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Loan performance in forbearance points to higher risk in FRESB

| October 2, 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.

Forbearance in Freddie Mac K-series and small balance loan or FRESB programs has stabilized over the past few months with very few new loans entering forbearance, a reasonable percentage curing and most either remaining in forbearance or starting repayment. K-series loans have shown much stronger credit, with much lower forbearance rates and higher cure rates than FRESB. This early performance difference implies substantial differences in eventual losses, with an average projected FRESB deal loss nearly five times as high as K-series. This has the most consequence for mezzanine and subordinate debt investors.

Preliminary projections of credit losses range from 0% to 8% for both K-series and FRESB deals. However, the average projected loss across the 72 forbearance-impacted FRESB deals is 2.4%, while the average projected loss across 157 K-series deals is 0.5%. Moreover, only 4 K-series deals have projected losses above 3.0% of outstanding collateral.

Early difference in delinquencies

The K-series program continues to have stronger credit performance in this Covid environment than the small balance program. The K-series has lower percentage of loans that ever entered forbearance, 2.0% of FHMS loans versus 11.2% of FRESB loans (Exhibit 1). Overall, 2.8% of Freddie multifamily loans entered forbearance due to COVID-19. Loan balances in forbearance came disproportionately from student and healthcare properties in Freddie K-series.

Exhibit 1: Comparison of forbearance across FHMS and FRESB shelves

Note: Forbearance data as of 9/28/2020. Summary totals outstanding as of 9/28/2020.
Source: Bloomberg, Amherst Pierpont Securities

Note: Includes multifamily loans securitized on FHMS and FRESB shelves only. Total outstanding data as of 9/28/2020; forbearance data as of 9/28/2020.
Source: Bloomberg, Amherst Pierpont Securities

A larger percentage of K-series loans have either cured (8.9%) or are performing in forbearance (85.2%), compared to FRESB loans (6.4% cured and 78.7% performing, respectively). In fact, of the FRESB loans that entered forbearance at any time, 14.9% of those are currently in some stage of delinquency or default, though the bulk of them are one payment late. Of the loans that entered forbearance, only 5.8% of those in K-series are currently either in some stage of delinquency or default (Exhibit 2).

Exhibit 2: Comparison of payment status of FHMS and FRESB loans in forbearance

Note: This only includes loans in forbearance due to COVID-19. Payment status as of 9/28/2020 tape date. Source: Bloomberg, Amherst Pierpont Securities

Based on the stability in the forbearance data, it is possible to make preliminary estimates of potential credit losses in Freddie multifamily on a deal-by-deal basis. Because the two populations of loans have different forbearance profiles, the loss projections use separate sets of assumptions, though the methodology is the same.

K-series deals with the greatest projected losses are shown in Exhibit 3.

  • Projected default rates are shown for each category of payment status (as of 9/28/2020). Loans that are not in forbearance and loans that have cured are assumed to have 0% default rates.
  • Loans already in default or 90+ days delinquent have a 100% default rate. Loans that are still performing but in forbearance have a 20% probability of default.
  • The assumed loss severity is 40%, compared to a historical average of 30%. Loss severities are expected to be higher for loans in forbearance due to the missed accrued payments, and loss severities rise generally in times of credit crisis.
  • Projected losses = Sum of projected default rate * severity of loss * % of deal in that payment status bucket

Exhibit 3: Projected credit losses for COVID-impacted K-series deals

Source: Bloomberg, Amherst Pierpont Securities

It is worth pointing out that those Top 3 K-series deals with very high percentages of loans in forbearance are specialized large loan (KL) and seniors housing (KS) deals. The FHMS KL1E deal has a single loan, and that loan is in forbearance. The projected loss of 8% is irrelevant, as the actual loss will most likely either be 0% because the loan cures, or it will be equal to the loss severity rate of the loan if it defaults. The seniors housing deals can have portfolios of properties where the loans are taken out by the same borrower. In that circumstance, it is also likely that either none of the loans will default or all of them will. Specialized deal structures, in particular, require deeper analysis of the collateral.

Loss projections for FRESB deals (Exhibit 4) use higher default rates and loss severities due to their weaker performance so far.

Exhibit 4: Projected credit losses for COVID-impacted FRESB deals

Source: Bloomberg, Amherst Pierpont Securities

The projected default rates for each status bucket and the loss severity rate used in this analysis are very conservative. Reasonable arguments exist for using default rates and loss severities that are significantly lower, which would result in lower projected credit losses across the deals.

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