Uncategorized

Bridge loan performance in agency deals vs CRE CLOs

admin | January 17, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Options for CMBS investors looking to get exposure to bridge-lending include CRE CLOs and the Freddie Mac value-add program. Both financing channels are structured to provide short-term loans for properties undergoing renovations, with borrowers expected to transition to lower cost, long-term financing at project completion. Principal paydown of some recent senior CRE CLO tranches is faster on average than the agency guaranteed classes of Freddie Mac’s value-add deals; however the Freddie deals tend to have a higher loan age at origination, which undercuts some of the performance advantage for investors.

Differences in underwriting criteria

The agency underwriting process can be time consuming and holds borrowers to stringent financial standards and limit on project scope. However, if multifamily renovation or repair projects fit into Freddie’s value-add box, then borrowers can get financing rates 75 bp to 150 bp below those of other lenders. The value-add program is intended for light renovations of multifamily properties not larger than 500 units, with budgets of $10,000 to $25,000 per unit, with half of the budget intended for interior upgrades. The loans typically have 3-year terms with two optional 1-year extensions for additional fees of 0.5% and 1.0%, respectively. There are no lock out periods for prepayment, though a 1% exit fee is due if the loan is not refinanced with Freddie Mac. A brief overview of the value-add program is here.

Sponsors of CRE CLOs provide bridge loans for any property type, and can accommodate projects that require heavier renovations and may be fundamentally more complex. Non-agency transitional lending documents include provisions for additional funding and extension options similar to those in agency loans but offer borrowers more flexibility; loans in CRE CLOs also typically include short-term prepayment lockouts.

Differences in structure and deal execution

Some CRE CLO issuers of managed deals have relaxed terms to allow loans with significant modifications to remain in the pool, making them a poor comparison to Freddie’s value-add deals which do not permit loans with rate modifications to remain in the pool. Static CRE CLO deals also lack the reinvestment period found in managed pools, so any prepayments, maturity extension, or credit events can only come from the collateral identified at origination.

Exhibit 1: Recent CRE CLO static A tranches vs Freddie Mac value-add A classes

Note: Amounts outstanding and loan sizes in millions. All data as of 1/15/2020. Source: Bloomberg, Amherst Pierpont Securities

There have been four Freddie Mac value-add deals issued since the beginning of 2018. The A classes of these deals are compared to the senior AAA classes of four static CRE CLOs which were issued at roughly the same time (Exhibit 1). The following differences are notable in the underlying collateral and structures of the two financing channels:

The Freddie Mac deals tend to have larger loan sizes at origination but fewer loans in the pool than these CRE CLOs.
The weighted average maturity (WAM) and weighted average life (WAL) of the Freddie bonds at origination tend to be consistently shorter than those of the CRE CLOs. This is likely due to the volume of value-add loans being smaller, so it takes longer for Freddie to assemble enough loans. The result is that the agency loans have seasoned more by the time the deal is issued than those in the CRE CLOs, which is why the weighted average loan age (WALA) at issuance is significantly longer for the agency deal.
The CRE CLO deals tend to pay principal (and interest?) sequentially, with the A class receiving all of the principal until it is retired. The value-add deals pay principal (and interest?) pro rata, with the A class receiving 85% and the B and C classes getting the other 15%. This contributes to the projected WAL of the agency bonds being shorter than that of the CRE CLOs, and makes the comparison of prepay speeds a bit more nuanced.
The differences in the weighted average coupons of the underlying mortgages ranges from 100 bp to 180 bp, and difference in the coupons on the bonds is 70 bp to 75 bp. This is very roughly indicative of the difference the financing rates for borrowers or compensation for investors, though the mortgages and deals are not perfectly contemporaneous.

Paydowns still look surprisingly similar

The collateral paydown profile of the four Freddie value-add A classes (Exhibit 2) can be compared to that of the four CRE CLO As (Exhibit 2). Instead of comparing the prepayment speeds – which can be volatile month to month given the relatively small number of loans in the deals, both graphs show the percentage of collateral remaining on the y-axis against the weighted average loan age on the x-axis. Although the Freddie deals tend to have a significantly longer loan age at issuance, on average the first loans begin to paydown at around 16 – 18 months of maturity, and most of the bonds have factors below 50% when the WALA reaches 24 months.

Exhibit 2: Paydowns in Freddie Mac value-add deals

Note: Cashflows and performance metrics as of 1/15/2020. Source: Bloomberg, Amherst Pierpont Securities

Exhibit 3: Paydowns in CRE CLO static deals

Note: Cashflows and performance metrics as of 1/15/2020. Source: Bloomberg, Amherst Pierpont Securities

The oldest bonds, the FHMS KI01 A and the BDS 2018-FL1 A, were both issued in February of 2018. The Freddie bond has nearly completely paid down, with a current loan age of 37 months and only 4% of its collateral remaining. The CRE CLO bond had a loan age eight months shorter at issuance, so the current loan age is only 29 months and there is still 22% of collateral remaining.

Both groups represent too small of a sample size to warrant drawing broad conclusions about performance. Taking an average of the bond factors (Exhibit 4) indicates that although paydowns begin in both groups when the WALA is about 16 months, the average prepay speeds in this sample of CRE CLOs is faster than the that of the Freddie value-add deals. However, the Freddie deals tend to be issued when the loans are significantly older – on average 12.5 months of age – compared to the CRE CLO deals which are issued at an average age of 5.25 month. So the benefit of these slower prepayments in the agency value-add loans is not entirely accruing to the investor.

Exhibit 4: Comparison of paydowns in Freddie value-add deals vs a sample of CRE CLOs

Note: The yellow highlights indicate the WALA when the bond was issued. Source: Bloomberg, Amherst Pierpont Securities.

So far the loan performance in these eight agency and CRE CLO deals has been nearly perfect, with only been one 30-day delinquency in a single loan in the BDS 2018-FL1 A deal, which occurred in December 2019. Going forward it will be interesting is to see if there is any significant difference in maturity extension between the loans in the agency bonds versus those in the CRE CLOs. Otherwise any differences in performance between agency bridge loans and those in CRE CLOs due to underwriting criteria or deal structure will likely remain idiosyncratic while growth in the economy and the commercial real estate market remains positive and stable.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.