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Freddie Mac K-deals lead spreads tighter in agency CMBS
admin | February 20, 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.
Agency CMBS spreads have gradually tightened for the past six months while the market has re-acclimated to a 10-year Treasury yield below 2.00%. Freddie Mac K-deal spreads tend to lead Fannie Mae DUS and Ginnie Mae project loans, primarily due to the more frequent issuance and deeper liquidity of the Freddie CMBS. The most recent Freddie K-deal pricing coincided with another leg down in rates, pushing spreads to a new multi-year low. Investors can pick up Fannie and Ginnie CMBS a few basis points wide before the bonds tighten on the follow and should overweight Freddie K B and C classes, which should also benefit from additional credit enhancement as loans are prepaid and defeased.
Exhibit 1: Agency CMBS spreads, 10-year weighted average life
Source: Amherst Pierpont Securities
A new Freddie K-deal had the A2 tranche price at swaps + 47 bp, 4 bp inside the last print at swaps + 51 bp for the benchmark class with a weighted average life of 9.75 years. This pushes the spread between 10-year K and DUS classes out to 8 bp from 4 bp.
Fannie DUS bonds typically trade a few bp wide to Freddie K’s for a variety of reasons. Investors tend to value the diversification provided by the larger pooled loan K-deals as opposed to the single loan DUS bonds. This is evident because Fannie Mae GeMS, which are pools of DUS bonds and structured similarly to K-deals, tend to price 1 bp or 2 bp inside of DUS, closer to Ks. This doesn’t collapse the spread completely, since Freddie’s CMBS program is considerably larger and has more frequent issuance (Exhibit 2). It retains a liquidity premium among investors.
Exhibit 2: Agency CMBS issuance in 2019
Source: Commercial Mortgage Alert
The prepayment protection in agency CMBS is an important factor behind the tightening of spreads during the recent rally as agency MBS spreads widen in anticipation of a steepening wave of prepayments. Prepayment speeds in Ginnie Mae project loans should tick higher as well, but the protection provided by the penalties does depress speeds across the stack (Exhibit 3). Older project loans with no penalties have shown signs of burnout over the past year since their prepay speeds have not been as fast as loans with low penalties.
Exhibit 3: Average prepayment speeds in Ginnie Mae project loans
Note: Data through January 2020. Source: Ginnie Mae, Amherst Pierpont Securities
Prepayments in Freddie K-deals require that the loans be defeased, which adds to the credit support in B and C classes. Over time as loans are defeased the classes can tighten significantly (Exhibit 4), eventually migrating up in the ratings.
Exhibit 4: Freddie Mac K-deal B and C classes
Note: Data as of 2/20/2020; spreads from Bloomberg. Source: Bloomberg, Amherst Pierpont Securities
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