquency rate of Freddie Macs multifamily portfolio at 26 bps as of Q4 2010 is clearly differentiated from nonagency CMBS, which had an overall delinquency rate of 9.5% as of Q4 2010.
DUS lenders enter into loss sharing agreements with Fannie Mae. In most cases, the loss sharing is a pari passu arrangement, in which the lender bears one-third of the losses and Fannie Mae the remaining two-thirds. A triple-A rating based on the timely interest and principal guaranty from Fannie Mae, qualifying for a 20% risk-based capital requirement for banks. A stable cash flow profile because of call protection and a guaranteed final maturity.1 Consistent liquidity, reflecting a number of active market makers. Bid/offer spreads range from 5 bps10 bps for the two primary bonds in the market (seven-year final maturity/6.5-year yield maintenance and 10-year final maturity/9.5-year yield maintenance). Low spread volatility compared with AAA CMBS. DUS MBS swap spreads had a standard deviation of 57 bps in 2008 compared with 234 bps for 10-year AAArated supersenior CMBS. Higher yields than Fannie Mae debentures and other comparable investments.
Fannie Mae DUS MBS are backed by multifamily mortgages. Fannie Mae delegates the underwriting and servicing to lenders that have been qualified based on criteria that cover capital, liquidity and business infrastructure. These lenders underwrite, close and sell loans in accordance with Fannie Mae credit and underwriting criteria. Fannie Mae created its DUS program in 1988. The primary purpose was to accelerate Fannie Maes origination process and increase its participation in the multifamily housing market. Before the DUS program, lenders had to go through the more time-consuming process of having Fannie Mae underwrite and approve loans. In August 1994, Fannie Mae began securitizing and issuing DUS MBS. Since then, the program has grown steadily, with $64.9 billion issued as of December 2010. DUS issuance surged in 1996, averaging $328 million per month, and rose again in 1998 when average monthly issuance hit $576 million. In 2001, issuance doubled again to nearly $1 billion per month as rates hit record lows following the recession and 9/11 attacks. Similar to other fixed-income products, issuance tends to increase when rates fall. In addition to the effect of low rates, the issuance in 20092010 has benefited from Fannie Maes shift from portfolio lender to liquidity provider.
1 Call protection has consisted primarily of yield maintenance agreements and, increasingly in recent years, of defeasance with Fannie Mae debentures. Prepayment lockouts and fees have also been used.
12.0 10.0 8.0 ($billion) 6.0 4.0 2.0 0.0 2002 2003 2004 2005 2006 2007 2008 2009 2010
Note Annual Issuance of 10/9.5 multifamily mortgage loans backing MBS. Source: Fannie Mae.
Underwriting
The credit quality of the underlying mortgages is high, in our view. The historical delinquencies of Fannie Maes entire DUS loan portfolio have been consistently below those of nonagency conduit commercial mortgages (Exhibit 8). According to Fannie Mae, serious delinquencies as of Q4 2010 stood at 71 bps for multifamily loans in its portfolio and loans underlying MBS, compared with 60+ day delinquencies of 14.22% for multifamily properties in non-agency CMBS deals. Differentiated collateral performance can be attributed to stringent underwriting. Conduit CMBS lending has in the past been subject to underwriting drift, reflecting an intensely competitive lending environment. In contrast, DUS loans are underwritten to a static grid. Fannie Maes loss sharing arrangement with lenders further differentiates DUS underwriting. The most common loss sharing arrangement requires that the lender bear a third of the losses from the loans it underwrites on a pari passu basis with Fannie Mae. However, the loss sharing arrangements vary between transactions. Exhibit 8: Fannie Mae Multifamily 60+ Day Delinquency Rate
16% 14% 12% 10% 8% 6% 4% 2% 0% 6/97 6/98 6/99 6/00 6/01 6/02 6/03 6/04 6/05 6/06 6/07 6/08 6/09 6/10
Note: Fannie Mae Multifamily deliinquencies include owned and securitized loans. Source: FannieMae, Intex Solutions, Inc., and Trepp LLC.
