By the Numbers
Freddie introduces a 3-month forward on multifamily credit
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.
Freddie Mac has launched a when-issued program for its multifamily K-series offerings. The new WI trust certificates earn the same coupon as the AM class for the reference deal, and investors can exchange WI for AM certificates after the deal settles. The WI offering lowers Freddie Mac’s market risk while it aggregates collateral before securitization. And WI certificates can be traded and financed in the repo market like the AM class. The slightly longer maturity of the WI stands to benefit from additional curve roll-down and potentially a slightly wider spread at pricing compared to the AM class.
The WI program was announced on September 8 and the inaugural deal, WI K132, priced on September 21. The spread at pricing was 27 bp over swaps, which was 1 bp wider than the most recently issued K131 AM class that priced on September 8 (Exhibit 1).
Exhibit 1: WI K132 versus recent K-deal AM and A2 classes
Source: Bloomberg, Amherst Pierpont Securities
Freddie Mac occasionally adjusts the structures or classes of deals in the K-series program to respond to market forces, improve efficiency and streamline their issuance. The GSE has been tinkering with AM class ever since the Federal Housing Finance Agency, under then-Director Mark Calabria, proposed new capital rules at the end of May 2020 (see New capital rules push a restructuring of K-series). Those capital rules, which included punitive treatment of credit risk transfers, were formally adopted in November 2020. In May 2020 Freddie Mac stopped issuing mezzanine B and C classes of K-series and expanded the size of the AM class from about 4.5% of the deal to between 10% to 14%.
The first loss, unguaranteed piece of a standard K-series deal is the D tranche, often called the B-piece—not to be confused with the dearly departed mezzanine B class. In standard K-series, the D tranche has been 7.5% of the deal, which historically has been more than enough to absorb the few credit losses experienced by the trusts (Exhibit 2). The trust with the largest losses was from the KX01 deal, which experienced losses of 2.1% of the original deal balance. Of the other eight trusts with losses, the average loss was 23 bp of the original deal balance.
Exhibit 2: Historical K-Deal Performance – Losses to the Trust
Note: As of June 30, 2021, Freddie Mac has not realized any credit losses on their K-Deal guarantees. There has been $30.13 million in total losses realized by B-piece investors (representing < 1 bp of total issuance) since the inception of K-Deals in 2009.
Source: Freddie Mac (page 10 of 12 of investor presentation).
In August this year, Freddie Mac issued the K130 deal with a B-piece that dropped from 7.5% to 5.0% of the outstanding balance (Exhibit 1). Although the historic credit losses indicate that the decrease in credit support is unlikely to have an impact on the guaranteed classes, the spread of the most exposed AM class widened by 3 bp relative to the spread of the A2 class, and the past two deals have priced the AM class at A2 + 8 bp.
Under new leadership of Acting Director Sandra Thompson, the FHFA proposed on September 15, 2021 to amend the capital rule, in part to encourage the distribution of credit risk from the GSEs back to private investors. It’s unclear whether or not Freddie Mac will choose to issue mezzanine classes again in their K-series deals, or what the impact would be on the AM class. The new WI program is linked to the AM class and functions as a pass-through for AM bonds if investors choose not to exchange their certificates. Given the relatively small size of the AM class, Freddie anticipates that over time new AM bonds will only be available to investors through the WI K-Deal program.
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