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Looking for tighter spreads, rising issuance of floating-rate agency CMBS

| 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.

Fannie Mae has recently issued its first DUS pools with underlying SOFR-indexed multifamily loans, in line with the schedule for transitioning from LIBOR to SOFR across its platform. The launch stands to bring in an important set of buyers back into the market, tightening spreads in the process and raising issuance of floating-rate CMBS.

The buyers of the new SOFR-indexed DUS ARM pools reportedly included some of the Federal Home Loan Banks, a group that began stepping back from all LIBOR markets in 2018 and 2019. The Federal Housing Finance Agency in 2019 formally instructed the FHLBanks to stop investing in LIBOR-indexed assets that matured after 2021, the scheduled expiration for LIBOR. The FHLBanks stopped investing not only in LIBOR-indexed securities but also in securities with underlying LIBOR-indexed loans. The new SOFR-indexed DUS backed by SOFR-indexed loans puts the FHLBanks back in play.

Fixed-rate DUS issuance over the last 18 months has been averaging $5.3 billion a month with DUS ARM issuance of $400 million. Historically, DUS ARM issuance averaged more than $1 billion monthly from 2015 to 2017, but issuance began to decline in early 2018 and has been fairly low since mid-2019.

Fannie Mae DUS issuance (monthly)

Source: Fannie Mae, Amherst Pierpont Securities

Although some of the decline in DUS ARM issuance is likely due to the attractiveness of low fixed rates, it also probable that many multifamily borrowers did not want the headache of getting a LIBOR-based loan when the transition to SOFR was right around the corner. Now Fannie and Freddie are offering multifamily borrowers SOFR-indexed loans at origination, so there is no uncertainty or potential upheaval due to transition issues when LIBOR ceases to be published at the end of 2021. As market participants, originators and borrowers become more comfortable with SOFR, it is likely that floating-rate loans will regain some lost ground and DUS ARM issuance could increase. The FHLBanks stepping back in as DUS ARM buyers coupled with a deeper, more liquid market over time could tighten spreads.

Background on Fannie Mae Multifamily SOFR ARMs

The transition to SOFR-indexed multifamily loans at Fannie Mae is official. The GSE will no longer accept applications for LIBOR-indexed ARMs as of September 30, 2020. The complete timeline for the transition in multifamily loans and securities is shown in Table 1.

Table 1: Fannie Mae’s timeline for multifamily transition to SOFR

Source: LIBOR Transition Playbook (page 35)

Fannie Mae announced on October 1, 2020 updates to their Multifamily MBS Prospectuses for SOFR indexed products.  An overview of the product conventions and changes from Fannie Mae’s LIBOR to SOFR-indexed multifamily loans is shown in Table 2.

Table 2: Product conventions for Fannie Mae MF ARMs

Source: LIBOR Transition Playbook (page 35)

There are a few providers that are now quoting prices and selling SOFR-based interest rate caps. Fannie Mae also allows borrowers to pay for embedded caps by adding a cap cost factor into the spread to the index. Details can be found in the recently updated Multifamily Selling and Servicing Guide

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