The quality of Fannie Mae DUS loans is due, in part, to the admission qualifications to become a DUS lender, according to Fannie Mae. Under the DUS program, Fannie Mae licenses DUS lenders that originate and sell multifamily mortgage loans. To participate, the lender must meet criteria that cover capital and liquidity levels, subject to periodic review.
The Agency CMBS Primer March 25, 2011 Exhibit 9: DUS Program Lenders
Alliant Capital Finance, LLC AmeriSphere Multifamily Finance, LLC Arbor Commercial Funding, LLC Beech Street Capital, LLC Berkadia Commercial Mortgage LLC CBRE Multifamily Capital, Inc Centerline Mortgage Capital, Inc. Citibank, N.A. CWCapital LLC Deutsche Bank Berkshire Mortgage, Inc (DB Mortgage Services, LLC) Dougherty Mortgage, LLC Grandbridge Real Estate Capital, LLC
Source: Fannie Mae.
Greystone Servicing Corporation, Inc. HomeStreet Capital Corporation HSBC Bank USA, N.A. JP Morgan Chase Bank, N.A. KeyCorp Real Estate Capital Markets, Inc M&T Realty Capital Corporation Oak Grove Commercial Mortgage, LLC Pillar Multifamily, LLC PNC Multifamily Mortgage, LLC Prudential Multifamily Mortgage, Inc. Red Mortgage Capital, LLC Walker & Dunlop, LLC Wells Fargo Bank, N.A.
DUS mortgage loan interest rates are set based on a three-tiered credit grid. Each tier varies according to the debt service coverage and loan-to-value (LTV) ratio of the property. The criteria for standard conventional multifamily loans are shown in Exhibit 10. Alternative loan types (e.g., student housing or manufactured housing) are subject to stricter standards. The majority of DUS MBS are backed by Tier 2 and Tier 3 loans. The higher the tier, the lower the guaranty fee paid to Fannie Mae. DUS loans are generally nonrecourse to the borrower and assumable. However, because Fannie Mae DUS are priced and traded at a zero prepayment speed and Fannie Mae guarantees final maturities, the assumption feature has no impact on DUS MBS convexity. There is a 1% assumption fee, which is not shared with the investor. Exhibit 10: FNMA DUS Underwriting Minimum Maximum DSCR LTV Ratio Tier 2 1.25 80% Tier 3 1.35 65% Tier 4 1.55 55%
Source: Fannie Mae.
Prepayment Protection
As in the CMBS market, the risk of an economically induced prepayment is greatly mitigated, if not eliminated, by prepayment protection. Prepayment protections may vary, but usually include yield maintenance or defeasance. The most prevalent form of DUS prepayment protection has been yield maintenance. DUS ARM pools, on the other hand, use a percentage-of-balance method. Defeasance is one of the best types of prepayment protection available. With defeasance, the borrower must replace the principal and interest cash flows of the DUS MBS with those of Fannie Mae agency debentures, if the loan is refinanced. Thus, from the investors perspective, there is no change to the principal and interest cash flows received. In addition, because the possibility of a property default-induced prepayment has been 10
eliminated, the DUS MBS spreads should not widen if the market rallies and the price of the DUS rises above par. As with yield maintenance, the borrower may refinance the loan during the last 90 days before maturity without defeasing or paying a premium. Defeasance prepayment protection occurs on fixed-rate loans with maturities less than or equal to 10.5 years. Yield maintenance agreements allow for a full loan prepayment at a premium. A pro rata portion of this premium is shared with the investor. Voluntary partial prepayments are prohibited at all times. For prepayments occurring between the end of the yieldmaintenance period and 90 days prior to maturity, a 1% premium is due but is not shared with the investor. Fannie Mae has the right, but is not required, to waive the 1% premium. There is no prepayment premium charged during the 90 days prior to loan maturity. In addition to having low call or early prepayment risk, Fannie Mae DUS MBS, unlike CMBS, have final maturities that are guaranteed by Fannie Mae, thereby mitigating extension risk. In the CMBS market, modifications have become more prevalent as borrowers sometimes negotiate with special servicers for maturity extensions or lower rates. Default-induced prepayments pose a material performance risk for DUS MBS that trade at premium prices. Since 2002, Fannie Mae has repurchased 100 10/9.5 loans, triggering prepayments without yield maintenance. Of those repurchases, 74 occurred in 2009 2010. The early payment of principal may occur in the event of default, casualty or a breach of lender representation and warranties. In these cases, no prepayment penalty is assessed, because the prepayment is not at the discretion of the borrower. This risk contributes to DUS MBS spreads widening at higher dollar prices.
