DUS delinquencies fall and prepayments rise

Mary Beth Fisher, PhD | January 21, 2022

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.

Fannie Mae DUS investors have started this year with tailwinds to performance. Delinquency rates have dropped rapidly for the past year as large numbers of loans cure forbearance.  And a steady stream of borrowers continues to prepay with yield maintenance or penalty premiums attached, which typically flow to investors. A modest backlog of defaults will likely materialize this year with potentially higher loss severities but overall minimal losses to Fannie Mae.

The dramatic spike in multifamily delinquency rates at the beginning of the pandemic far exceeded those seen during the housing crisis (Exhibit 1). Delinquency rates in Fannie Mae’s multifamily portfolio peaked at 0.80% in June of 2010, then more than three years to slowly drop back to about 0.10%. The onset of the pandemic spiked delinquency rates from 0.9% of outstanding loans in March of 2020 to a peak of 1.4% by June of that year. The spike was primarily driven by borrowers entering Covid-related forbearance programs to buffer losses of rental income.

Exhibit 1: Fannie Mae multifamily delinquency and default rates

Note: Delinquency rates are for loans 30+ days delinquent. Defaults are recorded when the loan completes workout and is disposed of by Fannie Mae. Loans in forbearance are recorded as delinquent by Fannie Mae. Data thru Q3 2021.
Source: Fannie Mae, Amherst Pierpont Securities

The backlog of potential defaults

The six months to 12 months of forbearance was enough for many borrowers to recover. Delinquency rates began falling by early 2021 and plummeted over the year as the pandemic receded and government benefit programs supported many tenants. There is a little bit of a hitch: the data indicates a slight rise in delinquencies at the end of the third quarter of 2021 from 0.47% in August to 0.52% in September. It’s not a phantom rise but was actually driven by an increase in seriously delinquent loans—those that are 60+ days delinquent (Exhibit 2). The 10 new seriously delinquent loans are not delinquent due to forbearance, as the program ceased accepting new applications for forbearance in the first half of 2021. Moreover, those loans that are 630 days delinquent date to April 2020 – the start of the pandemic and the initial wave of loans entering forbearance. Although it’s remotely possible some of these very long-term delinquent loans could cure, most are already in workout. Roughly speaking, the longer loans spend in workout the higher the loss severities, as the missed payments and costs to the special servicers both rise over time. This could be moderately offset by the strong multifamily property price appreciation over the past decade, which accelerated during the pandemic.

Exhibit 2: Fannie Mae multifamily seriously delinquent loans

Note: Data through December 2021.Fannie Mae monthly reports on serious delinquencies are available here (account and login required)
Source: Fannie Mae, Amherst Pierpont Securities

Prepayments with penalties remain steady

The strong property price appreciation over the past decade has resulted in a steady flow of DUS borrowers prepaying their loans despite the yield maintenance or penalty premiums typically required to do so (Exhibit 3). DUS loans often prepay when there only three months to six months remaining to maturity when the loan is in the “open period” and any prepay penalties that were attached have expired. During the housing crisis, when multifamily property prices dropped sharply along with single-family house prices, payoffs fell sharply across the board. Borrowers who were willing to pay penalties declined precipitously and stayed low for several years while the majority of loans matured or paid off without penalty during the open period.

Exhibit 3: Fannie Mae multifamily loan payoffs

Note: Data shows the percentage of Fannie Mae multifamily UPB paid off each month, using a 3-month rolling average.
Source: Fannie Mae, Amherst Pierpont Securities

That began to change in 2013 as multifamily property price appreciation began a decade-long march higher. Owners would refinance or sell their properties, absorbing the prepay penalties as a tax on doing business. Commercial real estate transaction volume slowed precipitously during the first year of the pandemic, but multifamily price appreciation began to accelerate. Historically low interest rates drove a refinancing wave, buffering the drop in outright sales. This kept the overall level of loans prepaying with penalties in a fairly stable range of 0.20% to 0.50% of the portfolio each month. Currently, about half of DUS loans that payoff each month do so with the borrower paying either yield maintenance or a penalty premium, which is typically 5% to 1% of the outstanding loan balance. The willingness to pay these premiums rose towards the top of the range in the second and third quarters of 2021.

Multifamily property price appreciation will likely slow in 2022, but the underbuilding of housing—particularly workforce housing, which the GSEs have a mandate to support—should take years to resolve. The longer-term outlook for the sector remains robust, and investors can benefit from what should be low involuntary prepayments due to delinquencies, but a reasonable flow of prepayment penalties as borrowers tap equity.