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Agency CMBS begins to stabilize

| March 27, 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.

The recently passed fiscal stimulus bill provides forbearance for multifamily renters and borrowers with loans backstopped by Fannie Mae, Freddie Mac and Ginnie Mae. Combined with new Federal Reserve purchases of agency CMBS through open market operations, agency CMBS spreads–even for classes of the securities without agency guarantees–show tentative signs of stabilization.

Agency CMBS spreads widened dramatically over the past several weeks as the coronavirus crisis began to shut down large swaths of the economy. For example, Fannie Mae DUS (10/9.5) spreads were below 60 bp in late February and peaked at 185 bp on March 23. Freddie K-deal spreads for the unguaranteed B and C classes rose from 150 bp and 200 bp, respectively, to well over 400 bp and 500 bp. Much of the widening was driven by forced selling and liquidation of several mortgage REITs that struggled to meet portfolio margin calls. The impact is evident in increases in average daily trading volume and net holdings of agency CMBS by primary dealers, which both jumped sharply the first few weeks of March (Exhibit 1).

Exhibit 1: Federal agency and GSE CMBS

Source: Federal Reserve primary dealer statistics, weekly data, last update 3/18/2020; Amherst Pierpont Securities

Protection for borrowers and tenants

Both GSEs and Ginnie Mae announced forbearance programs that allow multifamily borrowers to defer payments for at least 90 days provided landlords do not evict tenants solely for non-payment of rent during the forbearance period. These measures were reiterated in the CARES Act which also provided for forbearance for single-family and multifamily borrowers whose mortgages were insured, guaranteed or subsidized by any government agency. Expanded unemployment benefits and cash payments to households under the CARES Act may also further offset some of the potential delinquencies from tenants who have lost income due to the shelter in place or lockdown orders.

Fed purchases of agency CMBS

The forbearance programs and passage of the CARES Act has helped to stabilize the markets more broadly, but perhaps the strongest rudder for agency CMBS has been the Fed’s inaugural purchases of agency CMBS. The Fed conducted its first open market operation (OMO) for agency CMBS on March 27. The first operation targeted Fannie Mae DUS pools with a 10-year loan term and yield maintenance protection of 9.5 years (FNMA DUS 10/9.5), with a weighted average life of at least seven years. The minimum lot size per bond for the operation was $5 million with a total purchase size of $1 billion.

The Fed’s open market operations trading desk announced three further agency CMBS operations for March 31, April 2 and April 3. The three purchase operations tentatively total $3 billion and will include fixed-rate FNMA DUS pools, fixed-rate Freddie Mac K-series and Ginnie Mae project loans.

Support from Fed buying, forbearance programs and the CARES Act have combined to stabilize the market, as Fannie Mae DUS (10/9.5) spreads appear to have retraced to about 90 bp. Freddie K-deal spreads for 10-year classes typically trade a few basis points inside of DUS and have tightened in to similar levels in secondary trading.

Support for Freddie K-deal B and C classes

Open market operations for any asset class are governed by the Federal Reserve Act Section 14. Under this section the Fed is authorized to buy and sell obligations of the United States, states and counties in the United States or its territories, or “any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.”

Under Section 14 the Fed cannot buy classes of agency CMBS that are not fully guaranteed. For example, Freddie Mac B and C class securities of K-deals, or agency credit risk transfer securities, cannot be purchased under this framework. It does not mean that the Fed can’t support that part of the market, but they can’t do it via the OMO channel. They could expand the assets allowed to be financed by TALF to include agency and nonagency CMBS, or they could expand the assets bought by one of the SPVs. New issue and legacy nonagency CMBS were both eventually allowed to be financed by TALF during the financial crisis and financing totaled $12 billion (Exhibit 2).

Exhibit 2: TALF collateral financed during financial crisis (amounts in millions)

Source: Federal Reserve, Amherst Pierpont Securities

Spreads on the B and C classes have come off the wides, but their exposure to potential credit losses if there is a wave of defaults could keep a wedge between the guaranteed and unguaranteed securities for several months.

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