Credit Maturity Amortization Callability Bid/Ask Liquidity Call Risk Offer Spread
11
150
100
50
0 4/05 8/05 4/06 8/06 4/07 8/07 4/08 8/08 4/09 8/09 4/10 12/04 12/05 12/06 12/07 12/08 12/09 8/10 12/10
Exhibit 13: DUS 10/9.5 versus Fannie Mae Debentures (Past Five Years)
Date Maximum Minimum Average Standard Deviation Current 12/11/2008 3/25/2010 Spread (bps) 216 21 71 39 77
3/24/2011
As mentioned above, default-induced prepayment presents a material risk to price premiums for DUS bonds. Because most Fannie Mae DUS MBS are backed by one property and because Fannie Mae does not compensate the investor for involuntary defaults, a default on the underlying loan would constitute a prepayment at par. As such, DUS MBS prices tend to compress (i.e., spreads tend to widen) as interest rates decline. Fannie Mae DUS MBS also trade against 10-year swaps. Over the past 12 months, DUS MBS spreads have traded at an average spread of 83 bps to swaps. Prior to mid-2007, DUS MBS traded at an average of around 14 bps spread to swaps.
12
Basis Points
3/24/2011
DUS MBS also trade in relation to CMBS, although this relationship weakened in 2008. CMBS spreads spiked to 1,535 bps over swaps in November 2008, and DUS MBS reached their wides of 275 bps to swaps in the same month. Lower spread volatility for DUS MBS, in our view, is attributable to a static underwriting framework that did not experience the underwriting drift of recent-vintage CMBS, in addition to Fannie Maes guarantee of timely interest and principal and a guaranteed final maturity.
13
Exhibit 16: DUS 10/9.5 versus Super Senior 10-Year AAA CMBS
0 -200 -400 Basis Points -600 -800 -1000 -1200 -1400 12/06 12/07 12/08 12/09 12/10 3/07 6/07 9/07 3/08 6/08 9/08 3/09 6/09 9/09 3/10 6/10 9/10
Exhibit 17: DUS 10/9.5 versus Super Senior 10-Year AAA CMBS (Past Five Years)
Date Maximum Minimum Average Standard Deviation Current 2/19/2007 1/9/2009 Spread (bps) -59 -1,298 -262 256 -103
3/24/2011
Mega Pools
Mega pools and REMICs combine single loan DUS pass-through securities or other mega transactions. The result is a diversified collateral pool, greater transaction size, and, in the case of REMICs, the ability to structure a range of average lives. Multiple fixed-rate DUS pools with coupons within a 100-bp range may be pooled to create a Mega. Investors sometimes prefer Megas because the pools are diversified (DUS MBS pools are usually backed by one property) and large (size being attractive for liquidity and the large investment requirements of some investors).
14
ERISA Eligibility
Fannie Mae DUS MBS certificates are ERISA eligible, according to the Fannie Mae MBS Prospectus. Investors should refer to the prospectus and consult with ERISA professionals for further details.
15
Conservatorship
Fannie Mae was placed in conservatorship and brought under the supervision of the Federal Housing Finance Agency (FHFA) on Sept. 6, 2008. The conservator assumed all powers of the boards, management and shareholders. A $200 billion Senior Preferred Stock Facility provided by the U.S. Treasury effectively provides an explicit guarantee of Fannie Maes and Freddie Macs debt by ensuring that the GSEs maintain positive net worth, according to the FHFA. Under the agreement, the Treasury owns 79.9% of the common stock of each enterprise.
