Multifamily prepay speeds ramp up
admin | January 31, 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.
Falling interest rates and still healthy increases in multifamily property prices have pushed up prepayment speeds in agency multifamily loans over the past few quarters after hitting a trough at the end of 2018. This momentum is likely to continue at least into the first month or two of 2020. Two ways agency investors can lower prepay exposure is to extend in duration in Freddie Mac small balance securities or use a barbell strategy on prepayment penalties in Ginnie Mae project loans.
How much penalties deter prepayments
Over the last few years Ginnie Mae project loans have gravitated to fairly standard initial prepayment penalties of 10% that drop incrementally to 0%, usually by 1% per year. The declining point system typically has the expected impact on borrower tendency to prepay (Exhibit 1), with the lowest prepayment speeds exhibited by loans still in the highest penalty phase, and speeds gradually increasing as prepay penalties decline.
Exhibit 1: Voluntary prepayments by penalty amount in Ginnie Mae project loans
Note: CRR is calculated as voluntary prepayments as a percentage of outstanding deal balance excluding loans in lockout or that are defeasible. Construction loans are locked out from prepayment until they convert to project loans. This matches Intex’s CPR when forecasting. Prepay speeds updated through November 2019. Source: Ginnie Mae, Intex, Amherst Pierpont Securities.
An interesting trend that has emerged over the last 18 months is that Ginnie Mae project loans that are fully outside of the penalty window are showing signs of burnout. The prepayment speeds on these loans have dropped and mostly stayed below those of loans with 1 to 6 points of prepayment penalties remaining. A reasonable strategy to limit prepayment exposure in this product is to buy recently issued securities with as much penalty protection as possible, and older well-seasoned securities where the loans are outside the penalty phase.
Prepayments in Ginnie Mae project loans could rise a bit higher on average to perhaps 20 CRR, but rates are already so low that the refinance incentive can’t get back to pre-2018 levels of 300 or more basis points (Exhibit 2).
Exhibit 2: S-curves by rate incentive for Ginnie Mae project loans
Note: CRR is calculated as voluntary prepayments as a percentage of outstanding deal balance excluding loans in lockout or that are defeasible. This matches Intex’s CPR when forecasting. Prepay speeds updated through November 2019. Source: Ginnie Mae, Intex, Amherst Pierpont Securities.
Extend duration in Freddie Mac small balance loans
There is greater prepayment protection in the loans in the longer tranches of FRESB deals, so prepayments are naturally lower on average as the maturity of the tranche increases (Exhibit 3). Over the past two years the mix of penalties in 10 year tranches has shifted more towards yield maintenance, providing additional protection from prepayments. On average the hybrid tranches also predictably have lower prepayment speeds than the fixed rate tranches of the same maturity, then prepays tend to jump around the balloon when penalties typically substantially decline.
Exhibit 3: Average prepayment speeds across FRESB tranches for 2014-2019 vintages
Note: CPR includes voluntary and involuntary prepayments. The earliest vintages are 2014 and 2015 so prepay averages 5 years or more after issuance may be based on very few outstanding securities. at Source: Intex, Amherst Pierpont Securities.
Small balance loans show similar dynamics, with prepays tending to rise as penalties decline. Investors can insulate themselves to some extent from prepays by choosing the longer-life tranches and fixed-rate instead of hybrid securities. For complete agency multifamily prepayment analysis, please see our CMBS prepay reports.
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