Further Information
Bloomberg. Original loan and property information at the pool level as well as current WAC, WAM and balance data are available on Bloomberg for all DUS MBS and Megas backed by DUS MBS. Analytics are also available for most DUS fixed-rate pools along with delinquency information. Internet. Go to www.efanniemae.com then click on Multifamily Securities for information, ranging from current loan and property information (including delinquencies and debt service coverage), schedules of loan information (for pools closed after Sept. 1, 2001), product descriptions and current prospectus supplement narrative templates.
Conclusion
The shift in Fannie Maes mandate in 2009 ushered in a transitional period for the DUS market that must now adjust to a dramatic increase in issuance. The 15-fold increase in supply from $661 million in 2008 to $9.65 billion in 2009 resulted in DUS spreads drifting wider from 2009 to 2010 even as pricing on most other spread products tightened. The supply technical may offer investors an attractive spread for a risk profile that has included sub-1% serious delinquencies through the credit crisis and the added benefit of a Fannie Mae guaranty.
16
Step 1: Federal Housing Administration (FHA) Guaranty The first step for any GNMA multifamily deal begins with the Federal Housing Administration (FHA).2 The FHA provides mortgage insurance for multifamily and single-family loans originated by FHA-approved lenders. FHA-approved lenders can be, but are not limited to, commercial banks, insurance companies, mortgage banks, savings
2
The FHA was created in 1934 by the Federal Housing Act with the goal of making it easier for lower- and middle-income families to finance homes.
17
and loan institutions, pension funds and trust companies. This primer focuses on nonsingle-family mortgages that can be for the construction, rehabilitation, purchase and refinancing of multifamily and healthcare facilities and make up what is often referred to as the Project Loan market. Since 1970, the FHA has insured $158.5 billion (36,680 loans) of multifamily loans. A public or private entity can receive financing from an FHA-approved lender as long as the project falls under one of the FHA programs also known as sections in the Fair Housing Act, which are discussed in more detail later in the report. If the loan qualifies for one of the FHA programs, it is given an FHA guaranty. In return, the FHA receives a monthly premium from the lender. The FHA guaranty means that the ultimate payment of principal and interest on the loan is backed by the full faith and credit of the U.S. government. The FHA, however, does not guarantee the timeliness of principal and interest payments. In addition, in the event of a default, the FHA charges a 1% assignment fee and only begins accruing interest after the first month of missed payment. This results in a 99% repayment of principal and one month of lost interest. Step 2: GNMA Guaranty GNMA3 provides a second level guaranty for an FHA-insured loan. Essentially, GNMA makes up for the inadequacies of the FHA project loans by guaranteeing both the timeliness of principal and interest payments and by taking care of the 1% assignment fee in the event of a default. For the guaranty, GNMA charges a 13-bp fee. Since 1971, GNMA has insured $123.2 billion of FHA project loans. Early on in the program, GNMA provided a guaranty on only a small fraction of FHA-insured loans, whereas today GNMA insures more than 90% of FHA-insured loans. Step 3: A Deal Is Born The final phase of a GNMA Multifamily REMIC deal involves three partiesan FHAapproved lender, a dealer (investment bank) and the investors. Once an FHA project loan is insured with a GNMA guaranty, a dealer may purchase the loan and place it with an existing pool of GNMA-insured loans. When a dealer has enough loans, typically around 4080, the dealer structures a deal to be sold to investors. Although the majority of GNMA-insured loans are pooled and placed in REMIC structures, some are left as single loans and sold off individually to investors. The first GNMA multifamily deal to be launched under the GNR shelf name was in 2001 (GNR 2001-12).4 From 2001 through February 2011, there have been 195 deals with a total original balance of $59.5 billion, of which $44.5 billion is currently outstanding. Issuance in 2010 was $11.1 billon, up from $6.0 billion in 2009 and $3.8 billion in 2008 (Exhibit 19).
The FHA became part of the U.S. Department of Housing and Urban Development (HUD) in 1965. In 1968, Congress created GNMA as a government-owned corporation within HUD with the intent of making a more liquid secondary market for mortgages. 4 Prior to the GNR 2001-12 deal, GNMA-insured loans were securitized and placed in a number of Fannie Mae REMIC Trust deals, the first of which was Fannie Mae Grantor Trust 1995-T5. Since 2000, however, only a handful of GNMA multifamily loans have been in Fannie Mae deals, the last of which was Fannie Mae Multifamily REMIC Trust 2005-M1.
18
8 6 4 2 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2.2 4.5 6.6 6.6 5.5 4.9 3.8 2.4
6.0
6.0
*2011 data is through February. Source: Wells Fargo Securities, LLC and Intex Solutions, Inc.
The penalty points typically decline 1% each year, thus, a 5_5 is five years of lockout followed by penalty points of 5%, 4%, 3%, 2% and 1% for years six through 10, respectively. There are many variations (e.g., a loan in the GNR 2006-30 deal has two years of lockout followed by penalty points of 8% for three years and then 5%, 4%, 3%, 2% and 1% for the remaining years).
19
Project Loans and Construction Loan Certificates GNMA loans can be classified as project loans certificates (PLCs) or construction loan certificates (CLCs). Many loans begin as construction loans, and as a project is completed or rehabilitated, a borrower obtains longer-term financing in the form of a PLC. PLCs and CLCs can be further broken up into more detailed categories; the descriptions of these can be found in Exhibit 21. GNMA loans are also categorized by the FHA program under which they are insured. We take a closer look at those programs in the following section.
20
PN
LM
LS
RX
CS
FHA Program Types GNMA loans qualify for certain FHA programs when underwritten. A majority of the loans, 80%, fall into one of five groups. A breakdown of the FHA sections within the GNMA multifamily deals based on original loan balance is shown in Exhibit 22. Notice that some loans can qualify for more than one FHA program. A considerable amount of loans, for example, fall under both 232 and 223(f). We provide a brief description of the most common FHA programs below.
21
223(a)7 14% 232/223(f) 16% Source: Wells Fargo Securities, LLC and GNMA.
223(f) 18%
Sections 221(d)4 and 221(d)3 provide insurance for the construction and rehabilitation of multifamily housing for low- and moderate-income families that have lost their homes due to urban renewal, government actions or disaster. Section 221(d)3 applies to nonprofit borrowers, whereas Section 221(d)4 applies to profit-seeking borrowers. Section 223(a)7 allows the FHA to refinance loans that are currently insured under any section, resulting in the prepayment of the existing mortgage. The refinanced loan cannot be greater than the original loan amount and is allowed a term equal to the unexpired duration of the previous loan plus 12 years. Section 223(f) provides insurance for loans originated for the purpose of purchasing or refinancing multifamily complexes, hospitals and nursing homes that are not in need of major rehabilitation. The goal of the program is to allow refinancing to lower the debt service or to purchase existing properties to maintain a sufficient amount of affordable housing. Section 232 provides insurance on construction loans for new or rehabilitated nursing homes, intermediate care facilities, board and care homes, and assisted-living facilities for the elderly. Section 207 provides insurance for FHA-approved lender loans for the construction or rehabilitation of multifamily properties and manufactured home parks. Section 220 provides insurance for loans collateralized by multifamily properties that are in federally aided urban renewal areas or areas experiencing redevelopment. The purpose of Section 220 is to promote quality housing in areas where revitalization is planned. Section 213 provides insurance for loans backed by cooperative housing and allows nonprofit cooperative ownership housing corporations to develop the projects. Section 241 provides insurance to finance property improvements that should enable the property to remain competitive, to extend its useful life and to replace dated equipment without having to refinance.
22
A Tranche - WAL: 2.5 Coupon: 2.63% Original Balance: $150 million B Tranche - WAL: 6.1 Coupon: 3.81% Original Balance: $73 million C Tranche - WAL: 8.9 Coupon: 4.24% Original Balance: $24 million D Tranche - WAL: 12.8 Coupon: 4.62% Original Balance: $45 million Z Tranche - WAL: 21.5 Coupon: 4.87% Original Balance: $6.2 million IO Tranche - WAL: 6.1 Coupon: 1.47% Collateral 40 GNMA-Insured Mortgage Loans
38 Additional Loans
Note: Information is as of the time of issuance. Source: Wells Fargo Securities, LLC, GNMA and Intex Solutions, Inc.
Most deals have 4080 loans, although there have been outliers with as few as four loans and as many as 156 loans backing a deal. Deal sizes are normally in the range of $250 million$350 million, with the average, since 2001, at $302.6 million (Exhibit 24). The average deal size in 2010 was $315.9 million compared to $260.5 million in 2009.
23
Exhibit 24: Average Deal Size for GNMA Multifamily Remic Deals
500 450 400 Avg. Deal Size ($Mil.) 350 300 250 200 150 100 50 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 318.2 315.3 284.5 273.7 313.6 248.3 260.5 437.2 Avg. Deal Size - $302.6 million
373.3 315.9
Year
While not specifically documented anywhere, the Project Loan Default (PLD) curve is believed to have been developed by Donaldson, Lufkin & Jenrette in 2000 or 2001 and was based on historical default data.
24
The PLD curve assumes that involuntary prepayments begin immediately, starting at 1.30% in year one and then ramp up to 2.51% in year three before steadily declining to 0.25% for years 15 through 20. The sequential pay classes (usually A, B, C and D) are priced to the swaps curve while the accrual class (usually Z) is priced to the U.S. Treasury curve (specifically the 30-year bond).
25
Voluntary Prepayments and Defaults Actual Performance For our prepayment and default analysis, we used loan data provided by GNMA and HUD. Voluntary prepayments for GNMA loans experienced a substantial spike in 2010. We found 452 voluntary prepayments in 2010 with an original loan balance totaling $2.6 billion. In comparison, we found 203 instances of voluntary prepayments in 2009 with a total original loan balance of $1.2 billion. The bulk of the voluntary prepayments in 2010 came from the 2003, 2004 and 2005 vintages. The majority of voluntary prepays were loans that originally had five years of lockout. We are, however, also starting to see loans from the more recent vintages with only a few years of lockout starting to prepay. Unlike voluntary prepayments, which spiked in 2010, defaults in GNMA remic deals remain low. We found only 34 defaults in 2010 with a total loan balance of $230 million. Historically, the GNMA transactions have experienced very few defaults. The 2002, 2003 and 2004 vintages have accounted for the majority of GNMA loan defaults. The most common program types in terms of defaults have been 221(d)4, 223(f), 223(a)7 and 232.
26
Exhibit 27: Prepayments and Defaults in GNMA Remic Deals (Loan Count)
500 450 400 350 Loan Count 300 250 200 150 100 50 0
22 85 41 14 133 104 42 43 37 53 36 34 41 34 220 227 203 452
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Wells Fargo Securities, LLC, GNMA and HUD.
Exhibit 28: Prepayments and Defaults in GNMA Remic Deals (Loan Balance)
3,000 2,750 2,500 Loan Balance ($Mil) 2,250 2,000 1,750 1,500 1,250 1,000 750 500 250 0
481 326 275 197 74 5 6 55 34 632 170 144 206 275 230 849 1,232 1,185 1,185 2,619
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Wells Fargo Securities, LLC, GNMA and HUD.
Conclusion
Ginnie Mae project loan transactions provide another option for investors in the agency CMBS space. GNMA multifamily remic issuance topped $11 billion in 2010 and is on pace for another year of sizable issuance. As the principal and interest for these securities are guaranteed by the U.S. government, the main risk for investors is the timing of cash flows due to prepayments, both voluntary and involuntary (defaults). Defaults have remained low in GNMA remic transactions, but voluntary prepayments saw a significant spike in 2010. Investors need to be mindful of the shift in call protection to shorter lockout periods and the potential for faster prepayments.
27
DISCLOSURE APPENDIX Additional information is available on request. This report was prepared by Wells Fargo Securities, LLC. About Wells Fargo Securities, LLC Wells Fargo Securities, LLC is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. Important Information for Non-U.S. Recipients EEA The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. For certain non-U.S. institutional reader (including readers in the EEA), this report is distributed by Wells Fargo Securities International Limited (WFSIL). For the purposes of Section 21 of the UK Financial Services and Markets Act 2000 (the Act), the content of this report has been approved by WFSIL a regulated person under the Act. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive 2007. This research is not intended for, and should not be relied upon, by retail clients. The FSA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. Australia Wells Fargo Securities, LLC is exempt from the requirements to hold an Australian financial services license in respect of the financial services it provides to wholesale clients in Australia. Wells Fargo Securities, LLC is regulated under U.S. laws which differ from Australian laws. Any offer or documentation provided to Australian recipients by Wells Fargo Securities, LLC in the course of providing the financial services will be prepared in accordance with the laws of the United States and not Australian laws. Hong Kong This report is issued and distributed in Hong Kong by Wells Fargo Securities Asia Limited (WFSAL), a Hong Kong incorporated investment firm licensed and regulated by the Securities and Futures Commission to carry on types 1, 4, 6 and 9 regulated activities (as defined in the Securities and Futures Ordinance, the SFO). This report is not intended for, and should not be relied on by, any person other than professional investors (as defined in the SFO). Any securities and related financial instruments described herein are not intended for sale, nor will be sold, to any person other than professional investors (as defined in the SFO). Japan This report is distributed in Japan by Wells Fargo Securities (Japan) Co., Ltd, registered with the Kanto Local Finance Bureau to conduct broking and dealing of type 1 and type 2 financial instruments and agency or intermediary service for entry into investment advisory or discretionary investment contracts. This report is intended for distribution only to professional customers (Tokutei Toushika) and is not intended for, and should not be relied upon by, ordinary customers (Ippan Toushika). The rating stated on the document is not a credit rating assigned by a rating agency registered with the Financial Services Agency of Japan but a rating assigned by a group company of a registered rating agency. The rating agency groups call respectively Fitch Ratings, Moodys Investors Services Inc or Standard & Poors Rating Services. Any decision to invest in securities or transaction should be made after reviewing policies and methodologies used for assigning credit ratings and assumptions, significance and limitations of credit rating stated on the web site of rating agencies. Important Disclosures Relating to Conflicts of Interest and Potential Conflicts of Interest Wells Fargo Securities, LLC may sell or buy the subject securities to/from customers on a principal basis or act as a liquidity provider in such securities. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC research analysts receive compensation that is based on and affected by the overall profitability of their respective department and the firm, which includes, but is not limited to, investment banking revenue. Wells Fargo Securities, LLC Fixed Income Research analysts interact with the firms trading and sales personnel in the ordinary course of business. The firm trades or may trade as a principal in the securities or related derivatives mentioned herein. The firms interests may conflict with the interests of investors in those instruments. For additional disclosure information please go to: www.wellsfargo.com/research. Analysts Certification The research analyst(s) principally responsible for the report certifies to the following: all views expressed in this research report accurately reflect the analysts personal views about any and all of the subject securities or issuers discussed; and no part of the research analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst(s) in this research report.
This report, IDs, and passwords are available at www.wellsfargo.com/research This report is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments named or described in this report. Interested parties are advised to contact the entity with which they deal, or the entity that provided this report to them, if they desire further information. The information in this report has been obtained or derived from sources believed by Wells Fargo Securities, LLC, to be reliable, but Wells Fargo Securities, LLC does not represent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgment of Wells Fargo Securities, LLC, at this time, and are subject to change without notice. Performance analysis is based on certain assumptions with respect to significant factors that may prove not to be as assumed. You should understand the assumptions and evaluate whether they are appropriate for your purposes. Performance results are often based on mathematical models that use inputs to calculate results. As with all models, results may vary significantly depending upon the value of the inputs given. Models used in any analysis may be proprietary making the results difficult for any third party to reproduce. The securities referenced herein are more fully described in offering documents prepared by the issuers, which you are strongly urged to request and review. Wells Fargo Securities, LLC, and its affiliates may from time to time provide advice with respect to, acquire, hold, or sell a position in, the securities or instruments named or described in this report. If you are subject to ERISA, this report is being furnished on the condition that it will not form a primary basis for any investment decision. For the purposes of the U.K. Financial Services Authoritys rules, this report constitutes impartial investment research. Each of Wells Fargo Securities, LLC, and Wells Fargo Securities International Limited is a separate legal entity and distinct from affiliated banks. Copyright 2011 Wells Fargo Securities, LLC.